samlet årgang - Økonomisk Institut - Københavns Universitet

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Consumption
y 0
B 2
A 2
U 2 U 2
B 1
A 1
U 1
U 1
(1-m)w
NATIONALØKONOMISK TIDSSKRIFT 2005. NR. 3
Figure 1. Intensive versus Extensive Responses in the Convex Model.
preferences and/or budget sets. The observed discrete responses along the extensive
margin cannot be captured within a standard convex labor supply model. 2
To see the point, Figure 1 illustrates the choice of labor supply in the standard convex
model. In the figure, we consider two individuals facing the same budget constraint,
where y 0 is non-labor income, w is the wage rate, and (1 – m) w is the marginal net-oftax
wage. The indifference curves of the two individuals are drawn such that individual
1 has a relatively low valuation of leisure, while individual 2 has a relatively high valuation
of leisure. Consequently, it is optimal for the first individual to work many hours
(at point A 1 ), whereas the second individual chooses to stay outside the labor market
(at point A 2 ) since there is no point of tangency at positive hours. As we have drawn the
figure, the point of tangency for individual 2 is exactly at zero hours worked.
Consider now a small reduction in the tax rate increasing the slope of the budget line
a little bit. In principle, we want to consider a marginal (infinitesimal) tax change, but
we have exaggerated the size of the change in the figure for the point of illustration.
The increased slope of the budget line induces individual 1 to increase his hours of
work a little bit from point A 1 to point B 1 (an intensive response). For individual 2, on
the other hand, the higher net wage gives rise to an interior solution so that he decides
to enter the labor market at point B 2 (an extensive response). Notice that this extensive
Labor
2. See Eissa, Kleven and Kreiner (2005) for a more detailed discussion of the modeling of labor supply.