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Chapter 7: Household Production, the Family and the Life-Cycle

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Presentation on theme: "Chapter 7: Household Production, the Family and the Life-Cycle"— Presentation transcript:

1 Chapter 7: Household Production, the Family and the Life-Cycle
Household production and labor supply Joint labor supply decisions Factors influencing retirement

2 Household production Same as income vs leisure, except “leisure” can be used for household production Household production can be cooking, cleaning, taking care of children, “leisure”, or anything that generates utility Budget line is now a trade-off between “market goods” (income) and “home production”.

3 Household production When wage rate rises
Income effect: purchase more home-production (work less) Substitution effect: Purchase less home production (work more) Adjust home production to more “goods intensive” and less “time intensive” Eat out more often & more processed foods (rising obesity?) More home technology More help hired for home production (cleaners, gardeners, daycare,…) Reduce quantity and increase “quality” of kids Increased ability to substitute market goods for time will flatten indifference curves – increase work hours.

4 Joint labor supply decisions
In a married household, if couple decides one will stay home to take care of children, what determines outcome? Relative wages Relative utility/ability in providing childcare As womens wages rise relative to men’s, predicted effect on Who stays home with children? Division of time in home production?

5 Joint labor supply decisions
During a recession, wage offers fall. Offsetting effects on LFP Discouraged worker effect Added worker effect Evidence is that discouraged worker effect dominates and LFP drops during recessions Added worker effect has been shrinking due to Increased UI generosity More married women working

6 Choice of retirement age

7 Choice of retirement age
Steepness of I-curve reflects willingness to postpone retirement for additional income. Steepness of budget constraint determined by earnings profile Social Security formula pension plan features Wealth and substitution effects from change in budget constratint.

8 Choice of retirement age
If the financial rewards to postponing retirement beyond age 62 are increased, the person is faced with a wealth and substitution effect. Wealth effect: Holding retirement age constant, the person has greater wealth and will retire sooner. Substitution Effect: Holding wealth constant, the reward to postponing retirement has increased .. substitute money for years in retirement. Net effect: Ambiguous.

9 Choice of retirement age
Effect of increasing rewards to postponed retirement subst efffect > Wealth effect Wealth effect > subst efffect R*

10 Choice of retirement age
How do each of the following affect retirement age? steepness of earnings profile? Social Security formulae Calculating AIME & PIA reductions for early retirement credits for postponed retirement.

11 Choice of retirement age
Private pensions Defined benefit plan life annuity promised at retirement. annuity payment generally tied to years of service, final salary, and a "generosity factor". PV of defined benefit plan may eventually fall with retirement age (fewer years to collect annuity versus increase in size of annuity). “Actuarially fair” adjustment for postponing retirement by one year keeps PV of pension independent of retirement age. If life expectancy is 80, what is actuarially fair adjustment for a worker who can collect an annuity of $50,000 annually at age 65, assuming interest rate=0? If interest rate>0?

12 Choice of retirement age
Private pensions Defined Contribution Plan. a savings account that the worker may receive as a lump sum at retirement. PV of defined contribution plan grows with retirement age because contributions are added over time. Over time, there has been a switch from defined benefit to defined contribution plans. What's the effect of switching from DB to DC plans on retirement incentives?

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