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2001•RePEc: Research Papers in EconomicsOpen access

The labor-supply elasticity and borrowing constraints: Why estimates are biased

David Domeij, Martin Flodén

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Abstract

The labor-supply elasticity is a central element in many macroeconomic models. We argue that assumptions underlying previous econometric estimates of the intertemporal labor supply elasticity are inconsistent with incomplete markets economies. In particular, if the econometrician ignores borrowing constraints, the elasticity will be biased downwards. Within our model, the bias may be up to 50 percent. We find a similar bias in PSID data.

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The labor-supply elasticity is a central element in many macroeconomic models. We argue that assumptions underlying previous econometric estimates of the intertemporal labor supply elasticity are inconsistent with incomplete markets economies. In particular, if the econometrician ignores borrowing constraints, the elasticity will be biased downwards. Within our model, the bias may be up to 50 percent. We find a similar bias in PSID data.

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Available abstract

The labor-supply elasticity is a central element in many macroeconomic models. We argue that assumptions underlying previous econometric estimates of the intertemporal labor supply elasticity are inconsistent with incomplete markets economies. In particular, if the econometrician ignores borrowing constraints, the elasticity will be biased downwards. Within our model, the bias may be up to 50 percent. We find a similar bias in PSID data.

Key concepts: Economics, Elasticity (physics), Price elasticity of supply, Econometrics, Price elasticity of demand, Wealth elasticity of demand, Microeconomics, Materials science

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