The heterogeneity and dynamics of individual labor supply over the life cycle: facts and theory

In this paper we first document various facts about the labor supply decisions of male workers in the US over their life-cycle and we then build a theory of individ-ual life-cycle labor supply that builds on the neoclassical growth model. The theory features heterogeneous agents, incomplete markets, nonlinear wages, and variation in labor supply along the extensive and intensive margin. While the model economy is calibrated without explicitly targeting the facts on hours worked, the predictions of the theory on labor supply are quantitatively close to the observations documented in the data. We show that in the calibrated model economy there is a disconnect between the theoretical elasticity of labor supply obtained from the FOC of the indi-viduals ’ problem, the empirical elasticity recovered from simulated micro data using standard econometric techniques, and the macro elasticity obtained by simulating the aggregate labor supply response to a one period unanticipated tax increase on labor earnings. While the empirical elasticity of labor supply is 0.15 (a value well within the range [0,0.5] in the empirical literature), the theoretical and the macro elasticities are higher by a factor of three and six (with values of.46 and.85, respectively). Moreover, we simulate the model for different preference parameters and find that the empirica