Bounds on Elasticities with Optimization Frictions: A Synthesis of Micro and Macro Evidence on Labor Supply

By Raj Chetty. 2012

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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.

Subfields: Accounting, Economics and Econometrics, Gender Studies

View Paper: https://www.semanticscholar.org/paper/916ec6d93500600bf092ee64e0df9b0fe0467c33

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Citations in the corpus

Household Debt: Facts, Puzzles, Theories, and Policies (2015, methodology): “47 E.g., by incorporating optimization frictions a la Chetty’s work on labor supply (see Chetty (2012) and cites therein).”
Bunching and Non-Bunching at Kink Points of the Swedish Tax Schedule (2012, background): “for some ξ ∈ [k, k + ∆z].(6) Hence inserting (2) into (1) and rearranging gives”
Toward obtaining a consistent estimate of the elasticity of taxable income using difference-in-differences (2014, background): “In a classical analysis of individuals’ responses to a marginal tax rate change, τit = τ r it always because individuals never cross tax bracket lines in response to a tax rate change, but the model assumes away dynamic issues such as responding to transitory income shocks and overcoming adjustment ”
The Portuguese Slump and Crash and the Euro Crisis (2013, neutral): “5 (Chetty 2012).”
Financing Major Investments: Information About Capital Structure Decisions (2014, background): “Chetty (2012) observes (in the context of estimating labor supply elasticity) that small changes in the dependent variable are prominently affected by market frictions but large changes are more likely”
Teaching the Tax Code: Earnings Responses to an Experiment with EITC Recipients (2009, neutral): “Our reading of the literature suggests that an elasticity of e = 0.25 is an upper bound for the short-run intensive margin elasticity of earnings (Chetty 2012).”
Asymptotically exact inference in conditional moment inequality models (2011, background): “In contrast to other moment inequality settings, the rate of convergence is faster than root-n, and the asymptotic distribution depends entirely on nonbinding moments.”