Reconciling Cyclical Movements in the Marginal Value of Time and the Marginal Product of Labor

Recessions appear to be times when the marginal rate of substitution between goods and workers' time -- the marginal value of time -- falls below the marginal product of labor. If so, the allocation of workers' time is inefficient. I develop a model of households and production that reconciles cyclical movements in the marginal value of time and the marginal product of labor. The household part of the model takes microeconomic research on household data seriously. The model embodies the findings of this research that the Frisch elasticity of labor supply is less than one, that the intertemporal elasticity of substitution in consumption is less than one, and that consumption and hours of work are complements. The most important element of the reconciliation is an explicit treatment of unemployment in a search-and-matching setup with non-Nash bargaining. In the model, recessions do not result in private, bilateral inefficiency in the allocation of labor, but the unemployment rate may be socially inefficiently high.

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