BOUNDS ON ELASTICITIES WITH OPTIMIZATION FRICTIONS: A SYNTHESIS OF MICRO AND MACRO EVIDENCE ON LABOR SUPPLY

How can price elasticities be identified when agents face optimization frictions such as adjustment costs or inattention? I derive bounds on structural price elasticities that are a function of the observed effect of a price change on demand, the size of the price change, and the degree of frictions...

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Bibliographic Details
Published in:Econometrica Vol. 80; no. 3; pp. 969 - 1018
Main Author: Chetty, Raj
Format: Journal Article
Language:English
Published: Oxford, UK Econometric Society 01.05.2012
Blackwell Publishing Ltd
Wiley-Blackwell
Subjects:
Adjustment costs
Agency theory
Applications
Attention deficits
Calculus of variations and optimal control
Change agents
Changes
Earnings
Elasticity of demand
Estimated taxes
Estimation
Exact sciences and technology
Income taxes
Insurance, economics, finance
Labor economics
Labor supply
Labor supply elasticity
Labour supply
Macroeconomics
Mathematical analysis
Mathematics
Microeconomics
Modeling
Numerical analysis
Numerical analysis. Scientific computation
Numerical methods in mathematical programming, optimization and calculus of variations
Numerical methods in optimization and calculus of variations
Optimization
partial identification
Price changes
Price elasticity
Price elasticity of supply
Price theory
Prices
Probability and statistics
Sciences and techniques of general use
Statistics
structural estimation
Studies
Tax reform
Utilities costs
Utility functions
Utility theory
Estimation
Optimization method
Optimization
partial identification
Statistical method
Numerical analysis
Adjustment costs
Price
Marginal distribution
Friction coefficient
Variational calculus
structural estimation
Econometrics
Mathematical programming
ISSN:0012-9682, 1468-0262
Online Access:Get full text
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Summary:How can price elasticities be identified when agents face optimization frictions such as adjustment costs or inattention? I derive bounds on structural price elasticities that are a function of the observed effect of a price change on demand, the size of the price change, and the degree of frictions. The degree of frictions is measured by the utility losses agents tolerate to deviate from the frictionless optimum. The bounds imply that frictions affect intensive margin elasticities much more than extensive margin elasticities. I apply these bounds to the literature on labor supply. The utility costs of ignoring the tax changes used to identify intensive margin labor supply elasticities are typically less than 1% of earnings. As a result, small frictions can explain the differences between micro and macro elasticities, extensive and intensive margin elasticities, and other disparate findings. Pooling estimates from existing studies, I estimate a Hicksian labor supply elasticity of 0.33 on the intensive margin and 0.25 on the extensive margin after accounting for frictions.
Bibliography:I would like to thank Tim Armstrong, Soren Blomquist, Richard Blundell, David Card, Daniel Feenberg, Christopher Ferrall, John Friedman, Yuriy Gorodnichenko, James Hines, Caroline Hoxby, Susumu Imai, Guido Imbens, Damon Jones, Patrick Kline, Adam Looney, Day Manoli, Ariel Pakes, Valerie Ramey, Richard Rogerson, Emmanuel Saez, Johannes Spinnewijn, Harald Uhlig, Ken Wolpin, anonymous referees, and numerous seminar participants for very helpful comments. Gregory Bruich, Jane Choi, Peter Ganong, Nate Hilger, Tord Krogh, Jessica Laird, Zachary Liscow, Keli Liu, Laszlo Sandor, Heather Sarsons, and Danny Yagan provided outstanding research assistance. Funding from NSF Grant SES 0645396 and the Sloan Foundation is gratefully acknowledged. The code used to produce the results in this paper is available in the Supplement Material (Chetty (2012)).
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ISSN:0012-9682
1468-0262
DOI:10.3982/ECTA9043