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Universidad Auto
onoma de Madrid
Fall 2012
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 1 / 37
1 Outline
4 Concluding remarks
Hechos Estilizados (EE.UU.)
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 2 / 37
Summary
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 2 / 37
Budget constraints
c1 + b1 = w1 l1 ,
c2 = w2 l2 + (1 + R )b1 .
The only difference w.r.t. the previous lecture is that income is now
endogenous as yt = wt lt . The corresponding life-time budget constraint is
given by:
c2 w2 l2
c1 + = w1 l1 +
1+R 1+R
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 3 / 37
Preferences
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 4 / 37
The optimization problem
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 5 / 37
FOCs
c1 : u 0 (c1 ) = 0,
1
c2 : u 0 (c2 ) = 0,
1+R
l1 : v 0 (1 l1 ) + w1 = 0,
w2
l2 : v 0 (1 l2 ) + = 0.
1+R
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 6 / 37
Intertemporal consumption decisions
Combining the first ( = u 0 (c1 )) and second FOC yields the standard
Consumption Euler eqn.:
u 0 (c1 ) = u 0 (c2 ) (1 + R ),
| {z } | {z }
MC MB
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 7 / 37
Labor supply
With the use of the first FOC we can rewrite the FOC associated with
l1 in the following manner:
L
= v 0 (1 l1 ) + w1 = 0
l1
v 0 (1 l1 ) = u 0 (c1 ) w1
| {z } | {z }
MC MC
The above condition equalizes the marginal cost in utility terms from
the loss of leisure to the marginal gain from additional consumption.
Similarly, since = u 0 (c1 ) and u 0 (c1 ) = (1 + R )u 0 (c2 ):
L w2
= v 0 (1 l2 ) + =0
l2 1+R
( )v 0 (1 l2 ) = ( )u 0 (c2 )w2
| {z } | {z }
MC MB
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 8 / 37
Intertemporal Labor Supply
To obtain the equilibrium levels of labor supply we solve the FOCs for l1
and l2 in terms of :
L
= v 0 (1 l1 ) + w1 = 0 =
l1
v 0 (1 l1 )
=
w1
L w2
= v 0 (1 l2 ) + = 0 =
l2 1+R
v 0 (1 l2 ) (1 + R )
= .
w2
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 9 / 37
Intertemporal labor supply
v 0 (1 l1 ) v 0 (1 l2 ) (1 + R )
= ..
w1 w2
This condition can be rewritten as
v 0 (1 l1 ) w1
= (1 + R ) .
v 0 (1 l2 ) w2
The above condition implicitly defines the ratio of labor supply (l1 /l2 )
as an increasing function of the wage ratio (w1 /w2 ).
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 10 / 37
Logarithmic utility
1 1
c2 : = 0, (3)
c2 1+R
1
l1 : + w1 = 0, (4)
1 l1
1 w2
l2 : + = 0. (5)
1 l2 1+R
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 11 / 37
The Optimal Consumption Decisions (given x)
c1 = c2 (1 + R ),
Similarly, like before agents save a fixed proportion 1/(1 + ) of their
lifetime resources x = w1 l1 + 1w+2 lR2
x
c1 =
1+
c2 = x (1 + R )
1+
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 12 / 37
Optimal labor supply
Relative labor supply is again a function of the wage ratio w1 /w2 , but this
time we obtain a condition in levels.
In a first step we solve the FOCs for l1 and l2 in terms of :
L 1
= + w1 = 0
l1 1 l1
1
=
w1 (1 l1 )
L 1 w2
= + =0
l2 1 l2 1+R
(1 + R )
= .
w2 (1 l2 )
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 13 / 37
Optimal labor supply
1 (1 + R )
= ,
w1 (1 l1 ) w2 (1 l2 )
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 14 / 37
Optimal Labor Supply
w2 1l1
Hence, an increase in the relative wage w1 leads to a rise in 1l2 or
equivalently a fall in ll12 .
The agent decides to consume less leisure in the second period to
benefit from the rise in the relative wage. Below we will see that the
agent will use the credit market to consume part of the rise in w2 l2 in
the first period.
Formally, the real wage wt is a measure of the opportunity cost of
leisure in period t. Following an increase in w2 /w1 leisure in the
second (first) period is therefore relatively more expensive (cheaper).
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 15 / 37
Optimal Labor Supply
After an increase in the real interest rate the agents demand relatively
more leisure in the second period of life.
First explanation: the higher interest rate reduces the cost of future
consumption and raises the return to saving. This is an incentive to
work more and save more in the first period of life.
Second explanation: The rise in R is equivalent to a fall in the present
value of future wages, 1w+2R . This reduces the opportunity cost of
leisure in the second period.
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 16 / 37
Elasticity of Intertemporal Substitution of Labor
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 17 / 37
Example: log utility
Previously, we have seen that
1 l1 1 w2
= .
1 l2 (1 + R ) w1
Hence, h i
1 l1
1 l2 1
h i = ,
w2 (1 + R )
w1
and so,
h i
1l1 w2 w2
1l2 w1 1 w1
h i = 1 w2 = 1.
w2 1l1 (1 + R ) ( 1 + R ) w1
w1 1l2
In
other words, the elasticity is equal to 1 and so a x percent increase
in w 2
w1 leads to a x % rise in 11 l1
l2 .
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 18 / 37
Optimal consumption levels
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 19 / 37
Optimal Consumption Levels
Similarly, combining the FOC for l2
1 w2
+ = 0.
1 l2 1+R
1
and the condition that = c1 , we obtain:
1 1 w2
= .
1 l2 c1 1 + R
Hence,
c1 (1 + R ) = w2 w2 l2 ,
and so:
w2 l2 w2
w2 l2 = w2 c1 (1 + R ) = = c1 .
1+R 1+R
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 20 / 37
Optimal consumption levels
Since
w1 l1 = w1 c1
w2 l2 w2
= c1 .
1+R 1+R
we get
w2 l2
x = w1 l1 +
1+R
w2
= w1 c1 + c1 .
1+R
x
Using the fact that c1 = 1+ , we can therefore write:
w2
(1 + )c1 = w1 c1 + c1 ,
1+R
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 21 / 37
Solutions for c1 and c2
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 22 / 37
Solution for l1
To obtain the value for l1 , we substitute the expression for c1 into the
condition w1 l1 = w1 c1 ,
w1 l1 = w1 c1
1 w2
= w1 w1 +
2(1 + ) (1 + R )
1 1 w2
w1 l1 = w1 1
2(1 + ) 2(1 + ) (1 + R )
Hence,
1 + 2 1 1 w2
l1 = .
2 ( 1 + ) 2 ( 1 + ) 1 + R w1
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 23 / 37
Solution for l2
w2 l2 = w2 c1 (1 + R )
(1 + R ) w2
= w2 w1 +
2(1 + ) (1 + R )
(1 + R ) 1 (1 + R )
= w2 [ 1 ] w1 .
2(1 + ) 1 + R 2(1 + )
So,
2+ (1 + R ) w1
l2 = .
2(1 + ) 2(1 + ) w2
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 24 / 37
A special case
Suppose for the moment that = 1 and R = 0.
The constant consumption level satisfies:
1 w2 1
c1 = w1 + = [w1 + w2 ] = c2 ,
2(1 + ) (1 + R ) 4
1 + 2 1 1 w2
l1 =
2(1 + ) 2(1 + ) 1 + R w1
3 1 w2
=
4 4 w1
2+ ( 1 + R ) w1
l2 =
2(1 + ) 2 ( 1 + ) w2
3 1 w1
= .
4 4 w2
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 25 / 37
A special case
Given the optimal choices for lt , total labor income satisfies
x = w1 l1 + w2 l2
3 1 w2 3 1 w1
= w1 + w2
4 4 w1 4 4 w2
3 1 3 1
= w1 w2 + w2 w1
4 4 4 4
1
= (w1 + w2 )
2
and the agent consumes half of x in each period.
Finally, if w2 = w1 , then
1
l1 = l2 = .
2
Hence, the agent works half time in both periods and consumes his or
her entire labor income, so b1 = 0.
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 26 / 37
Concluding remarks
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 27 / 37
Horas Trabajadas (USA 2000)
50 40
W eek ly hours w ork ed
20 3010
20 30 40 50 60
Age
Men Women
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 28 / 37
Salario Medio por Hora (USA 2000)
25 20
H ourly W age
15 10
5
20 30 40 50 60
Age
Men Women
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 29 / 37
Horas Trabajadas y Salario Medio por Hora (USA 2000)
Male Female
50
25
40
20
H ourly W age
30
15
20
10
10
5
20 30 40 50 60 20 30 40 50 60
Age
Hourly wage Weeklyhours worked
Graphs by Sex
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 30 / 37
Horas Trabajadas y Salario Medio por Hora (Mujeres-USA
2000)
40
35
20
H ourly W age
30
15
25
10
20
15
5
20 30 40 50 60 20 30 40 50 60
Age
Hourly wage Weeklyhours worked
Graphs by evermar
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 31 / 37
Salario horario por Nivel de Educacion (USA 2000)
35 30
(m e a n ) h o u rw a g e
15 20 10 25
20 30 40 50 60
Age
Less HS HS
Some college College +
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 32 / 37
Horas Trabajadas por Nivel de Educacion (USA 2000)
45
40
(m e a n ) u h rs w o rk
25 30 20 35
20 30 40 50 60
Age
Less HS HS
Some college College +
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 33 / 37
Salario y Horas Trabajadas por Nivel de Educacion (USA
2000)
Less HS HS
40
20 25 30 35 40 45
30
20
M e a n h o u ly wa g e
10
20 25 30 35 40 45
30
20
10
20 30 40 50 60 20 30 40 50 60
Age
Hourly Wage Weekly Hours of work
Graphs by educ
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 34 / 37
Horas Trabajadas y Salario Medio (Historico Anual)
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 35 / 37
Tendencias en Horas Trabajadas
Cambio Porcentual 1970-2002
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 36 / 37
Participacion Femenina y Trabajo Domestico
Dynamic Macroeconomic Analysis (UAM) III: Labor Supply in Two Periods Fall 2012 37 / 37