Ch. 7: LIFE-CYCLE ASPECTS OF LABOR SUPPLY.

Ch. 7: LIFE-CYCLE ASPECTS OF LABOR SUPPLY.

• Choice of retirement age

Choice of retirement age

• Steepness of indifference curve reflects willingness to postpone retirement for additional income.

• Steepness of budget constraint determined by – earnings profile– Social Security formula– pension plan features.

• Pure Wealth effect would result from a parallel shift of budget constraint (e.g. win lottery, inherit money)

• Wealth and substitution effect would result if slope of budget constraint is altered.


• If the financial rewards to postponing retirement beyond age 62 are increased, the person with is faced with a wealth and substitution effect.

• Wealth effect: Holding retirement age constant, the person has greater wealth and will retire sooner.

• Substitution Effect: Holding wealth constant, the reward to postponing retirement has increased .. substitute money for years in retirement.

• Net effect: Ambiguous.


• Effect of increasing rewards to postponed retirement

R*

Wealth effect > subst efffect

subst efffect > Wealth effect


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.

http://www.sba.muohio.edu/evenwe/courses/eco202/sp00/readings/soc%20sec%20ben.htm

http://www.ssa.gov/retirechartred.htm

http://www.ssa.gov/OP_Home/cfr20/404/404-0313.htm


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 collect an annuity of $50,000 annually at age 65, assuming interest rate=0? If interest rate>0?


Private pensions

•Defined Contribution Plan.•a savings account that the worker may receive as a lump sum at retirement.

• 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 incentives?

Ch. 7: LIFE-CYCLE ASPECTS OF LABOR SUPPLY.

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Transcript of Ch. 7: LIFE-CYCLE ASPECTS OF LABOR SUPPLY.