Modeling Political Reforms: The Discrete Approach to Labor Supply

Abstract

This chapter discusses the underlying methodology how to identify and evaluate the expected effects of political reforms on the individual level. It introduces the discrete choice approach by which it is possible to simulate labor supply decisions of households in a realistic framework. The chapter starts with a short discussion of economic modeling using simulation algorithms. The goal is to show that a micro-simulation, which is able to include behavioral changes of the decision units, offers strong possibilities to study the impact of a policy reform on the household sector. In a second step, the discrete choice approach to labor supply is explained in detail. In the beginning the discrete framework is discussed that treats individual working hours as the dependent but categorical variable. Then, the concept of stochastic utility is introduced that allows estimating the coefficients and the transition probabilities by a multinomial logit model. Afterwards, the developed utility model is specified by a transcendental logarithmic utility. The chapter ends with a discussion of the methods to capture the behavioral adjustments of households triggered by a policy reform.