The Aggregate Labor Supply Curve at the Extensive Margin:A Reservation Wedge Approach

We present a theoretically robust and empirically tractable representation of the aggregate laborsupply curve at the extensive (employment) margin. First, we introduce the simple and basicconcept of the reservation wedge: the hypothetical percent shift in an individual’s potentialearnings required to render her indifferent between employment and nonemployment. Thisconcept generalizes reservation wages to the context of heterogeneity in earnings. For any givenspecific model, the reservation wedge serves as the sole scalar sufficient statistic for employmentpreferences. The CDF of the reservation wedgesisthe aggregate labor supply curve at theextensive margin. Second, we directly measure the wedge distribution in a representativehousehold survey – thereby nonparametrically mapping out the global labor supply curve of theU.S. population. For small deviations, the empirical curve exhibits large Frisch elasticities above3, hence locally consistent with business cycle evidence. Rather than constant, the empirical arcelasticities shrink towards 0.5 for larger, upward shifts, thereby potentially also reconciling largelocal elasticities with the small arc elasticities implied by recent quasi-experimental evidencefrom tax holidays. Third, in a model meta-analysis, existing models would fail to match theglobal shape of this empirical curve. Fourth, we engineer one model to fit the empirical curve.A business cycle accounting exercise reveals that this fitted model (under the assumption ofefficient rationing) would help reconcile cyclical employment fluctuations with labor supply. Joint with Preston Mui.

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