Public Economics Lectures Part 1: Introduction

Dynamic Life Cycle Model: Policy Rules
λ = u c0
is the marginal utility of initial consumption
The two first order conditions imply that
l t = l(w t , λ/(β(1 + r)) t )
c t = c(w t , λ/(β(1 + r)) t )
Current labor and consumption choice depends on current w t
All other wage rates and initial wealth enter only through the budget
constraint multiplier λ (MaCurdy 1981)
Easy to see for separable utility:
u(c, l) = u(c) − v(l)
⇒ v ′ (l t ) = λw t /[β(1 + r)] t
⇒ l t = v ′−1 (λw t /[β(1 + r)] t )
Suffi ciency of λ greatly simplifies solution to ITLS model
Public Economics Lectures ()Part 5: Income Taxation and Labor Supply 132 / 217