Slutsky Equation and Negative Elasticity of Labor Supply: Behavioral Bias or Optimal Consumption-Leisure Choice?



Summary

One of the applications of the prospect theory is the behavioral phenomenon of the negative elasticity of the individual labor supply. This paper argues that the negative elasticity of labor supply can be understood better with the help of the interpretation of the Slutsky equation with regard to the common consumption-leisure choice. The interpretation of the Slutsky equation corresponds to the empirical evidence that leisure is a net complement for an important part of consumption.


Keywords

Slutsky equation, prospect theory, labor supply, consumption-leisure choice