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Labor Supply, Aggregation and the Labor Wedge

  • Jose Lopez

    (HEC PARIS)

This paper discusses the role of household heterogeneity in a model in which idiosyncratic consumption and labor income risks manifest as a distortion to the intra-temporal optimal condition of the representative agent. Aggregation over the undistorted labor-leisure condition of each household leads to a wedge between the Marginal Rate of Substitution, between consumption and leisure, (MRS) and the Marginal Product of Labor (MPL), through the lens of the representative agent model. I use household survey data to assess the properties of this aggregation wedge. I find that it is consistent with the systematic deviation between the MRS and the MPL observed in aggregate data, the so-called "Labor Wedge", for both the long-run and the business cycles. Additionally, I explore the quantitative implications of the model assuming imperfect insurability against idiosyncratic shocks. I show that cyclical changes in the distribution of household productivity and in the degree of risk sharing lead to cyclical changes in the aggregation wedge, as if the representative agent faced higher labor taxes - or was lazier- during recessions. The model also exhibits novel dynamics for labor, relative to the benchmark RBC, because of the various labor supply elasticities induced by the individual productivities and the wealth distribution.

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Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 737.

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Date of creation: 2012
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Handle: RePEc:red:sed012:737
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  1. Yongsung Chang & Sun-Bin Kim, 2007. "Heterogeneity and Aggregation: Implications for Labor-Market Fluctuations," American Economic Review, American Economic Association, vol. 97(5), pages 1939-1956, December.
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  7. Kim, Sunghyun Henry & Kollmann, Robert & Kim, Jinill, 2010. "Solving the incomplete market model with aggregate uncertainty using a perturbation method," Journal of Economic Dynamics and Control, Elsevier, vol. 34(1), pages 50-58, January.
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  9. Hanno Lustig, 2004. "The Market Price of Aggregate Risk and the Wealth Distribution," UCLA Economics Online Papers 299, UCLA Department of Economics.
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  12. Kjetil Storesletten & Chris Telmer & Amir Yaron, 1996. "Asset pricing with idiosyncratic risk and overlapping generations," Economics Working Papers 405, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 1999.
  13. Robert Shimer, 2009. "Convergence in Macroeconomics: The Labor Wedge," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(1), pages 280-97, January.
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  15. Krusell, P & Smith Jr, A-A, 1995. "Income and Wealth Heterogeneity in the Macroeconomic," RCER Working Papers 399, University of Rochester - Center for Economic Research (RCER).
  16. Kjetil Storesletten & Chris I. Telmer & Amir Yaron, 2004. "Cyclical Dynamics in Idiosyncratic Labor Market Risk," Journal of Political Economy, University of Chicago Press, vol. 112(3), pages 695-717, June.
  17. Christopher A. Pissarides, 2007. "The Unemployment Volatility Puzzle: Is Wage Stickiness the Answer?," CEP Discussion Papers dp0839, Centre for Economic Performance, LSE.
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  19. MaCurdy, Thomas E, 1981. "An Empirical Model of Labor Supply in a Life-Cycle Setting," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1059-85, December.
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