Working Paper: NBER ID: w15616
Authors: Raj Chetty
Abstract: 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.
Keywords: elasticity; labor supply; optimization frictions
JEL Codes: E62; H2; J22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimization frictions (F12) | intensive margin elasticities (D11) |
| optimization frictions (F12) | extensive margin elasticities (H31) |
| optimization frictions (F12) | observed Hicksian labor supply elasticity (J49) |
| observed elasticities (D12) | structural elasticities (H30) |
| utility costs of ignoring tax reforms (H29) | observed elasticities (D12) |