Insurance and Opportunities: The Welfare Implications of Rising Wage Dispersion

58 Pages Posted: 5 Oct 2005

See all articles by Jonathan Heathcote

Jonathan Heathcote

Minneapolis Fed

Kjetil Storesletten

University of Oslo - Department of Economics; Centre for Economic Policy Research (CEPR)

Giovanni L. Violante

New York University, Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: August 2005

Abstract

This paper analyzes the welfare effects of changes in cross-sectional wage dispersion, using a class of tractable heterogeneous-agent economies. We emphasize a trade-off in the welfare calculation that arises when labor supply is endogenous. On the one hand, as wage uncertainty rises, so does the cost associated with missing insurance markets. On the other hand, greater wage inequality presents opportunities to increase aggregate productivity by concentrating market work among more productive workers. We find that the observed rise in wage dispersion in the United States over the past three decades implies a welfare loss roughly equivalent to a 2.5% decline in lifetime consumption. Assuming Cobb-Douglas preferences, this number is the result of a welfare gain of around 5% from the endogenous increase in productivity coupled with a loss of around 7.5% associated with greater volatility in consumption and leisure.

Keywords: Insurance, labor supply, productivity, wage dispersion, welfare

JEL Classification: D31, D58, D91, E21, J22, J31

Suggested Citation

Heathcote, Jonathan and Storesletten, Kjetil and Violante, Giovanni L., Insurance and Opportunities: The Welfare Implications of Rising Wage Dispersion (August 2005). CEPR Discussion Paper No. 5200. Available at SSRN: https://ssrn.com/abstract=821150

Jonathan Heathcote

Minneapolis Fed ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

HOME PAGE: http://www.jonathanheathcote.com

Kjetil Storesletten (Contact Author)

University of Oslo - Department of Economics ( email )

P.O. Box 1095 Blindern
N-0317 Oslo
Norway
+47 2284 4009 (Phone)
+47 2285 5035 (Fax)

HOME PAGE: http://folk.uio.no/kjstore/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Giovanni L. Violante

New York University, Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States
212-992-9771 (Phone)
212-995-4186 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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