Chapter 7:
Household Production, the Family
and the Life-Cycle
• Household production and labor supply
• Joint labor supply decisions
• Factors influencing retirement
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”.
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
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.
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?
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
• Choice of retirement age
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.
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
• Substitution Effect: Holding wealth constant,
the reward to postponing retirement has
increased .. substitute money for years in
• Net effect: Ambiguous.
Choice of retirement age
• Effect of increasing rewards to postponed retirement
subst efffect >
Wealth effect
Wealth effect >
subst efffect
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.
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?
Choice of retirement age
Private pensions
•Defined Contribution Plan.
•a savings account that the worker may receive as a lump sum at
• 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
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