The effects of uncertainty on savings, consumption, and labor supply

by Richard Buddin

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The purpose of this paper is to develop a theoretical model of individual savings, consumption, and labor supply under uncertainty. This paper differs from existing literature on savings under uncertainty by the explicit treatment of the labor supply decision. Previous work has implicitly assumed that labor supply was predetermined and uninfluenced by either the extent of uncertainty about future opportunities or the level of opportunities in any future state of the world. If labor supply is not exogenous, an individual's flexibility in an uncertain world is enhanced. When current market opportunities are large relative to expected future opportunities, the individual can increase current hours and savings to hedge against future adversity. Similarly, when relatively adverse market opportunities prevail, the individual can substitute into leisure time activities or home production.

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