Consumption, reservation wages, and aggregate labor supply

Abstract

This paper exploits micro data on the joint distribution of consumption and wages to measure the Frisch labor supply elasticity at the extensive margin. The approach is based on a derived reservation property of the working decision that holds in a class of models where the labor choice is intratemporal: given consumption, there exists a unique wage level above which individuals work and below which they do not. It is shown that this property is robust to heterogeneity in borrowing constraints, discount factors, and wage processes within the class of models. Applying it directly to the observed joint distribution of consumption and wages, I find that the aggregate Frisch elasticity at the extensive margin is 0.4 and that across various demographic groups, the elasticity ranges from 0.2 to 0.6. However, the elasticity variation is more pronounced across consumption groups and the elasticity is decreasing in consumption within demographic groups. The latter findings imply that the measured elasticity critically depends on the composition of consumption groups in the sample.