Labor supply with a minimum hours threshold

Abstract

This paper considers the importance of minimum hours thresholds for the interpretation of individual labor supply data. An analysis of quarterly labor-supply outcomes for prime-age males in the Survey of Income and Program Participation suggests that such thresholds are an important aspect of weekly hours choices. A simple contracting model is presented that incorporates mobility costs and a nonconvexity in the relation between weekly hours and effective labor input. This nonconvexity gives rise to a two-part employment schedule. In periods of low demand, some individuals are temporarily laid off, while others work a minimum threshold level of hours. In periods of higher demand all available workers are employed at hours in excess of the threshold level. The model provides a simple interpretation for the role of demand-side variables in explaining annual labor-supply outcomes. It can also explain the weak correlations between annual hours and average hourly earnings that have emerged in earlier studies. Under suitable assumptions on preferences, the intertemporal labor-supply elasticity can be recovered from the relationship between earnings and hours per week. Estimation results for the SIPP panel yield elasticity estimates that are similar to those in the literature based on annual data. If the model is correct, however, annual labor supply is considerably more sensitive to changes in productivity than these estimates suggest.