Loss Aversion and Labor Supply

Abstract

In many occupations workers’ labor supply choices are constrained by institutional rulesregulating labor time and effort provision. This renders explicit tests of the neoclassical theoryof labor supply difficult. Here we present evidence from studies examining labor supplyresponses in “neoclassical environments” in which workers are free to choose when and howmuch to work. Despite the favorable environment the results cast doubt on the neoclassicalmodel. They are, however, consistent with a model of reference dependent preferencesexhibiting loss aversion and diminishing sensitivity.

Keywords: loss aversion, intertemporal substitution, labor supply, reference dependent preferences

JEL Classification: J22, B49