06 Heckman MaCurdy

A Life Cycle Model of Female Labour Supply
Author(s): James J. Heckman and Thomas E. Macurdy

Source: The Review of Economic Studies , Jan., 1980, Vol. 47, No. 1, Econometrics Issue
(Jan., 1980), pp. 47-74
Published by: Oxford University Press
Stable URL: https://www.jstor.org/stable/2297103
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Review of Economic Studies (1980) XLVII, 47-74 0034-6527/80/00030047$02.00
? The Society for Economic Analysis Limited
A Life Cycle Model of Female

Labour Supply
JAMES J. HECKMAN
University of Chicago
and
THOMAS E. MACURDY
Stanford University
INTRODUCTION
This paper presents an empirically tractable model of the life cycle labour supply decisions
of married women in an environment of perfect certainty. Two dimensions of married
female labour supply activity-annual hours of work and annual participation in the work
force-are integrated in a coherent intertemporal framework. Structural economic rela-
tionships between life cycle labour supply decisions and wages and contraints at all ages are
examined. The meaning and measurement of differential labour supply responses to
"permanent" and "transitory" wage rates and incomes are considered.
Eight years of panel microdata taken from the Michigan Panel Survey of Income
Dynamics are used to estimate the model. An estimate of the elasticity of substitution
between married female non-market time at different ages is derived. The model is used to
evaluate the response of female labour supply to " transitory " shocks in income and wage
rates. Contrary to previous empirical work by Mincer (1962), we find little evidence of a
married female labour supply response to "transitory" shocks in household income
exclusive of the wife's earnings including income shocks due to the unemployment of the
head. Our empirical results are thus consistent with the permanent income hypothesis,
suitably broadened to accommodate the effect of wage rates on income through their effect
on labour supply.
In addition to the substantive contributions just mentioned, one major econometric
innovation is presented in this paper. A simply computed fixed effect " Tobit" model is
proposed and implemented on panel data and its statistical properties are discussed. The
fixed effects considered in this paper have a sound economic interpretation and serve as
surrogates for a host of relevanL omitted variables which govern life cycle choices but
which are generally inaccessible to empirical analysts. In the context of the model
presented in this paper, controlling for fixed effects eliminates cohort bias that plagues
previous empirical studies of life cycle labour supply that are based on synthetic cohort
data constructed from a single cross section. The fixed effect Tobit model presented in this
paper also provides a solution to the problem of sample selection bias in long panels.
The structure of the paper is as follows. In the first section, a brief survey of previous
work on the labour supply of married women is offered in order to place the current work
in context. In the second section, a simple model of life cycle labour force participation
and hours of work is presented, and alternative strategies for estimating it are considered.
In the third section, an estimatable version of the model is derived. The fourth section
reports estimates of parameters of the model. In the fifth and concluding section, a brief
summary of the analysis is given.
47

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48 REVIEW OF ECONOMIC STUDIES
1. SURVEY OF PREVIOUS WORK
In this section, a brief survey of the main features of the literature on female labour supply
is presented. This survey is designed to highlight the main developments in this field in
order to place the analysis of this paper into a proper perspective. For a much more
comprehensive analysis of the recent literature on female labour supply, the reader is
referred to the work of Killingsworth (1979). Much of the material in this section draws on
Heckman (1978a).
The modern literature begins with the pioneering work of Mincer (1962). In his work
Mincer presents a one period model of female labour supply in which the period is a
life-time. Following the work of Friedman (1957) and specific suggestions of Nerlove
(1960), Mincer introduces the notion of differential labour supply responses to permanent
and transitory wage rates and incomes, and uses this notion to reconcile, in part, the
discrepancy between time series and cross section estimates of female labour supply
functions. According to Mincer's model, women choose levels of market time on the basis
of "permanent" wage rates and income. Life-time variation in costs and opportunities-
due to children, unemployment of the spouse, and general business cycle variation-
influence the timing of labour force participation and not the volume of labour supplied to
the market. The timing decision of work activity is given by a profit maximizing
calculation: work when it is financially most profitable relative to non-market alternatives.
Abstracting from life cycle variation in opportunity costs, and assuming that non-market
time at one age is a perfect substitute for non-market time at any other age, the probability
that a woman works in any one of T equispaced segments of her life cycle is, for large T,
closely approximated by the fraction of her life-time that she works. The economic model
implies a special multivariate distribution for the T dummy variables that indicate whether
or not the woman works in each of the T segments. Each indicator variable has the same
marginal distribution but the correlation structure for the dummy indicators is not
specified by the theory except that it must be stationary and non-degenerate. Alternative
measures of labour supply such as participation in a given period, aggregate labour force
participation and average spell length are all transformations of the fraction of the
life-time that the woman works. Women more likely to work at all are more likely to have
longer spells of participation.
Subsequent work on labour supply by Cain (1966), Kosters (1969), Hall (1973), and
Hanoch (1976) has been less clear on the issue of the appropriate time frame for analysing
labour supply and on the interrelationships among dimensions of work activity. Most
researchers let their data source determine the appropriate time dimension for their
analysis, but assume that the one period model applies to that dimension. Typically,
annual hours are taken as the dependent variable for a regression analysis and life cycle
relationships are ignored, or casually treated. The most "rigorous" specifications of one
period models ignore life cycle considerations completely. The only analysis that
considers intra-year dimensions of labour supply is that of Hanoch (1976) who considers
hours per week and weeks per year-two arbitrary dimensions-which are of interest solely
because of data availability.
In this paper, we follow Mincer's lead and investigate relationships among two
dimensions of life cycle labour supply-annual hours of work and annual participation over
the life cycle-without imposing Mincer's implicit assumption that non-market time at one
age is a perfect substitute for non-market time at any other age. A major result from our
empirical work is that the non-market time of different ages is far from being perfectly
substitutable.
A recurring discordance between estimates of substitution effects of wage rates on
labour supply obtained from cross section participation data, and estimates of substitution
effects from annual hours of work data, stimulated two important papers by Lewis (1967)
and Ben Porath (1973). Both authors demonstrate that the labour force participation

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HECKMAN & MACURDY MODEL OF FEMALE LABOUR SUPPLY 49
decision at any age is a discrete decision and that estimates of participation equations
produce parameters that are conceptually distinct from estimated parameters of hours of
work functions. Both papers ignore the focus on the life cycle that is implicit in Mincer's
work. In the Lewis-Ben Porath model, participation and hours of work at any age are
generated from a concave utility function defined for that age. By changing the nature of
the preference function from that implicitly utilized by Mincer, they demonstrate that
participation and hours of work equations are not as closely related as they are if Mincer's
assumption of perfect substitutability between leisure at different ages is accepted. Ben
Porath and Lewis (implicitly) ignore all components of intertemporal substitution in time.
The Ben Porath-Lewis papers were a stimulus to later work by Heckman (1974b)
who formulates a model of annual participation, and annual hours of work and wage rates,
that explicitly develops the interrelationship between hours of work and labour force
participation. Later work by Hanoch (1976) extends Heckman's analysis by considering
hours worked per week and weeks worked per year as separate dimensions of labour
supply. The important point for the present discussion is that neither author considers life
cycle interrelationships among labour supply decisions. A major goal of the current
analysis is the extension of the Heckman (1974b) analysis to a life cycle model. The work
described in this paper also extends the dynamic analyses of participation by Heckman and
Willis (1977) and Heckman (1978b) to a structural dynamic model that accommodates
both hours of work and participation decisions in a unified framework.
Another topic considered in this paper is one that has received considerable attention
in the recent literature: the selection bias that arises from estimating wage functions and
hours of work functions on subsamples of working women (Gronau (1974), Lewis (1974),
Heckman (1974b)). The analysis presented in previous papers is applicable to cross
section data. The methodology outlined in this paper extends that analysis to panel data
and proposes a simply computed "fixed effect" scheme to deal with the problem of
selection bias in long panels.
Smith's important work on the life cycle labour supply of married women (1977)
warrants discussion. His theoretical model is an extension of the Ghez-Becker (1975)
model. That model considers the substitution of time and goods over the life cycle of a
single "representative" consumer. Smith estimates his model on aggregated synthetic
cohorts formed from cross sections of consumers at different ages. The constructed
synthetic cohorts are assumed to depict life cycles of representative consumers.
Smith's theoretical analysis ignores the life cycle labour force participation decision
and his empirical work ignores the phenomenon of sample selection bias that may explain
some of his empirical results.' The analysis in this paper considers distinct participation
and hours of work functions, and explicitly controls for sample selection bias. Dis-
aggregated panel data are used to avoid some of the problems (such as confounding of age,
period and cohort effects) that arise from using cross section data to estimate life cycle
behavioural equations.
2. A DYNAMIC MODEL OF LABOUR FORCE PARTICIPATION

AND HOURS OF WORK AND ALTERNATIVE
STRATEGIES FOR ESTIMATING IT
As an alternative to the Mincer model that retains his life cycle focus and imbeds the
Kosters-Hall-Smith approach within it as a special case, we propose a simple model that is
empirically tractable in which time at one age is not a perfect substitute for time at other
ages.
Consumers are assumed to operate in an environment of perfect certainty. Life is
finite, with horizon T. Utility at age t is a strongly concave function G(C(t))+J(L(t))
where C(t) and L(t) are the instantaneous consumption of goods and leisure at time t. L(t)

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lies in the unit interval, 0?_ L(t) _ 1. Although we do not require contemporaneous strong
separability for most of our theoretical results, we maintain this assumption because it is
used in the empirical analysis. The consumer faces wage W(t) at age t and it is assumed to
be independent of his choices. For simplicity the price of goods is normalized to unity.
Consumers start life with assets fQ(O), credit markets are perfect (with lending and
borrowing rate r), and the rate of time preference is p.
The consumer's problem is
rT
max J e-Pt[G(C(t)) +J(L(t))]dt ... (1)
subject to
T
fQ(0) = e rt[C(t) - W(t)(1-L(t))]dt. ... (2)
The conditions for an optimum are satisfaction of the budget constraint and
G'(C(t)) e ()tA (O) ...(3)

J'(L (t)) >- e (e - r) tA (0) W(t).. 4
A (t) = \ (O)e rt ... (5)
where A (0) is the Lagrange multiplier asso
marginal utility of wealth in period 0). Condition (4) determines the supply of labour at
each instant. At those points in time at which condition (4) is a strict inequality, the
individual does not work.
The marginal utility of wealth constant demand functions for goods and leisure may
be written as
C(t) = C(e(p-r)tA (0)) ... (6)

tL*(e(P-r)tA (0) W(t)) if J'(L(t)) - e(pr)tA (0) W(t)
L(t) = L(e(PrtA (0) W1(t)) = 1if J1(1)> e (p-r) tA(0)1V (t) 7

where the functions C( * ) and L*(*) are the inverse functions of G' and J', respectively. As
a consequence of strict concavity of preferences, these demand functions satisfy
dL() 0 AC(t) aL(t) AA (0) and aA (0) o02
a W(t) ' 0, oA (O) ', AA (0) aW(t) aQ(0)
Labour supply at time t, h (t) = 1 - L(t), is
h (t) = h (e (pr)tA (0) W(t)) = 1 -L(e (pr)tA (0) W(t)), . . . (8)

so that
ah(0)-0 and a W(t)
Throughout this paper we refer to demand functions (6), (7), and (8) as
functions. These functions are invariant to monotonic transformations of
function (1) since first order conditions (3) and (4) remain valid for all such trans-
formations. The A (0) constant demand functions are marginal utility of wealth constant
demand functions only for the particular normalization of lifetime utility given by (1). It is
this normalization that is required to interpret A (0) as the marginal utility of wealth.
There are two measures of lifetime labour supply. The first is the total number of
hours spent in market activities over the life cycle. This measure is given by
HH= j h(t)dt - h(e(P-r)tA(0)W(t))dt. ... (9)

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The second is the total number of "periods" the consumer works. Letting I
dummy variable that assumes the value of one when the consumer works (
e(p-r) A (0) W(t)) and the value of zero when he does not (i.e. f'(1) > e(P-r)tA
measure is given by
T
IIH I (t)dt. ... (10)
Lifetime labour supply concepts

leisure time at each age is a perfect
model presented in this paper, the two concepts diverge.
In order to characterize the relationship among various dimensions of life cycle labour
force activity, consider a wage profile of the form
W(t) = , '(t) O t ct', t" t _T

tco(t)+b t'<t<t"
where w (t) is a smooth function of time and b is a non-negative cons

implies an increase in the wage rate over the open interval (t', t")
The effect of an increase in b on labour force participation de
individual works during the period (t', t"). Recall that for those
individual does not work, it must be the case that
(M > e(-)() ... (11)
i.e. the marginal value of t

individual does not work duri
wage over this period must
Assuming that the increase
interval (t', t"), the increase in
so because there is no price
Next suppose that the indivi
to verify that
aA(0)< 3
ab
Hence, increases in wage rates in periods in which the consumer works increases the
marginal value of time at full leisure over the entire life cycle. For those ages outside the
age range (t', t"), the "likelihood" of participation unambiguously decreases. The
"likelihood" of participation at ages within the period (t', t") can increase or decrease
depending on whether the increase in the marginal value of time exceeds the increase in
the wage rate.
This point may be summarized in the following diagram. For convenience, let
p - r -0. The "reservation wage" at each instant is (1/A (0))/J'(1), where A (0) is th
equilibrium marginal utility of income. This is displayed as line BB' in Figure 1. Th
market wage is assumed to follow profile AA'. The consumer works in the interval (t3, t6)
of his life cycle. Up to age t3, and after age t6, he does not.
Suppose that wage rates increase over the period (t1, t2). Because I(t) = 0, t1 < t <
A (0) is unchanged and there is no response to such a wage change at any point in the
cycle. Next, consider an increase in wage rates over the period (t4, t5) in which th
consumer works. Because A (0) declines, the reservation wage function shifts up from
to CC'. An increase in wage rates of this type causes the entry date t3 to increase, the exi
date to decrease, and hours of work at all working ages other than those in the age ra
(t4, t5) to decrease. The effect on total hours of work is ambiguous. Thus, II must decreas

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MARGINAL
VALUE t
OF TIME --_B
J'(1 ) C?_____ '_---a C'
X(O) B I
,/
/' I
I II"
"
A I A
0 tl t2 t3 t4 t5 t6 T
AGE
FIGURE 1
while HH may increase or decrease; that is, the fraction of the lifetime that the consumer
works will decrease and the total number of hours worked may increase.
There are three lessons to draw from this simple example: (i) Increases in wage rates at
other ages will not increase labour supply at a given age and decreases in wage rates at
other ages will not decrease labour supply at a given age. More generally, current labour
supply behaviour depends on wage rates (and other parameters) in other periods. (ii)
Lifetime labour supply measures II and HH need not move together and certainly are
characterized by different functions. (iii) The reservation wage function J'(1)/A (0) utilized
in much recent labour supply analysis (Gronau (1973), Heckman (1974b)) depends on
future and past wage rates so that the separation between market wages and reservation
wages that is so convenient in that analysis is inappropriate in a life cycle model. Only in
the special case of determining whether or not the consumer ever works is it possible to
separate wage rates from the reservation wage function. Estimates of reservation wages
based on a static model of labour supply may be seriously biased if a life cycle model is
appropriate (see Heckman (1978a)).
Direct calculation of the wage and asset elasticities for h (t), II, and HH reveals that
these different dimensions of life cycle labour supply, while generated from the same set of
preferences and constraints, are conceptually distinct, and no close relationship neces-
sarily exists among fitted elasticities.
2.1. Alternative Strategies for Estimating the Life Cycle Model
The theory just presented is straightforward. Its application to data is not. In this section
we discuss three approaches pursued in the literature and then present the one adopted in
this paper. The first approach, due to Ghez and Becker (1975) estimates demand
functions (6) and (7) using synthetic cohorts constructed from cross section data. The
second approach, due to Heckman (1971), utilizes individual cross section data to estimate
Hicks-Slutsky income and substitution effects. The third approach, due to Nerlove (1960)
and Mincer (1962), postulates differential labour supply responses to "permanent" and
" transitory " wage rates and income. The fourth approach, adopted here, treats A (0) as a
fixed effect and estimates equations (6) and (7) using panel data.
The main problem in implementing the theory is the lack of data. The theory of life
cycle labour supply proposed above asserts that labour supply decisions at each age are a
function of prices and wages at all ages. Supplementing the model to accommodate

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demographic variables that shift preferences (or affect household production, to use
another jargon), labour supply is also a function of demographic variables at all ages. The
analyst rarely has access to all of the requisite data. Accordingly, some assumptions must
be made in order to make any empirical progress.
One approach, due to Ghez (1970), and implemented by Ghez and Becker (1975) and
Smith (1977), constructs synthetic cohort data from cross section materials. The cross
section synthetic cohort is assumed to follow the labour market career of a typical
individual over his life cycle. The " individual " is at the same level of life-time utility, and
has a constant value of A (0) over his life cycle. Regression estimates of equations (6)
and (7) using synthetic cohort data secure estimates of the parameters of the L and C
demand functions.4
As Ghez and Becker (1975) and Smith (1977) acknowledge, their empirical pro-
cedure is ill equipped to deal with all but the most elementary sort of cohort effects. Even if
cohort bias is successfully avoided, the method does not estimate the wealth effect of wage
and asset change on labour supply since, by assumption, everyone in the sample (consisting
of a synthetic cohort) is at the same level of lifetime utility and also has the same value of
A (0). The best that the method can do is to isolate the parameters of the A (0) constant
labour supply functions assuming no aggregation or cohort bias.
A second approach, due to Heckman (1971), uses cross section data on individuals to
estimate all the parameters of the full life cycle model. Missing wage and demographic
data for periods outside of the cross section are estimated from regression equations fit to
the available cross section data. Using predicted values of missing wage rates, demo-
graphic variables and assets, it is possible to estimate all of the parameters of the full life
cycle model.
Adopting a discrete time model for expositional ease, one variant of these models is
In h (t) = d: +0 ETs t In W(j) + y In W(t) +q n Q(0) + e (t), t = 0O, ...,3 T. ...
The error term is assumed to possess classical properties. This model assumes that all of
the interperiod-cross substitutions effects ((3) are equal and age invariant. The own period
wage effect (-y) is also assumed to be age invariant.6 Interest rate and time preference
parameters are absorbed into the intercept a, and demographic variables are ignored.7
The missing wage and asset data are predicted using instrumental variables (such as
education, polynomials in age, and the like) to fit regression equations in a cross section,
and predicted values are inserted into equation (12). From estimated values of (3, -y and
one can estimate Hicks-Slutsky compensated substitution effects.
Like the methodology used by Ghez and Becker, this procedure is plagued by cross
section cohort bias. Unlike their methodology, if the cohort bias can be eliminated,
Heckman's estimating procedure retrieves both income and substitution effects of wage
change by utilizing data on individuals.
The third approach, due to Mincer (1962), and pursued in later work by Cain (1966),
Kalachek, Mellow and Raines (1978) and others, is to proceed by analogy and redefine the
problem of estimating labour supply functions so that it resembles the problem of
estimating a consumption function. By analogy with Friedman's permanent income
hypothesis, labour supply is assumed to be a function of "permanent" wage rates and
"permanent" income. Unlike the assumptions maintained in the literature on the
consumption function, labour supply is also assumed to respond to "transitory" wage
rates and " transitory " income. Indeed, Mincer assumes and produces evidence in support
of the notion that the wife's labour supply response to transitory income is larger in
absolute value than her labour supply response to permanent income.8
There are two problems with this approach. First, the theoretical rationale for
decomposing labour supply responses into responses to "permanent" and "transitory"
components of wage and income series is never spelled out. In fact we demonstrate below

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that Friedman's analysis of the consumption funct

to an analysis of labour supply. Second, in order to
operational definitions of permanent and transitor
The crucial idea in Friedman's model of life cycl
perfect certainty is that consumption at each age is a
of the lifetime distribution of income receipts, i.e
labour supply decisions, and letting fk(O) be the p
receipts, permanent income, Y, is the highest cons
sustained. Thus Y is defined as
T
YJ ertrdt = f(0),
or
rfl(O)
(1-e rT)
As T -* 00, this definition agrees with Friedman's. Transitory income at age t

between actual income receipts at age t and Y. Lifetime consumption decis
on lifetime wealth which is a multiple of permanent income. Transitory income
components have no effect on consumption. An economically meaningful empirically
operational definition of permanent income is available that does not require knowledge
of the consumer's preferences for its definition or implementation.
It is natural to search for a corresponding summary scalar measure of wage rates in a
model in which life cycle labour supply decisions are considered. In general, there is no
"permanent wage rate " or scalar measure that summarizes all of the relevant aspects of
the distribution of wage rates over the life cycle required to determine consumption or
labour supply at a point in time.
The reason for this is simple: exogenous income receipts enter the consumer's
maximization problem only as a discounted sum. Hence, it is possible to derive a scalar
measure that summarizes all of the relevant information about this flow of income. The
wage stream cannot be summarized so simply. Inspection of the lifetime budget constraint
and the first order conditions given by equations (2), (3) and (4) reveals that the entire
profile of wages enters into the choice of consumption of goods and leisure at each age.
Any economically relevant single summary measure of the lifetime distribution of wage
rates must depend on consumer preferences and initial values of wealth and interest rates
in all except certain trivial special cases. And, in general, more than one such number is
required in order to summarize the effect of the lifetime distribution of wage rates on
consumption and labour supply.9
One is always free to construct arbitrary statistical definitions of permanent wage
rates and incomes. For example, Cain (1966) defines permanent income as the conditional
expectation of measured income given a set of exogenous variables.'0 Transitory income
is the difference between measured income and permanent income. Kalachek, Mellow
and Raines (1978) define permanent and transitory wage rates in a similar fashion. A
more sophisticated variant of these procedures, based on the work of Nerlove, exploits
panel data to estimate permanent and transitory components." For example, following
Friedman and Kuznets (1945, p. 353, Equation (1)), the wage rate in year t may be written
as
ln W(t)= + V(t) + bV(t - 1), t = O, ..., T, ...(13)
where f is a permanent component, and the V(t)'s are indep

tributed random variables. For wage rates more than two per
component X is the only source of covariance.

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Given a statistical process for wage rates such as the one given by equation (13), it is
possible to estimate the differential labour supply responses to permanent (i.e. k) and
transitory (i.e. V(t)) wage rates. Nerlove (1967) considers such a procedure in his work on
" unobserved components" models in which agents are assumed to respond differently to
different components of a time series. Given the stochastic process for wage rates
(equation (13)), the labour supply function may be written as
In h (t) = CO + C10 + C2 V(t) + C3 V(t -1) + C4fl(O) + e (t) . .. (14)
where labour supply responds differently to separate components of the wage series.
Under the maintained assumptions, e (t) is uncorrelated with X, V(t) and V(t - 1). It is
straightforward to verify that if the correct labour supply model is given by (12), least
squares estimators of the parameters of equation (14) (with estimated values of V(t),
V(t- 1) and (k substituted for actual values)'2 have the following probability limits
plim Ci=,3T+,y
plim C2 = y + 3b
plim C3 = yb + .'13
Given estimates of b obtained from a panel data analysis of the wage function, one can
estimate the structural parameters of interest by solving for -y, (3 and T.
There are two points to extract from this example. (i) Given limited data on wage
rates over the life cycle and confidence in the stability of the wage function over the life
cycle, one can, in principle, solve for the structural parameters of interest. Putting matters
this way, the third approach to estimating a life cycle model is really just a variant of the
second approach.
However, the Nerlove procedure takes Cl, C2 and C3 as structural parameters o
interest. These parameters confound the economic parameters of interest (the -y and the
3) with parameters of the wage process (the b).
This leads to the second point: (ii) There is very little economic content in estimated
responses to " permanent " and " transitory" components in the wage series. The struc-
tural parameters are -y, j3 not C1, C2, C3. Accordingly, this sort of Nerlove decomposition
is of little direct interest for estimating a structural model. (For related comments on
Nerlove's unobserved components model in a production smoothing context, see Ward
(1978).) This result is not surprising: if one defines "permanent" and "transitory" by
statististical criteria, it should come as no surprise that estimated labour supply responses
to such components confound "statistical" and "economic" parameters.'4 Similar
remarks apply to the statistical decompositions employed by Mincer, Cain, Kalachek,
Mellow and Raines, and Lillard.
The strategy adopted here for estimating a life cycle labour supply function uses panel
data on individuals to estimate the A (0) constant demand functions given in equations (6)
and (7). The procedure differs from that used by Ghez and Becker and Smith because it
utilizes panel observations on individuals to estimate these functions.'5 Using individual
observations, we avoid the aggregation bias inherent in the use of synthetic cohorts.'6
The empirical method used in this paper, due to MaCurdy (1977, 1978), treats A (0) as
a fixed effect. "A (0) " is a very messy, but scalar, function of wage rates, interest rates,
rates of time preference and initial assets that is implicitly determined by substituting
demand functions (6) and (7) into budget constraint (2). In the analysis of the consumption
decision, all of the relevant information about the life-time distribution of income receipts
can be summarized in A (0). Given A (0) and p - r the optimal consumption decision is fully
determined. Any distribution of lifetime income receipts that keeps A (0) fixed implies the
same optimal consumption behaviour.

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In the labour supply function, A (0) summarizes m

cycle distribution of wage rates on current labour supply choices. Given A (0), p - r, and the
current wage, one can fully characterize the labour supply choices of consumers. In terms
of a data reduction problem, the A (0) constant demand functions presented in equations
(6) and (7) reduce the effect of wage rates outside period t on labour supply in period t into
a manageable scalar measure.
The A (0) demand functions simplify the empirical analysis. They permit the analy
dispose of arbitrary, and intrinsically meaningless definitions of permanent and transitory
wage rates. Like the permanent income theory applied to consumption data, they reduce
the dimensionality of the empirical problem. A (0) is a fixed constant for an individual over
his life-time. One can treat A (0) as a fixed effect in a statistical model, just as one can
treat unmeasured permanent income as a fixed effect in an analysis of the consumption
function. Using panel data, one can eliminate the fixed effect, and hence purge the
analysis of unobservable variables that are bound to be correlated with the included
variables as a consequence of the fact that A (0) is a function of all parameters in all
periods.'7 Introducing A (0) also controls for cohort and individual idiosyncratic effects,
and avoids having to resort to the assumption, maintained in previous studies based on
cross section data, that cohort effects are "smooth" (e.g. Ghez-Becker (1975), Smith
(1977)).
Estimation of the A (0) system using panel data yields a clean solution to part of the
problem of estimating intertemporal consumer demand functions. " A (0) " labour supply
systems do not, directly, estimate all of the parameters required to characterize life cycle
labour supply. Approximate estimates of life-time wealth effects on labour supply can be
achieved by regressing estimated fixed effects on estimates of life-time wealth. In contrast
with the parameters estimated from the A (0) constant system, which are estimated cleanly,
estimates of parameters obtained by regressing "A (0)" on life cycle variables are less
cleanly estimated.
In the absence of full information about the life-times of individuals, estimation of the
A (0) syste-m permits identification of certain parameters from the available data and
eliminates the intrusive effect of omitted variables that cannot be measured. The fixed
effect essentially becomes a surrogate for life-time measures not at our disposal that
reduces an impossible problem into a manageable one.
The method does not require the assumption of perfect certainty. Nor does i
necessarily rely on the assumption of intertemporal strong separability. However, if this
separability assumption is relaxed, so that utility in one period depends on consumption in
adjacent periods, one requires information on wage rates and constraints in the adjacent
periods in order to estimate the A (0) constant demand system. If the " adjacent periods "
are the lifetime of the individual, there is no empirical advantage that accrues to estimating
the A (0) functions in contrast with the more traditional equation (12).
3. AN ESTIMATABLE ECONOMETRIC MODEL OF LABOUR SUPPLY

AND WAGE GROWTH
In this section of the paper, a specific econometric model is proposed. The model is a
version of the A (0) constant labour supply model described above. Discrete time analysis
is used since only discrete time data are available. Simple specific functional forms are
utilized so that estimated parameters can be given a concrete interpretation.
Utility at age t, (U(t)), is written as the following function of L(t) and C(t),
U(t) = A (t) (L (t)) + B (t) (C(t))`, t = 0, ..., T ...(15)
O<a, y<1
A(t), B(t) > 0.

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So, lifetime utility is
T 1 -t(A(t)(L(t)) +B(t)(C(t))T). ..(16)

A(t) and B(t) are age specific modifiers of "tastes" or "household production". Vari-
ables like the presence of children, education, and the like plausibly affect consumer
preferences (or "household production functions"). It is assumed that A(t) =
exp{Z(t)4i + ?1(t)}, where Z(t) is a vector of measured determinants of "leisure " choices,
and e1(t) is an error term representing unobserved characteristics.
Wage rates are assumed to be determined outside the model. The wage equation can
be written as
ln W(t) = X(t)8 + 62(t), t = 0, ..., T ... (17)
where X(t) is a set of exogenous determinants of wages (e.g. education, local labour
market variables and the like) and ?2(t) is a mean zero disturbance.
The A (0) constant demand function generated from the preference function (15) is
L(t) A() (1+P A (0) W(t) if the woman works

L otherwise
where L denotes the tot

ignored. Taking natural logarithms of this function, these labour supply equations can be
written as
(L- h( )) ( [ln A (0)-lna+(p-r)t-lnA(t)+lnW(t)] if the woman works

(n ) otherwise
where the h(t) is hours of work. To simplify the notation, we assume
In + J-p -r.
The disturbance vector ( 1(t), ?2(t)) is assumed to follow a components of variance

scheme
1(t) = r1 + U1(t) ... (20)

62(t) = 12 + U2(t)
where
E(Ui(t)) = 0, i = 1, 2
E(Ui(t) U1(t')) = o-i, i, j = 1, 2, t =t

=0, t#t'.
Thus, non-zero covariance between Ul(t) and U2(t) is p

error vector (Ul(t), U2(t)) is serially uncorrelated.
since q1 and 712 are left freely correlated. The err
generated by a bivariate normal distribution.

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Substituting the reduced form wage equation and the expression for A(t) representing
"tastes" into the equation determining hours of work given by (19), the labour supply
equation may be written as
f +a-1ia-1
(P _) t-Z(t) a-
0 +X(t)
1
i + V1(t)
if _ (p-r) __1
In(Lh (t)) = ifV1t -- t+Z(t) 1-X(t) 1+lnL .(21)
ln if V,(t) >- 1t+Z(t) 1-X(t) 1+lnL

where
f= (InA (0)-ln a-1l +fl2) and VI(t)= (U2(t)-Ul(t)).

a-i a-i
This labour supply equation and the wage equation given by (17) constitute the full
life cycle model of labour supply estimated in this paper. The model contains two
individual fixed effects: f in the hours of work equation and 2 in the wage equation. It is
inappropriate to treat f as a random effect that is uncorrelated with exogenous variables
because f includes ln A (0) as one of its components and A (0) depends on all of the
measured and unmeasured variables in the model. For this reason we treat f as a
parameter. A parallel argument can be made for treating 2 as a parameter. Estimation of
these parameters obviates the need for data on the full life cycle of individuals. To obtain
estimates of lifetime wealth and wage effects on labour supply, the estimated fixed effects
are regressed on measures of life-time wealth and wage rates.
A crucial parameter in the model is the intertemporal substitution elasticity
(1/(a - 1)). If a = y, life-time utility function (16) is of the CES form and (1/(1 -a)) is an
estimate of the Hicks-Allen elasticity of substitution between leisure time at different
ages. Even if a : y, (1/(1- a)) is a McFadden (1963) direct elasticity of substitution
between leisure in different time periods. " (1/(a - 1)) " gives the percentage change in
relative leisure consumed in any two periods with respect to the percentage change in the
relative price of leisure in those periods.
Demand equation (19) is invariant to monotonic transformations of life-time utility
function (16). The marginal utility of wealth is not. This observation underscores the
point made in Section 2, that A (0) is literally the marginal utility of income only for one
(arbitrary) transformation of the utility function.
Explicit expressions for life-time labour supply measures II and HH introduced in
equations (9) and (10) in Section 2 are given in Appendix B.
3.1. Estimation
Identification of the parameters of the model can be secured either through exclusion
restrictions or through (more tenuous, but currently fashionable) covariance restrictions.
If one or more variables appears in X(t) that does not appear in Z(t) (and is not " t "), the
model is identified.
We estimate the parameters of our model by the method of maximum likelihood. We
estimate two sets of parameters of our model using two different likelihood functions given
in Appendix A. The first likelihood function accounts for selection biases due to
truncation in hours of work and the fact that wage rates are unobserved when women do
not work. This likelihood function is an extension of Heckman's (1974b) cross sectional
model of female labour supply to a full life cycle model. The second likelihood function

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contains all the terms in the first but, in addition, it accounts for the condition that requires
that a woman must work at least one year in the panel in order to be included in the
effective sample from which parameters are estimated. This requirement arises because of
the behaviour of the fixed effect estimator in our model.
The programmes developed for our model estimate fixed effects for the wage func-
tion and hours of work function.'9 If a woman never works in the sample period,
estimated fixed effect in the hours of work function and participation equation is
unbounded. Also, for such a woman, it is not possible to estimate a fixed effect for her
wage equation since no wage is observed for her in the sample period. Thus, the effective
sample on which the empirical work is based is a sample of women who work at least once
in the eight years of the panel data.
If the number of panel observations per person becomes large, and if the number of
persons in the sample becomes large, maximum likelihood estimators from both likelihood
functions are consistent and asymptotically normally distributed.20
Fixed effects in non-linear models pose difficult statistical problems if the number of
time periods observed for each household is small, as is true for our sam~ple. One such
difficulty is the "incidental parameters" problem first discussed by Neyman and Scott
(1948). Since the number of observations per household is fixed, it is not possible to
consistently estimate fixed effects. In non-linear models-in contrast with linear models-it
is in general not possible to devise estimators of the structural parameters that are not
functions of the fixed effects. In this case, the inconsistency in estimated fixed effects is
transmitted to the estimated structural parameters.
Whether or not this is a serious matter cannot be settled a priori. All samples are
finite, and many cannot be imagined to become infinite (e.g. cross section data from states
in the United States). We invoke asymptotic arguments in the hope that the rate of
convergence of estimators is sufficiently rapid that the asymptotic arguments are valid. A
serious analysis of this matter requires a study of the rate of convergence of proposed
estimators.
In the multivariate probit and Tobit cases considered here, such an analysis is difficult.
Elsewhere (Heckman (1979)), Monte Carlo methods are used to demonstrate that in the
case of a multivariate probit model with fixed effect in which there are no lagged dependent
variables, and in which the number of panel observations per household is eight-the
number used in the empirical work in this paper-the maximum likelihood fixed effect
estimator behaves well in the sense that the estimated parameter values are very close to
the true parameter values. Although no Monte Carlo investigation of the Tobit model
proposed in this paper has been performed, the Monte Carlo results for the multivariate
probit model with fixed effect are sufficiently reassuring that the " incidental parameters"
p ~~~~~~~~~~~~~~21
problem appears to be practically unimportan
estimator should be even better behaved because it combines the linear regression model
with the probit model. Estimated fixed effects absorb the "true" fixed effects and the
effects of variables that do not change over the sample period. To retrieve the latter, it is
possible to regress the estimated fixed effects on the time invariant variables to estimate
their effect on the " dependent" variable. If the number of observations per household is
"large", such regression estimators are consistent, and the standard regression-covari-
ance matrix provides the correct standard errors.
The model is estimated for a given value of L, the maximum amount of leisure that the
consumer has at his disposal. Following the suggestions of Ghez and Becker (1975) and
Smith (1977), we estimate the model for L = 8760 hours, the number of hours in a year.
4. EMPIRICAL ANALYSIS
In this section, we report empirical estimates of the model presented in Section 3. The
estimates are best regarded as a first instalment on our ongoing work. In this paper we do

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not account for such potentially important constraints as tax rates, imperfections in the
capital market, fixed costs of work, and the like. Here, we assume that the model
presented in Section 3 is correct and seek to determine estimates of its parameters.
This section has the following structure. We first discuss the data used in the empirical
work. Then, we present our specification of the model. Empirical content is given to the
"taste shifter" parameter (A(t)) in equation (19) and the determinants of wage equation
(17) are specified. Finally, we present and discuss our empirical results.
4.1. Data
Our sample consists of 672 white women, age 30-65 in 1968, interviewed in the Michigan
Panel Survey of Income Dynamics, who were continuously married to the same spouse
during the survey year. This measure of work effort is the product of weeks worked times
Appendix C.
Two dimensions of life cycle labour supply are used: annual hours of work and annual
labour force participation. A woman is defined to be a market participant if she worked for
money some time in the survey year. This definition of participation is consistent with the
notion of Lucas and Rapping (1970) who view unemployment as one of many forms of
non-market activity.
Hours of work are defined as the number of hours the woman worked for money
during the survey year. This measure of work effort is the product of weeks worked times
" average " or "usual" hours worked per week. This measure avoids the kind of sample
selection bias first noted by DaVanzo et al. (1973) that arises from multiplying reported
weeks worked in the year by reported hours worked in the survey week. The second
measure of labour supply tends to eliminate individuals who supply fewer annual hours to
the market, and hence eliminates labour supply observations on the basis of the dependent
variable (if such observations are treated as non-workers) or severely and non-randomly
understates the true measure of labour supply (if zero hours are assigned to such
observations and they are retained in the sample used to fit hours of work functions).
Mean values of the variables used in our empirical analysis are presented in Tables I
and II. Table I records the mean values of variables for the full sample of 672 women. As
noted in Section 3, the fixed effect "Tobit" scheme used in this paper estimates the
parameters of the model on the subsample of 452 women who have worked at least once in
the eight years of panel data.22 This is true whether conditioned or unconditioned
likelihood function is maximized. The mean values of variables for the effective sample of
452 women are reported in Table II. As expected, this table displays a higher cross section
labour force participation rate than that in Table I. The average level of education is
higher and the mean level of family income exclusive of the wife's earnings is lower in this
sample. It is interesting to note that in the full sample real earnings (exclusive of the wife's
contributions) rise over the course of the panel but in the sample of workers, real earnings
rise and then fall. The effective sample is somewhat younger than the full sample.
4.2. Specification of the Model
To complete the specification of the model, we select a set of variables, Z(t), that
determine " household productivity " or tastes for leisure (i.e. A(t)) as well as variables th
affect life-time wealth (and hence operate through A (0)).
We first consider the specification of the variables in Z(t). A considerable body of
previous empirical work on female labour supply suggests that the presence of children
and their age composition affect the value of women's time in the home. The wife's
education may affect her productivity in the household. If households are credit con-
strained, as Mincer (1962) assumes, current family income (exclusive of the wife's
earnings) affects the value that the household places on the wife's time. A test of Mincer's
hypothesis is to determine whether or not current family income is a determinant of A(t

138.199.58.56 on Fri, 02 Jun 2023 14:16:41 +00:00
NoTEs:
byconsumerpidx)
theircldbangpo.
Hourlywagefkinvs($)
Numberofsvatin672
(c)Unemploythursagivfdb.
TABLEI
Meanvlusofribthmp
(d)Particponsefbyumvlhqwk.
(b)Adumyvarile=1fthwpnsok"c.
Ageofwi4.956-78*01 Head'snulhorfmpytC2571038*.6 Wife'sducaton(yr)1P7*- Futrewokxpcainsfb06-
Childrenvgfamyut1-6354*2089
1968702345
Labourfceptin049.57* (deflatbyconsumrpix)2374*6051-8 Doesthwifavndcgr?03*-' Headrtiosbl?(1=y,0hw)-849*273 Didwfeorkbmag?072- Numberofyastlih0-28173.9* Childbearngfs0945-67*8.1 Expectdnumbrofhil09754.321 Numberofchildnsta602741895 Totalnumberfchid285690
This content downloaded from oftheacyungswmipl38rd.Tvb

Familyncoexusvfw'rg(dt140P2-35687
(a)Thistenumbrofylcdp.v,w
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NoTEs:
byconsumerpidx)
Hourlywagefkinvs($)
SeTablIfordintsv.
Numberofsvatin452
TABLEI
Meanvlusofribthcmp
Ageofwi43-256*7890 Head'snulhorfmpytc21P48-30567 Wife'sducaton(yr)124- Futrewokxpcainsf"0-64

Headrtiosbl?(1=y,0hw)-67.93548 Didwfeorkbmag?0-84 Numberofyastlih0*293174. Birthncueya0-2*.1 Childbearngfs0-946.78'5 Expectdnumbrofhil09-75.432 Childrenvgfamyut1-806*543.9 Numberofchildnsta60-28341 Totalnumberfchid2-804567
Labourfceptin0-724*169 (deflatbyconsumrpix)2-374*60518 Doesthwifavndcgr?0-4
This content downloaded from Familyncoexusvfw'rg(dt10649-3 x
1968702345
Hourswkedinthyabgv1P3x0-5*674 on Fri, 02 Jun 2023 14:16:41 +00:00
138.199.58.56
holding A (0) fixed. If it is not, Mincer's hypothesis is rejected and the version of the
permanent income hypothesis outlined in Sections 2 and 3 is accepted.
As noted by Cain (1966), holding income effects constant the unemployment time of
the head may provide substitutes for the wife's time in the home and hence may reduce her
reservation wage. In the same vein, if the head is retired or disabled, the value placed on
the wife's non-market time may increase-either because her leisure time is complemen-
tary with his or because his disability increases the demands on her non-market time.
We next consider the determinants of A (0). In addition to all the variables just listed,
the theory of Section 2 implies that future values of variables as well as measures of wealth
should affect A (0). In this paper, we consider the effect of the wife's education, average
family income, future fertility plans, premarital work experience and realized fertility
measures on A (0).
As noted in Section 3, the estimated fixed effect for the labour supply equation
incorporates In A (0) and the effect of the set of "Z(t)" variables that do not change over
the course of the panel (e.g. the direct effect of education on preferences). Regressions of
estimated fixed effects on variables that do not change can only retrieve the combined
effect of such variables on current labour supply through their effect on ln A (0) and on
Z(t)q. There is no way to disentangle separate effects for a variable that does not chang
over time. Thus we cannot obtain separate coefficients for the effect of education on
household productivity (via Z(t)f) and its more general "wealth" effect through A (0).
However, these two types of effects can be distinguished for variables that change over the
sample period.
This decomposition is useful for testing certain hypotheses that have been advanced in
the literature on female labour supply. For example, Cain (1966) and Mincer (1962)
disagree over the importance of transitory variation in family income on the labour supply
decision of the wife. The econometric scheme proposed in this paper permits one to
separate out the effect of year to year fluctuation in income on labour supply (via Z(t)q)
and the wealth effect of levels of income on labour supply (via A (0)). This study supports
Cain's contention that transitory fluctuations in earnings have less effect on the female
participation decision than do permanent fluctuations. In our work, we find no response of
female labour supply to transitory income fluctuations (holding A (0) fixed).
The wage specification adopted in this paper is conventional-perhaps so much so as to
be controversial in light of recent work by Polachek (1975) and Mincer and Polachek
(1974). The natural logarithm of the wife's hourly wage rate is hypothesized to depend on
her education, the state of the local and national labour market, work experience, and
expectations of future work experience.
The controversial aspect of the approach adopted here is that experience is proxied by
age minus schooling minus six. A more satisfactory approach would be to make
experience fully endogenous, but this is not without its serious econometric problems (see
Sedlacek (1978)). Accordingly, we adopt a reduced form approach to the wage function
and focus our attention on labour supply.23
4.3. Empirical Results
Our estimation procedure is in two stages. In stage one, we use the method of maximum
likelihood to estimate labour supply equation (21) and wage equation (17). Next, we
regress estimated fixed effects from the first stage on education, proxies for wealth and
future fertility measures.
Table III reports two sets of estimates for the parameters of the wage function and the
value of time function. In the first column, estimates are presented from a likelihood
function which does not correct for the potential selection bias that may arise from using a
sample of women who work at least once in the eight years of the panel to estimate the
model. The second column reports estimates that correct for the possibility of such

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TABLE III
Maximum likelihood estimates of the model

(asymptotic normal statistics in parentheses)
Unconditioned system Conditioned system

Parameters L = 8760 L = 8760
q Parameters
(Effects on household production and preferences)
Number of children less than age 6 2-2 x 10-2(4.3) 2-2 x 10-2,5.8)
Family income, exclusive of wife's earning 5.1 x 10-9(0.01) 5-06 x 10- (0.03)
Number of children in the family unit 1 4 x 10-28.9) 1 4 x 10-2(17 1)
Wife's age (r- p) 1.35 x 10- (18.4) 1.4 x 10-2(280)
Head's hours unemployed 1 4 x 10 -8(o00) 1-4 x 10-8(0.03)
Head retired or disabled? 2.8 x 10-2(4.3) 2*7 x 10-2(10.5)
,( Parameters
(Effects on In wage rates)
Local labour market unemployment -5483 x 10-5(50.11) -538 x 10-5 (-614)
Experience (age-schooling-6) 342x (50-6) 3.44x10 (646)
Experience squared -4-05 x 10-4(-22-5) -4-0 x 10-4(-31.2)
Interequation correlation
(W12A(W11W22)1) -0-29(-16-6) -0-29(- 16-65)

Standard deviation in reduced form hours of work 0.28(93.9) 0.28(130.5)
Standard deviation in wage rate 0.59(143-1) 0.59(136)
a (substitution parameter) 1-4 x 10-3(49) 1-4 x 10-3(68-5)

Fixed effects
Hours (In A (0)-711)
Mean -20*5 -20 5
Standard deviation 0*52 0*56
Wage (712)
Mean 4*75 4-75
Standard deviation 0*52 0-53
Log likelihood value 5 95 x 103 6-01 x 103
selection bias by conditioning the sample likelihood by the probability of the event that a
woman works at least once in the eight years of panel data. Comparison of the estimates
from the unconditioned system with the estimates obtained from the conditioned system
reveals that there is little impact of conditioning on the estimated structural coefficients.
Inspection of the signs of estimated coefficients reveals that all variables operate as
hypothesized. "Total number of children currently in residence" and "young children
less than six " both raise the demand for time at home. Since children less than six are also
counted in total number of children, the estimated positive coefficient on the first variable
implies that younger children exert a greater demand for home time than older children-
an inference that previous researchers have drawn. In contrast with previous studies,
however, the current finding is a pure substitution effect holding A (0) constant. The
estimates reported here are free of any wealth effect of children and hence are pure
"household production " or " direct preference " effects.
The coefficient on the wife's age in the 4 system is an estimate of the difference
between the rate of interest and the rate of time preference (r - p). This difference ranges
between 1P33 per cent and 1-4 per cent, and is significantly different from zero.
There is no effect of family income on the wife's demand for leisure holdingA (0) fixed.
This result is consistent with permanent income theory and the model presented in this
paper. "Transitory" fluctuations in income have no effect on labour supply behaviour.
Mincer's (1962) hypothesis of an income smoothing motive for the wife's work activity
receives no support in this study. This finding does not imply that there is no effect of

138.199.58.56 on Fri, 02 Jun 2023 14:16:41 +00:00
income on participation. It does imply that the only channel of influence of income is
through A (0)-or life-time wealth-exactly as predicted by a model of perfect foresight with
no revision in plans.24
A similar finding emerges with respect to the impact of the husbands' measured hours
of unemployment on the wife's labour supply. The head's hours of unemployment appear
to have no effect on the wife's labour supply holding A (0).constant.25 However, retirement
or disability of the head results in an increase in the value of the wife's time and a reduction
in her labour supply, suggesting that the head's non-market time is complementary with
the wife's.
The estimates of the coefficients of the wage equation are entirely conventional.
Labour market variables do not determine wage rates. Wage growth decelerates over the
life cycle.
There is a strong negative correlation (-0.29) between the unobservables in the
reducedform demand for leisure function and the unobservables in the wage function. This
correlation implies that women whose unobserved components make them less likely to
work are the ones with lower unobserved components of wage rates. Holding wealth
effects constant, a higher value of the current wage leads women to supply more hours to
the market. The wage elasticity of demand for leisure time is essentially minus one.
Converted to a wage elasticity of labour supply (evaluated at the sample mean hours of
work for working women), the elasticity is 5.5.26 As previously noted a can be used to
compute the elasticity of substitution between leisure at different ages. The estimates of a
imply an elasticity of substitution roughly equal to 1. This estimate tends to refute
Mincer's contention that this elasticity of substitution is high.27
The similarity of the estimated fixed effects and the structural coefficients for the
unconditioned and the conditioned systems suggests that the sample selection bias that
might arise in estimating equations on samples of women who have worked at least once
does not appear to be an empirically important phenomenon in hours of work and wage
functions once fixed effects are introduced into labour supply and wage equations.
It is of considerable interest to investigate the effects of variables on the fixed effects
estimated from the wage rate and labour supply equations. By regressing the estimated
fixed effects on the sample means of the variables used in Table III, as well as on
variables-like education-that stay fixed over the sample period, it is possible to approxi-
mate the full life cycle labour supply function. Assuming that the number of observations
per person is " large ", such regression estimators are consistent and asymptotically normal
with correct standard errors given by the usual least squares formulae.
These results are reported in Table IV. According to the regressions of the estimated
fixed effect28 from the labour supply equation on explanatory variables, the effect of wife's
education is to depress it-a result consistent with the notion that wife's education
augments market and non-market resources of the household and hence generates a
positive wealth effect which translates into a negative effect on the marginal utility o
income, and hence a positive effect on the demand for leisure. Since the estimated fixed
effect includes both the direct effect of education. on the demand for leisure (operatin
through its effect on preferences) and the effect of education on resources (through A (0)),
the estimated effect of education reported here is net of these two effects. Any household
productivity augmenting effect of education that leads to more leisure being demanded is
outweighed by the wealth effect.
In contrast with the empirical results for transitory income reported in Table III,
"permanent" (really eight year average) family income depresses A(0)-statistically
significantly so-and raises the demand for leisure. Thus we find permanent wealth effects
of income but no "transitory" effects. Previous cross section work combines these two
effects.
Both the average number of children and the average expected number of children
raise A (0)-i.e. decrease wealth-exactly as would be expected if childbearing reduces the

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TABLE IV
Regressions of estimated fixed effects on life cycle variables and variables that remain fix
(Fixed effects generated from the model with parameter estimates reported in Table III. " t" statistics in
parentheses)
Unconditioned system Conditioned system

Variables L = 8760 L = 8760
Dependent variable: structural hours of

Intercept -20-4 -20-5
Wife's education (years) -0.055(-4.8) -0-057(-4-8)
Wife has advanced degree (dummy= 1 if yes) -0.324(-2.7) -0 38(-2 9)
Family income (8 yr. avg.) -1-08x 10- (-3-1) -1-2x 10- (-3.4)
Expected number of children (8 year average) 0 625(2 05) 0-64(2- 1)
Children less than 6 (8 year average) 0-11(1-43) 0.07(0.86)
Childbearing finished (8 year average) 0.55(1.16) 0.52(1.1)
Number of years to last birth (8 year average) -0048(-1.3) -0 054(-1.4)
Wife worked before marriage (8 year average) -0 051(-0*87) -0.058(-0.99)
Numbers of children (8 year average) 0 033(2.5) 0.032(2.33)
Mean experience (age-schooling-6) 0-012(4-22 0.013(3.8)
Mean unemployment hours 8.4 x 10 (0 3) 8*45 x lO-5(0.3)
Mean retired/disabled -0.66(-1 1) -0.54(-0.84)
R 2 0-31 0*325
Dependent variable:
Intercept 3-8 3-77
Wife's education (years) 0.07(6.75) 0.075(6.9)
Wife worked before marriage 0-056(0.91) 0-062(1.03)
County unemployment rate (8 year average) 0-013(0.96) 0-02(1-5)
Expectations of future work (8 year average) 0.08(1.7) 0.047(0.90)
Wife has advanced degree (dummy= 1 if yes) 0*3(2*3) 0-36(2-7)
Mean experience (age-schooling - 6) -0-4 x 10-3(-0-294) -3-4 x 10-3(-0.24)
Mean experience squared -1.3 x 10-5(-0-05) -4.4 x 10-5(-0. 19)
R2 0*23 0*251
flow of financial resources to the household by curtailing the life-time market activity of
the wife. The older the household, the higher A (0)-a result consistent with cohort effects
in initial wealth with later cohorts having higher initial wealth. The other variables entered
in the equation are not statistically significant at conventional levels and hence are not
discussed here.
Next consider the regressions of the estimated fixed effect from the wage equation on
the explanatory variables. As expected, education raises wage rates-and significantly so.
The estimated effect of education on wage rates is close to that reported in other studies.
The estimated coefficient on " advanced degree " is statistically significant suggesting that
the log wage-education relationship is non-linear. Higher values of county unemployment
rates appear to raise wage rates-a result consistent with recent work on "equalizing
differential " payments for unemployment risk. However, the coefficient is not statistical
significantly different from zero. Pre-marital work experience and future work expec-
tations do not appear to be significant determinants of wage rates. The insignificant
coefficients for the experience variables suggest that there are no cohort effects in wage
rates or initial endowments of skills that operate through simple shifts in the intercept in
the wage equation.
5. SUMMARY
This paper presents an empirically tractable life cycle model of the labour supply decisions
of married women. Two dimensions of labour supply activity-annual hours of work and
annual participation-are analysed in a coherent intertemporal framework. Two distinct

138.199.58.56 on Fri, 02 Jun 2023 14:16:41 +00:00
measures of life-time labour supply are considered. An implicit assumption maintained in

previous work-that non-market time at one age is a perfect substitute for non-market time
at any other age-is relaxed and the empirical work presented in the paper refutes it. The
paper considers the meaning and measurement of labour supply responses to
"permanent" and "transitory" income and wage rates in a model of decision making
under perfect certainty without credit constraints. Empirical evidence consistent with the
permanent income hypothesis is presented; we find no evidence of a married female labour
supply response to "transitory" income variation.
A simply computed fixed effect Tobit model suitable for analysis of panel data is
proposed and implemented. The fixed effect has a sound economic interpretation and
serves as a surrogate for a host of omitted life cycle variables that determine labour supply
decisions. The statistical model developed in this paper can be used to solve problems of
truncation and selection bias in long panels.
The model is estimated on eight years of panel data drawn from the Michigan Panel
Survey of Income Dynamics. Apart from the findings cited above, we find further
empirical results that are in accord with the predictions of the theory. Labour supply is
inversely related to life-time wealth measures. Children affect life-time labour supply
decisions. Future values of variables determine current labour supply decisions.
APPENDIX A
THE LIKELIHOOD FUNCTION AND ITS COMPUTATION
Altering the notation somewhat from that given in the text in order to simplify the
exposition, the wage equation for individual i at time t is
ln W(i, t) =X(i, t)f +r2(i) + V2(i, t), i = 1, ..., I, t = 1, ..., T. ...(A.1)
The equation for hours of work is
fK (i, t) + V1 (i, t) if V1 (i, t) <--K (i t)+lInLf

In (L- h (i, t)) = f V(i t)-K(i t)+ln L ... (A.2)
where
K(i, t)=f(i)++ t-Z(i, t) +X(i, t) (3

a -1 a-1 a-l'
f(i) (ln A (i, 0)-ln a -7q1(i)+q2(0)-

at-i
The joint distribution of (V1(i, t), V2(i, t)) is a bivariate normal with
E(Vk(i,t))=O, k=1,2; foralli,t
E(VI(i, t)Vk(j, r)=clk 1, k = 1, 2, ij, tr ... (A.3)

= 0 otherwise.
The joint density of (V1(i, t), V2(i, t)) may be written as
g(V&(, t), V2(i, t)).

This density may always be written as
g(V1(i, t), V2(i, 0) = 92(V2(i, t) I V1(i, t))gl(Vl(i, t))

i.e. as the product of the marginal and the conditional density, where
gi(Vi(i, t))= exp 1 (V0(i,t))1 ... (A.4)

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while
9 V2 (i t) _ 0 2 VI(i t
g2(V2(i, t) I V(i, t)) = 1(2 2 Y exp 2-- co_ _ ? /
l(2i)(022-0l2/0l)l exp (w22- 12/w11)
Let d(i, t) denote a dummy variable that assum

- K(i, t) + In.L and the value of zero when VI(i,
function for d (i, t), In W(i, t) and In (L- h(i, t)) may be written (ignoring inessential
constants) as
I T iK(i, t) -InL
In ( =1 (-d (i, t)) In b(D (i -nL
1
+i=1 t=l d(i, t)[-- in wol2 (in (L-h(i, t))-K(i, t))2]

2 2coll
__ @~~~~~~~~~~2 X . . (A.6)
+I ET t)1=l ( 012~w
+ E = Et ld(i, t) 2 In (022--
1 [In W(i, t)-X(i, t),B -72(i)- l(In (L-h(i,

2 (01~~21
2(022 -) A
where 'D is the cumulative distribution function of the unit normal. This likelihood
function is a life cycle version of Heckman's (1974b) cross section model of female labour
supply.
Subject to identifying exclusion restrictions, the likelihood function achieves a
maximum with respect to ,B, a, 4f, p - r, (011, (012, and (022, and p2(i) and f(i), i = 1, ...,
Note that L is treated as a known parameter in our work. Note that if d(i, t) = 0 for
observation i, t = 1, ..., T, no value of fl2(i)is defined, and the likelihood maximizing value
of f(i) is +0.
Define the following means of observations for which xT=1 d (i, t) > 0. (The positivity
condition is required to ensure that wages are observed at least once for individual i.
Otherwise, no estimate of the fixed effect for wages is possible.)
In W(i)-ET i In
= T (i)W(i, t)d(i, t)
Zt=l d(i, t)
T= X(i, t)d(i, t)
Et=l d(i, t)
K(i
in(-(i)) t=It=
T K(i, t)d (i, t)
In (fL-h(i))== In (L- h (i t))d(i, t)
Using this notation, the first order condition for an optimum for the l
72(i) iS
772(i) = In WV(i) -X_(i, t)(3-1-2(ln (L - h (i))

(Oil
Given f8, (012,'Oll, (022, a, f,, (p - r), and f(i), the likelihood maximizing value of fl2(i) M

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satisfy equation (A.7). From this equation, one can substitute for 2(i) in likelihood
function (A.6) to eliminate the parameter. The concentrated likelihood function so
obtained is then optimized.
The optimization algorithm operates as follows. Given a, 13, 4+, (p - r), 0r11, 0rl2,
(or o I, (012, w)22), one can optimize the function for f(i) for each individual (i = 1
who works at least one period. Given f(i), one can optimize with respect to the remaining
parameters of the model. Using an idea due to T.Anderson (1959), and extended by
Berndt, Hall, Hall and Hausman (1974), second derivatives of the likelihood function are
not explicitly computed. Instead, the summed outer product of the first partials of the log
likelihood is used to estimate the second partials of the log likelihood function. This
procedure greatly reduces the computational burden. Successive iterations on fixed effects
and parameters leads to rapid convergence of the likelihood to an optimum.
A LIKELIHOOD FUNCTION THAT CORRECTS FOR SMALL

SAMPLE CONDITIONING
As noted above, the estimated fixed effect for a woman who does not work during the
sample period is +oo. (This problem arises in the multivariate probit model (Heckman
(1979)), in the multivariate logit model (Andersen (1973, p. 69)), and in general fixed
effects quantal choice models.)
An alternative to likelihood function (A.6) that explicitly recognizes the conditioning
that arises from estimating the parameters on a subset of women who work at least once
(T=1 d(i, t) _ 1), is a conditional likelihood function that explicitly accounts for this
conditioning.
The probability that woman i works at least once in the T years of the panel is
P(i) = 1 -_fT1 ,(K(i t)-n L)

11
For convenience, let the first I - I observations be those on women who work while the
remaining I -I, observations are for those who do not. Then the conditional likelihoo
function is the same as that of equation (A.6) except I, is substituted everywhere for I, an
the log of the conditional probability of the sample
Et., ln P(i)
is subtracted from the function presented in equation (A.6) in order to properly condition
the sample. Assuming bounded values for the regressors and fixed effects limT, P(i) = 1
and the conditioning becomes irrelevant as T becomes large.
This conditional likelihood function is well behaved in the sense that it produces
estimators of all of the parameters of the model (except, of course, for f(i), i = II + 1, ..., I)
under the identification conditions previously given. Intuitively, it seems reasonable that
the conditional estimator should perform better than the unconditional estimator.
However, no formal proof of this has been developed. If I -* oo and T is fixed, neither
estimator is consistent for reasons already given. Nonetheless, correcting for sample
selection composition has been shown, in other work, to make important and plausible
differences in empirical estimates. Generalizing from that experience, it is plausible to
assert that such is the case in this model.
The concentration procedure introduced in the previous section can be used in the
conditional likelihood function as well.
APPENDIX B
This appendix develops the two measures of life-time labour supply give
and (10) in the text for the specific econometric model proposed in Section 3. Recall that

138.199.58.56 on Fri, 02 Jun 2023 14:16:41 +00:00
I(t) denotes a dummy variable indicating a woman's labour force participation status at
time t; in particular,
I1 if V1(t) _ -K(t) + ln L, (i.e. if a woman works) (B 1)

t 0 if V1(t) > -K(t) +ln L, (i.e. if a woman does not work)
where
K(t)=f + )t-Z(t) +X(t) =ln (L-h(t))-Vi(t).

a-1 a-1 a-i
Therefore, the total number of periods a woman is expected to work in her lifetime is
E{II} = E zT=0 I(t)
t=O Zprob (I(t) = 1)
_ T [(- K(t) +Iln L) ... .(B.2)

where E is the expectation operator, prob is the probability operator, 1 is the normal
cumulative distribution function, and W0 is the variance of V1(t). Since h(t)=
L - eln(L-h(t)), the empirical equation for hours of work in period t is given by
Le K(t)+V 1(t) if I1(t) = 1

h() 1 0 if I ( t) = 0 . . . (B.3)
So, expected hours of work in period t is
E(h(t))=E(h(t)II(t)= 1) prob (I(t)= 1)
= [L-eK(t)E(eVl(t) vi(t) = 1)] prob (I(t) = 1)

-iiK(t)+lIn_L\ K_ 29 Kt)IL
=Lt(t VJ() -)) eK(t)w71(w( ( lL1) ... (B.4)
Hence, the total number of hours a woman is expected to work in her lifetime is
E(HH)=E(Eto h(t))=Zt=0 L()( f K( )+L))
K(t)+2s?ll <s,(- (t)+(n01 1) }* (B. 5)
APPENDIX C
This appendix reports the exclusion criteria used to generate the samples used in the
empirical analysis. The primary sample is the Michigan Panel Survey of Income Dynamics
for 1976 (Institute for Social Research, 1976). In the total sample, 5862 observations
were available.
The following criteria were used, in order to construct the sample of 672 white
women, age 30-65 in 1968 who were continuously married to the same spouse in the years
1968-1975 used in this paper. The figures for observations lost are marginal losses given
the losses due to the criteria preceding the criterion in question.
(i) Families were restricted to have a male head, a usable age variable, and some wife
present in each year. Loss: 3375 observations.
(ii) The wife's age was restricted to be between 30 and 65 in 1968. Loss: 536
observations.

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(iii) Family composition was restricted to be stable, i.e. no change in the head or the
wife. Loss: 675 observations.
(iv) Observations were excluded if they were from the non-random low income
sample. Loss: 396 observations.
(v) Nonwhites were excluded. Loss: 90 observations.
(vi)* Good data (with no coding errors) available on city size. Loss: 20 observations.
(vii) Family income vari-ables were required to contain no coding or measured
misreporting error. Loss: 8 observations.
(viii) Education variables for the wife were required to be available. Loss: 2
observations.
(ix) If there is no answer to the annual labour force participation question (for the
wife), or if there is inconsistency between the question about participation and the wife's
earnings data, the observation was excluded. Loss: 34 observations.
(x)* If the wife's labour force experience not available from either the husband
(1975) or the wife (1976), the observation was rejected. Loss: 10 observations.
(xi)* If the wife's labour force experience measured (since 18) exceeds the maximum
possible (age minus 18), the observation is excluded. Loss: 36 observations.
(xii)* If the wife did not answer a question on her full time experience (defined as
whether she worked "full time" within a year), the observation was rejected. Loss: 7
observations.
(xiii) If the wage rate of unskilled labour in the wife's county of residence is not
available, the observation is excluded. Loss: 20 observations.
Other missing data were assigned the mean value of the complete observations.
This research was supported by NSF Grant SOC77-27136 and Grant 10-P-90748/9-01 from the Social
Security Administration. We are greatly indebted to Robert Cotterman for discussions on the contents of this
paper, and to Guillherme Sedlacek and Ralph Shnelvar for valuable research assistance. Angus Deaton, Bob and
Brownwyn Hall, John Pencavel and Guillherme Sedlacek provided useful comments on this paper. The authors
assume responsibility for any errors.
NOTES
1. For example, his estimated negative relationship between participation rates and wage rates.
2. These properties of these functions do not require the assumption of contemporaneous strong
separability (see Heckman (1974a) and (1976)).
3. Substituting the A (0) constant demand functions for goods consumption and leisure given by (6) and (7)
into the budget constraint given by (2) produces an equation that implicitly determines the equilibrium value of
A (0). Differentiating this equation with respect to b and using the restrictions implied by concavity of preferences
and strong separability verifies this result.
4. Thus in the log-linear specifications adopted by Ghez and Becker and Smith, A (0) is absorbed into an
intercept of the estimated demand functions. These authors do not assume contemporaneous strong separability.
5. Ghez and Becker do not interpret their parameter estimates as those of a A (0) constant demand function
but rather as estimates of a life-time utility constant demand system. They fail to note that as a consequence of
their assumption that the synthetic cohort is the experience of a single "representative" individual, not only
life-time utility but also A (0) is the same for each observation in the synthetic cohort. For development and
elaboration of this point see MaCurdy (1978).
6. Heckman's model can be used to approximate the model developed in the preceding section. However,
it is more general and does not require the assumption of intertemporal strong separability maintained above. If
that assumption is maintained, G3 < 0, but y is unsigned.
7. Heckman includes these variables in his analysis.
8. The argument implicitly assumes that households are credit constrained contrary to the model
developed above. We note, parenthetically, that even in this situation, the ordering of transitory and permanent
responses assumes a decline in income. For increases in income, the ordering is not obvious. This suggests an
asymmetry in the ordering of the absolute value responses depending on whether or not income increases or
decreases. This model has never been made explicit and is worthy of much more theoretical and empirical study.
9. See Heckman (1978c) for further discussion and development of these points. Similar points arise in
Friedman's model (1957, p. 15) when uncertainty is introduced.
* These variables were used in another part of Heckman's general project on female labour supply but not
in this paper.

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10. Mincer's definition (1962) can be put in this form as well. For a comparison of Cain's definition and
Mincer's, see Cain (1966, p. 93).
11. For an application of Nerlove's model to labour supply data, see Lillard (1978).
T 12. To compute these estimated values one requires linear restrictions of the form V(-
Zt=0 V(t) = 0. Obviously, one could estimate the wage function and the labour supply function jointly
literally extracting the components from the time series and plugging the estimated components into the labor
supply equation.
13. One can prove this result simply by substituting the wage components into labour supply equation (1),
and substituting out terms. Note that the optimality of least squares in this case rests crucially on the assumption
that V(t), X, and V(t -1) are uncorrelated with the disturbance in the labour supply equation (e (t)). If this
assumption is not made (and it seems unacceptably strong), other covariance restrictions must be imposed to
secure identification.
14. In the context of a labour supply model, uncertainty about preferences, or the state of the market, one
could meaningfully discuss differential responses to permanent or transitory components. With the exception of
the work by MaCurdy (1978), and Burdett and Mortensen (1977), there has been little work on labour supply
under uncertainty.
15. In fairness to Ghez and Becker, Smith and Heckman, panel data of the sort used in this paper were not
available when they performed their empirical work.
16. Marginal utility of income constant demand functions have been estimated as a computational device
by Houthakker and Taylor (1970,2nd ed., Chapter 5). See also the discussion in Phlips (1974, pp. 190-193 and
250-260). The essential difference between our work and that of Houthakker and Taylor and Phlips is that we
treat A (0) as a fixed effect that serves as a surrogate for missing data while they estimate the A (0) constant
functions as an intermediate step toward estimating a complete system of ordinary demand functions under the
assumption of no missing data. We thank Orley Ashenfelter for directing our attention to the work of
Houthakker and Taylor.
17. For this reason, it is inappropriate to treat A (0) as a random effect that is uncorrelated with explanatory
variables.
18. For the uncertainty case, A (0) is not a fixed effect. In fact, MaCurdy (1977) shows that ln A (t) is a
random walk with drift in the presence of uncertainty about interest rates and wage rates.
19. In Appendix A it is noted that it is possible to concentrate each likelihood function to achieve a simply
computed model.
20. Assuming time varying variables, the crucial assumption is T -* ao. One needs I -*00 to secure
consistent estimators of the effects of time invariant variables.
21. Monte Carlo investigations by Wright and Douglas (1976) for a fixed effect logit model produce further
evidence in support of this contention.
22. As noted in Appendix A, the estimated fixed effect for women who never work is 00 so that such women
contribute no information on the structural parameters of the model.
23. Sedlacek is currently incorporating endogenous experience into a model that resembles this one.
24. An alternative explanation for this result is that if there are errors in the income variables, deviations of
income from individual means-the variable used to perform the test in light of the fact that a fixed effect is entered
in the labour supply function-will be error ridden and our estimate of a response to transitory income change will
be biased toward zero.
25. It is important to note that hours of unemployment experienced by the head as measured in the
Michigan Panel Survey of Income Dynamics also include hours he spends out of work on strike.
26. Logarithmic differentiation of the identity h (t) = L - L(t) with respect to log wages yields
alnh -L alnL (1L) alnL

alnW L-LalnW h aln W
According to the estimates of a in Table III, (a ln Lla ln W) = -

work (1350) yields the above labour supply elasticities. If the system is re-estimated at L = 5000, most of the
estimated coefficients are unchanged but the implied labour supply elasticity is 2-7.
27. The restriction 0 < a < 1 given in equation (15) forces the estimated elasticity of substitution to exceed
unity. This restriction will be relaxed in our later work. Thus, although our estimate can be used to reject
Mincer's hypothesis of a very large elasticity of substitution, it cannot be considered as a definitive estimate of the
elasticity of substitution.
28. This is the fixed effect defined as ln A (0)-
29. In deriving this expression we rely on the following result: Let M = -K(t) +ln L and E(V1 (t)) = con,
then
E(eVl(t) |I(t) = 1) = (D(v/1)) v I | eXe-1(x2/ a ) dx
= (D (3))12 1 e0w11 e-((X-W11)2/2w11)dX

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= (4?(vM )))1 eiilt(Mj-7).
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06 Heckman MaCurdy

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A Life Cycle Model of Female Labour Supply

Author(s): James J. Heckman and Thomas E. Macurdy

Stable URL: https://www.jstor.org/stable/2297103

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A Life Cycle Model of Female

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1. SURVEY OF PREVIOUS WORK

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2. A DYNAMIC MODEL OF LABOUR FORCE PARTICIPATION

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fQ(0) = e rt[C(t) - W(t)(1-L(t))]dt. ... (2)

G'(C(t)) e ()tA (O) ...(3)

C(t) = C(e(p-r)tA (0)) ... (6)

L(t) = L(e(PrtA (0) W1(t)) = 1if J1(1)> e (p-r) tA(0)1V (t) 7

h (t) = h (e (pr)tA (0) W(t)) = 1 -L(e (pr)tA (0) W(t)), . . . (8)

ah(0)-0 and a W(t)

HH= j h(t)dt - h(e(P-r)tA(0)W(t))dt. ... (9)

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IIH I (t)dt. ... (10)

Lifetime labour supply concepts

W(t) = , '(t) O t ct', t" t _T

where w (t) is a smooth function of time and b is a non-negative cons

(M > e(-)() ... (11)

i.e. the marginal value of t

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2.1. Alternative Strategies for Estimating the Life Cycle Model

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In h (t) = d: +0 ETs t In W(j) + y In W(t) +q n Q(0) + e (t), t = 0O, ...,3 T. ...

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that Friedman's analysis of the consumption funct

As T -* 00, this definition agrees with Friedman's. Transitory income at age t

where f is a permanent component, and the V(t)'s are indep

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In h (t) = CO + C10 + C2 V(t) + C3 V(t -1) + C4fl(O) + e (t) . .. (14)

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In the labour supply function, A (0) summarizes m

3. AN ESTIMATABLE ECONOMETRIC MODEL OF LABOUR SUPPLY

U(t) = A (t) (L (t)) + B (t) (C(t))`, t = 0, ..., T ...(15)

A(t), B(t) > 0.

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So, lifetime utility is

T 1 -t(A(t)(L(t)) +B(t)(C(t))T). ..(16)

ln W(t) = X(t)8 + 62(t), t = 0, ..., T ... (17)

L(t) A() (1+P A (0) W(t) if the woman works

where L denotes the tot

(L- h( )) ( [ln A (0)-lna+(p-r)t-lnA(t)+lnW(t)] if the woman works

where the h(t) is hours of work. To simplify the notation, we assume

The disturbance vector ( 1(t), ?2(t)) is assumed to follow a components of variance

1(t) = r1 + U1(t) ... (20)

E(Ui(t) U1(t')) = o-i, i, j = 1, 2, t =t

Thus, non-zero covariance between Ul(t) and U2(t) is p

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ln if V,(t) >- 1t+Z(t) 1-X(t) 1+lnL

f= (InA (0)-ln a-1l +fl2) and VI(t)= (U2(t)-Ul(t)).

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4.2. Specification of the Model

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4.3. Empirical Results

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