A continuous labour supply model in microsimulation: a life-cycle modelling approach with heterogeneity and uncertainty extension.

Jinjing Li,Denisa Maria Sologon,Alejandro Raul Hernandez Montoya

doi:10.1371/journal.pone.0111903

Abstract

This paper advances a structural inter-temporal model of labour supply that is able to simulate the dynamics of labour supply in a continuous setting and addresses two main drawbacks of most existing models. The first limitation is the inability to incorporate individual heterogeneity as every agent is sharing the same parameters of the utility function. The second one is the strong assumption that individuals make decisions in a world of perfect certainty. Essentially, this paper offers an extension of marginal-utility-of-wealth-constant labour supply functions known as “Frisch functions” under certainty and uncertainty with homogenous and heterogeneous preferences. The lifetime models based on the fixed effect vector decomposition yield the most stable simulation results, under both certain and uncertain future wage assumptions. Due to its improved accuracy and stability, this lifetime labour supply model is particularly suitable for enhancing the performance of the life cycle simulation models, thus providing a better reference for policymaking.

Highlights

The empirical literature on structural labour supply models has gained an increasing interest over the past decades, as these models became important tools for policy makers to examine potential reform options
This paper develops a structural lifetime model for estimating and simulating continuous labour supply
The model is consistent with the lifetime economic theory and is able to capture the individual heterogeneity to a larger extent than existing labour supply models by using more refined estimation techniques, including fixed effect vector decomposition (FEVD) and the mixed coefficients estimation method

Summary

Introduction

The empirical literature on structural labour supply models has gained an increasing interest over the past decades, as these models became important tools for policy makers to examine potential reform options. This paper examines the uses of continuous labour supply models in the context of forward simulations and explores the potential of incorporating better controls for heterogeneities in a microsimulation context. The original interest in life-cycle labour supply was motivated by the need to investigate various dimensions of labour supply, such as the determinants of the shape of the life-cycle hours profile, the labour supply response to the aggregate wage, the changes and the source of the idiosyncratic year-to-year changes in labour supply. The existing literature, manages to shed little light on the original questions. It focuses mainly on one aspect of the inter-temporal hours variation, namely the labour supply response to the wage growth along a known life-cycle trajectory, whilst ignoring other aspects. One ignored aspect is the labour supply response to wage changes under uncertainty, meaning wage changes that determine individuals to revise their expectations of their future wages [5]

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