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Dynamic Effects of Labor Supply: a mechanism explaining cross-sectional differences in hours

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  • Ricardo Manuel Santos

    (Trinity University)

Abstract

This paper first establishes the empirical fact that over the last quarter of the 20th century, the average weekly hours worked increased for workers in the highest wage quintile while it decreased for the ones at the lowest. In 1976, a worker in the lowest quintile worked 2.8 hours more per week than a high wage worker (worker in the highest quintile), but by 2006, the low wage worker worked 1 hour less. During this period, there was also a wide increase in wage inequality. The typical mechanism in which hours are only determined by contemporaneous wages cannot simultaneously explain the pattern found in both variables for every quintile. This paper attempts to reconcile these cross-sectional trends in both hours and wages for the U.S. during this time period. As a first step, we show that compositional changes (in education, occupation and age) within quintiles can only explain a fraction of the observed pattern. Next, we propose a mechanism in which individuals' current decisions of how much to work take into account two components: the contemporaneous benefit of the wage received, and also how current hours worked affects the probability of moving across the wage distribution in later periods. The latter dynamic component is estimated from our dataset. We find that changes over time in how hours affect these probabilities provided incentives that differ across the quintiles, and are consistent with the labor supply decisions observed in the data. We incorporate these two components into an equilibrium model of heterogeneous agents with uninsurable income risk. We are able to replicate the decline in hours for the bottom of the distribution as well as the increase at the top. The ratio of hours worked between the two groups delivered by the model also fits the trend found in the data. (Copyright: Elsevier)

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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

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Handle: RePEc:red:issued:10-28

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Keywords: Macroeconomics; Labor supply decisions; Heterogeneous agents;

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References

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  1. Edward P. Lazear & Sherwin Rosen, 1979. "Rank-Order Tournaments as Optimum Labor Contracts," NBER Working Papers 0401, National Bureau of Economic Research, Inc.
  2. Heckman, James J, 1979. "Sample Selection Bias as a Specification Error," Econometrica, Econometric Society, Econometric Society, vol. 47(1), pages 153-61, January.
  3. Guillaume Vandenbroucke, 2005. "Trend in Hours: The U.S. from 1900 to 1950," Economie d'Avant Garde Research Reports, Economie d'Avant Garde 11, Economie d'Avant Garde, revised Nov 2005.
  4. Juan Carlos Conesa & Sagiri Kitao & Dirk Krueger, 2007. "Taxing Capital? Not a Bad Idea After All!," NBER Working Papers 12880, National Bureau of Economic Research, Inc.
  5. Katz, L.F. & Murphy, K.M., 1991. "Changes in Relative Wages, 1963-1987: Supply and Demand Factors," Harvard Institute of Economic Research Working Papers, Harvard - Institute of Economic Research 1580, Harvard - Institute of Economic Research.
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  7. Conesa, Juan Carlos & Krüger, Dirk, 2005. "On the Optimal Progressivity of the Income Tax Code," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5040, C.E.P.R. Discussion Papers.
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  9. Bell, Linda A. & Freeman, Richard B., 2001. "The incentive for working hard: explaining hours worked differences in the US and Germany," Labour Economics, Elsevier, Elsevier, vol. 8(2), pages 181-202, May.
  10. Altonji, Joseph G, 1986. "Intertemporal Substitution in Labor Supply: Evidence from Micro Data," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 94(3), pages S176-S215, June.
  11. David H. Autor & Lawrence F. Katz & Melissa S. Kearney, 2008. "Trends in U.S. Wage Inequality: Revising the Revisionists," The Review of Economics and Statistics, MIT Press, vol. 90(2), pages 300-323, May.
  12. MaCurdy, Thomas E, 1981. "An Empirical Model of Labor Supply in a Life-Cycle Setting," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 89(6), pages 1059-85, December.
  13. Michael W. L. Elsby & Matthew D. Shapiro, 2012. "Why Does Trend Growth Affect Equilibrium Employment? A New Explanation of an Old Puzzle," American Economic Review, American Economic Association, American Economic Association, vol. 102(4), pages 1378-1413, June.
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