LASUT · A Quantitative Theory of Labor Supply with Heterogeneous Agents: From Individual to Macro Elasticities

The aggregate response of labour supply to business cycle shocks is a central element in macroeconomic analysis and is the object of an important debate among economists. This debate matters as our understanding of the business cycle data and of the consequence of tax policies rely critically on the elasticity of aggregate labour supply. Because the standard macroeconomic analysis is based on a theory of a single (representative) individual, this analysis cannot distinguish between individual and aggregate labour supply. In an insightful paper, Chang and Kim (2006) construct a heterogeneous agent economy and find that the macro labour supply elasticity can be significantly larger than the micro elasticity. This proposal aims to develop a theory of labour supply decisions of heterogeneous individuals that is consistent with micro level data. The theory will be used to study issues in macroeconomic analyses that depend critically on the elasticity of labour supply: a) Can differences in income taxation account for the large differences in labour supply between North America and Europe? b) How does income taxation affect labour supply decisions across the heterogeneous individuals? c) Existing business cycle theory cannot account for the relative volatility of employment and hours per worker. Can heterogeneity in the labour force resolve this puzzle? d) How responsive are retirement decisions to changes in the social security system and in the tax code? How should the social security system be reformed to confront the demographic imbalances threatening its sustainability? This ambitious proposal will help the researcher to reintegrate among the European academics and will provide a clear input to the European research area. Luisa Fuster is eager to be one of the leading researchers of the IMDEA Social Sciences and to become a reference among European academics.