Local Price Variation and Labor Supply Behavior

ences can be quite large, especially for housing. For example, according to 1990 Census data, the median housing price in New York is more than three times that of the median housing price in Cleveland.2 The question addressed in this paper is whether the common practice of ignoring local price variation in labor supply studies is as innocuous as has generally been assumed. In standard economic theory, labor supply decisions depend on the complete set of prices: the wages and the prices of relevant consumption goods. Nonetheless, as Abbott and Ashenfelter (1976) noted some 30 years ago, economists generally have found it a useful abstraction, in both theoretical and empirical work, to ignore prices other than wages in labor supply studies. For example, none of the empirical results on labor supply discussed in the prominent reviews of Pencavel (1986), Killingsworth and Heckman (1986), or Blundell and MaCurdy (1999) are derived by procedures that account for variation in any price other than wages.1 However, most empirical work on labor does use national datasets of individuals who live in different locations and therefore face different prices for locally priced goods. These price differIn standard economic theory, labor supply decisions depend on the complete set of prices: wages and the prices of relevant consumption goods. Nonetheless, most theoretical and empirical work in labor supply studies ignore prices other than wages. We address the question of whether the common practice of ignoring local price variation in labor supply studies is as innocuous as generally assumed. We describe a simple model to demonstrate that the effects of wage and nonlabor income on labor supply typically differ by location. In particular, we show that the derivative of the labor supply with respect to nonlabor income is independent of price only when the labor supply takes a form based on an implausible separability condition. Empirical evidence demonstrates that the effect of price on labor supply is not a simple “up-or-down shift” that would be required to meet the separability condition in our key proposition. (JEL J01, J21, R23)