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Ch. 7: LIFE-CYCLE ASPECTS OF LABOR SUPPLY.

Ch. 7: LIFE-CYCLE ASPECTS OF LABOR SUPPLY. Choice of retirement age. Choice of retirement age. Steepness of indifference curve reflects willingness to postpone retirement for additional income. Steepness of budget constraint determined by earnings profile Social Security formula

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Ch. 7: LIFE-CYCLE ASPECTS OF LABOR SUPPLY.

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  1. Ch. 7: LIFE-CYCLE ASPECTS OF LABOR SUPPLY. • Choice of retirement age

  2. Choice of retirement age • Steepness of indifference curve reflects willingness to postpone retirement for additional income. • Steepness of budget constraint determined by • earnings profile • Social Security formula • pension plan features. • Pure Wealth effect would result from a parallel shift of budget constraint (e.g. win lottery, inherit money) • Wealth and substitution effect would result if slope of budget constraint is altered.

  3. Choice of retirement age • If the financial rewards to postponing retirement beyond age 62 are increased, the person with is faced with a wealth and substitution effect. • Wealth effect: Holding retirement age constant, the person has greater wealth and will retire sooner. • Substitution Effect: Holding wealth constant, the reward to postponing retirement has increased .. substitute money for years in retirement. • Net effect: Ambiguous.

  4. Choice of retirement age • Effect of increasing rewards to postponed retirement subst efffect > Wealth effect Wealth effect > subst efffect R*

  5. Choice of retirement age • How do each of the following affect retirement age? • steepness of earnings profile? • Social Security formulae • Calculating AIME & PIA • reductions for early retirement • credits for postponed retirement.

  6. Choice of retirement age • Private pensions • Defined benefit plan • life annuity promised at retirement. • annuity payment generally tied to years of service, final salary, and a "generosity factor". • PV of defined benefit plan may eventually fall with retirement age (fewer years to collect annuity versus increase in size of annuity). • “Actuarially fair” adjustment for postponing retirement by one year keeps PV of pension independent of retirement age. • If life expectancy is 80, what is actuarially fair adjustment for a worker who collect an annuity of $50,000 annually at age 65, assuming interest rate=0? If interest rate>0?

  7. Choice of retirement age • Private pensions • Defined Contribution Plan. • a savings account that the worker may receive as a lump sum at retirement. • PV of defined contribution plan grows with retirement age because contributions are added over time. • Over time, there has been a switch from defined benefit to defined contribution plans. • What's the effect of switching from DB to DC plans on retirement incentives?

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