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MicroConLab Report Summary

Project ID: 340480
Funded under: FP7-IDEAS-ERC
Country: United Kingdom

Mid-Term Report Summary - MICROCONLAB (Microeconometrics of Consumer and Labour Supply Behaviour)

This research aims first to extend the analysis of consumer behaviour to allow for preference heterogeneity, multiple goods and taste change; second to examine the life-cycle behaviour of consumption and labour supply choices in a dynamic environment with uncertainty. The overall aim is to significantly enhance our knowledge of consumer and labour supply behaviour using frontier microeconometric analysis.

The research on consumer behaviour has developed new nonparametric methods that can flexibly estimate counterfactuals for individuals characterized by unobserved characteristics. Using UK micro data on consumer demand, I have applied these methods to construct bounds on individual demand counterfactuals subject to revealed preference inequalities. A key part of this research has been on the development of models under economic shape restrictions. The first contribution of this research, now published, presents a method for consistent nonparametric estimation of a demand function with nonseparable unobserved taste heterogeneity subject to the shape restriction implied by the Slutsky inequality. This is used to estimate gasoline demand. The framework is then extended to allow for endogeneity of prices and develops an instrumental variables approach. Very recently I have developed this research to allow for measurement error in prices, which are typically recorded as a simple average in the area rather than the actual price facing the individual consumer. In this approach, the true price faced by the consumer is unobserved to the researcher. Instead, the researcher observes a regional average of the price. This is an important feature of applied demand analysis, because the price faced by the household is frequently not collected from the household but imputed based on regional averages using the location of the household. If this location is measured at a more aggregate level than appropriate to capture the relevant market, the price variable will exhibit Berkson error. We are currently applying this method to estimate demand for gasoline at different quantiles using transport survey data for the US, based on the National Household Travel Survey (NHTS).

Another part of the programme of work on heterogeneity and consumer behaviour concerns the analysis of taste change. In this on-going research, I am developing a systematic approach for incorporating taste variation into a revealed preference framework for heterogeneous consumers is developed. This is used to examine the extent to which changes in tobacco consumption are driven by price changes or by taste changes, and whether the significance of these two channels varies across socioeconomic groups. Statistically significant educational differences in the marginal willingness to pay for tobacco are recovered with more highly educated cohorts experiencing a greater shift in their tastes.

The research on the dynamics of consumer behaviour has partly involved the development of the Norwegian administrative data to construct consistent measures of consumption and earnings from the population register. This research with Professor Magne Mogstad and Michael Graber, employs several data sources in the register that we link through unique person-level identifiers. Since 1993, we observe all sources of annual income, including earnings, self-employment income, capital income, and cash transfers, as well as most types of assets holdings and liabilities, such as real estate, financial portfolio, and debt. These data have several advantages over those available in most other countries. Because most components of income and wealth are third-party reported (e.g. by employers, banks and financial intermediaries), the coverage and reliability are rated as exceptional by international quality assessments. Because in Norway, most register data is a matter of public record, there is no attrition from the original sample due to refusal by participants to consent to data sharing. Our income and wealth data pertain to all individuals, and not only to jobs covered by social security, individuals who respond to wealth surveys, or households that file estate tax returns. Measures of incomes and wealth are recorded without any top or bottom coding. Finally, unique identifiers allow us to match spouses to one another and parents to children, thereby constructing measures of household income and consumption. For each household, we have direct information on virtually all components of net market income and net returns. We are now beginning to use this data in the study of consumption responses to income and asset price shocks.

A key aim of my research programme on earnings and consumption dynamics has been to develop a new quantile-based panel data framework to study the nature of income persistence and the transmission of income shocks to consumption. In this new approach the persistence of past shocks to earnings is allowed to vary according to the size and sign of the current shock. Consumption is modeled as an age-dependent nonlinear function of assets, unobservable tastes and the two earnings components. Exploiting the enhanced consumption and asset data in recent waves of the Panel Study of Income Dynamics, we find that the earnings process features nonlinear persistence and conditional skewness. We confirm these results using population register data from Norway. We then show that the impact of earnings shocks varies substantially across earnings histories, and that this nonlinearity drives heterogeneous consumption responses. The framework provides new empirical measures of partial insurance in which the transmission of income shocks to consumption varies systematically with assets, the level of the shock and the history of past shocks.

My research on consumption inequality and labor supply, primarily with Luigi Pistaferri and Itay Saporta-Eksten, has resulted in the recently published in the American Economic Review, examining the link between wage and consumption inequality using a life cycle model incorporating consumption and family labor supply decisions. The overall goal in this research is to understand the mechanisms behind access smoothness of consumption to wage shocks. I set up a flexible life cycle model that allows for several potential sources of smoothing. The first, a traditional one in the literature, is self-insurance through credit markets. The second is family labor supply, i.e., the fact that hours of work can be adjusted along with, or alternatively to, spending on goods in response to shocks to economic resources. In particular, I focus on family labor supply, which includes for example the response of the wife’s labor supply to shocks to husband wages. The third insurance channel is a progressive tax/transfer system operating on joint family earnings, implying that any shock to after-tax income is attenuated relative to shocks to before-tax income. Finally, households may have access to external sources of insurance, ranging from help received by networks of relatives and friends to formal market insurance.

Using data from the 1999-2009 waves of the Panel Study of Income Dynamics (PSID), has highlighted several important findings. First, female labor supply is an important consumption insurance device against wage shocks faced by the husband, both on the intensive margin (i.e., through shifts from part-time to full-time, and vice versa) and on the extensive margin (i.e., shifts from not working to working, and vice versa). Second, in our flexible life cycle model with self-insurance through savings, endogenous family labor supply, non-separable preferences, government transfers and progressive taxation, there is little evidence of "missing" insurance explaining consumption movements in response to wage shocks. Third, we estimate sizable Frisch labor supply elasticities for both husband and wife, but show that the implied Marshallian elasticities are much smaller (and close to zero for the husband) due to strong wealth effects. Finally, we find significant evidence of Frisch complementarity between the leisure times of the spouses and evidence of Frisch substitutability between consumption and hours at the intensive margin.

Finally, my ERC funded research on labour supply decisions has examined the interaction between female labour supply, human capital investments and welfare reform, resulting in a recently published paper in Econometrica. In this research we estimate a dynamic model of employment, human capital accumulation— including education, and savings for women in the United Kingdom, exploiting tax and benefit reforms, and use it to analyze the effects of welfare policy. We find substantial elasticities for labor supply and particularly for lone mothers. Returns to experience, which are important in determining the longer-term effects of policy, increase with education, but experience mainly accumulates when in full-time employment. Tax credits are welfare improving in the U.K., increase lone-mother labor supply and marginally reduce educational attainment, but the employment effects do not extend beyond the period of eligibility.

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United Kingdom
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