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Structural Labor Supply Models when Budget Constraints are Nonlinear

Author

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  • Bruce D. Meyer
  • Bradley T. Heim

Abstract

 Structural labor supply methods are generally needed to separate out income and substitution effects, to calculate deadweight losses, and to study policies that make budget constraints highly nonlinear. However, the relationship between the economic assumptions, implicit restrictions, and biases in various estimation methods is not well understood. This situation leaves researchers in a quandary about what approach they should use. As a result, many recent papers cite papers by MaCurdy and co-authors as a justification for avoiding structural methods, and instead using simple estimation methods such as differences in differences. This paper examines the role of economic assumptions in structural labor supply methods and how some of the assumptions may be relaxed. We first show the sources of inconsistency in the local linearization method. We then examine the standard approach generally attributed to Hausman, and show that this approach relies on the convexity of preferences in the construction of the likelihood function. We show that the criticisms of MaCurdy can be reinterpreted as showing where in the estimation method the assumption of convexity is enforced. We provide a formal argument that if observed preferences are nonconvex, but the estimation method does not allow for nonconvexity, then estimated parameters may not satisfy the Slutsky restrictions, as has often been found. Finally, we show that the standard methods in the literature do not permit estimation of parameters consistent with nonconvex preferences, and describe methods that allow for less restrictive assumptions

Suggested Citation

  • Bruce D. Meyer & Bradley T. Heim, 2004. "Structural Labor Supply Models when Budget Constraints are Nonlinear," Econometric Society 2004 North American Winter Meetings 567, Econometric Society.
  • Handle: RePEc:ecm:nawm04:567
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    Citations

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    Cited by:

    1. Dagsvik, John K. & Locatelli, Marilena & Strøm, Steinar, 2006. "Simulating labor supply behavior when workers have preferences for job opportunities and face nonlinear budget constraints," Memorandum 20/2006, Oslo University, Department of Economics.
    2. Michiel Evers & Ruud de Mooij & Daniël van Vuuren, 2005. "What explains the variation in estimates of labour supply elasticities?," CPB Discussion Paper 51, CPB Netherlands Bureau for Economic Policy Analysis.
    3. Stavins, Robert & Hanemann, W. Michael & Olmstead, Sheila, 2005. "Do Consumers React to the Shape of Supply? Water Demand under Heterogeneous Price Structures," Discussion Papers dp-05-29, Resources For the Future.
    4. Kowalski, Amanda E., 2015. "Estimating the tradeoff between risk protection and moral hazard with a nonlinear budget set model of health insurance," International Journal of Industrial Organization, Elsevier, vol. 43(C), pages 122-135.
    5. Olivier Bargain, 2004. "On modeling household labor supply with taxation," DELTA Working Papers 2004-14, DELTA (Ecole normale supérieure).
    6. Olivier Bargain & Andreas Peichl, 2013. "Steady-State Labor Supply Elasticities: An International Comparison," AMSE Working Papers 1322, Aix-Marseille School of Economics, Marseille, France.
    7. Daniel Aaronson & Eric French, 2009. "The Effects of Progressive Taxation on Labor Supply when Hours and Wages Are Jointly Determined," Journal of Human Resources, University of Wisconsin Press, vol. 44(2).
    8. Heim, Bradley T. & Meyer, Bruce D., 2004. "Work costs and nonconvex preferences in the estimation of labor supply models," Journal of Public Economics, Elsevier, vol. 88(11), pages 2323-2338, September.
    9. Dagsvik John K & Locatelli Marilena & Steinar Strom, 2007. "Evaluation of tax reforms when workers have preferences over job attributes and face latent choice restrictions," Department of Economics and Statistics Cognetti de Martiis. Working Papers 200706, University of Turin.
    10. Christophe Muller, 2003. "Female Activity Choice In A Dual Context: An Integrated Model For Formal And Informal Sectors In Cameroon," Working Papers. Serie AD 2003-39, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
    11. John K. Dagsvik & Zhiyang Jia, 2008. "An Alternative Approach to Labor Supply Modeling. Emphasizing Job-type as Choice Variable," Discussion Papers 550, Statistics Norway, Research Department.
    12. Kumar, Anil, 2008. "Labor supply, deadweight loss and tax reform act of 1986: A nonparametric evaluation using panel data," Journal of Public Economics, Elsevier, vol. 92(1-2), pages 236-253, February.

    More about this item

    Keywords

    Labor Supply; Taxes; Nonlinear Budget Constraints;

    JEL classification:

    • J22 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Time Allocation and Labor Supply

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