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I was asked the following by a student (I work in mathematics/complex systems, my student in econometrics):

In econometric studies that measure the elasticity of labor supply and inform policymakers on the labor supply costs of various potential policy structures, researchers often find, for example, that 'wage decrease due to policy $X$ has an elasticity of 0.2.' This implies a 10% decrease in wage results in a 2% decrease in labor supply. However, it seems these studies may not fully consider the implications in an equilibrium context, where a sequence of events could occur, such as the price moving down, leading to a reduction in labor supply, which then moves the price up again, creating a feedback loop. How do economists address or account for these feedback loops when advising policymakers based on labor supply elasticity measurements?

I was suggesting this would have been studied somewhere before, perhaps in an economics textbook? Could anyone discuss what is known about this idea of seemingly paradoxical/unrealistic spiraling of labour supply due to an initial small decrease in wages/increase in taxation?

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  • $\begingroup$ "n econometric studies that measure the elasticity of labor supply" It would be helpful to be given a specific study to get a better picture of what your student is thinking of. $\endgroup$
    – Giskard
    Jan 27 at 6:07
  • $\begingroup$ Could you potentially recommend an article or review that discusses the effect of wages or taxation on labour supply? Something that presents the basic theory of how these variables are related, I can provide it as reading. It should help answer the question for him to be exposed to the theory. $\endgroup$
    – apg
    Jan 27 at 14:09
  • $\begingroup$ I sure can't! But I think getting the reference from the student might make an answer by others easier. Also, some info on their level (BA, MSc, PhD) might be nice! $\endgroup$
    – Giskard
    Jan 27 at 17:34
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    $\begingroup$ The student (PhD) is not particularly clear about the literature, but is a good innovator, so is conjuring ideas up which may have been thought of before (based on some knowledge of economics from lectures in past courses). I just can't see where information about this sort of self-reinforcing decline in wages would appear. In a textbook? On labour economics perhaps? $\endgroup$
    – apg
    Jan 27 at 20:15

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How do economists address or account for these feedback loops when advising policymakers based on labor supply elasticity measurements?

Estimates refer to an equilibrium context. Policy analysts are supposed to anticipate and reflect in their estimate the overall impact that the policy at issue would have on other variables. Otherwise an estimate would be meaningless due to how economic agents react to that policy.

Analysis of a policy entails consideration of how the policy is expected to impact supply and demand curves. Translated to graphical terms, the policy might cause a change of slope and/or a shift of the curve(s). Statements such as "policy X will cause the wage to have an elasticity of 0.2" simply are readings of the resulting curve(s), in this case of their slope at the equilibrium point.

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