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A Dynamic Model of Labor Supply, Consumption/Saving, and Annuity Decisions under Uncertainty

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  • Hugo Benitez-Silva

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    Abstract

    This paper presents a dynamic model of labor/leisure, consumption/saving and annuity decisions over the life cycle. Such a dynamic model provides a framework for considering important policy experiments related to the reforms in Social Security. We address the role of labor supply in a life cyle utility maximization model, extending the classical optimal lifetime consumption problem under uncertainty first formalized in Phelps (1962) and later in Hakansson (1970). We introduce the labor decision in the finite horizon consumption/saving problem and solve numerically the stochastic dynamic programming utility maximization problem of the individual. Analytical solutions are infeasible when the individual is maximizing utility over consumption and leisure, given non-linear marginal utility. We illustrate how such a model captures changes in labor supply over the life cycle and show that simulated consumption and wealth accumulation paths are consistent with empirical evidence. We also present a model of endogenously determined annuities for the consumption/saving and labor/leisure framework with capital uncertainty in the presence of bequest motives and Social Security. This provides new insights into the ``annuity puzzle'' and the effects of Social Security on labor supply and welfare.

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    File URL: http://www.sunysb.edu/economics/research/papers/2000/00-06.pdf
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    Bibliographic Info

    Paper provided by Stony Brook University, Department of Economics in its series Department of Economics Working Papers with number 00-06.

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    Length: 45
    Date of creation: 2000
    Date of revision:
    Handle: RePEc:nys:sunysb:00-06

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    Postal: Stony Brook, NY 11794-4384
    Phone: (631)632-7540
    Fax: (631)632-7516
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    Web page: http://www.stonybrook.edu/economics
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    Related research

    Keywords: Life Cycle Models; Consumption and Savings; Annuities; Social Security; Labor Supply;

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