Reservation Wage as an Average Over a Planning Horizon
To calculate an individual's reservation wage, one must determine the total expected value of their reservation option over a specific planning period. This calculation relies on averages because key factors, such as the exact duration of unemployment and the precise wage of a future job, are uncertain. The value is composed of two parts: the utility received during the expected period of unemployment (e.g., for weeks) and the utility from the new job they expect to find for the remainder of the period (e.g., for weeks). The reservation wage () is then defined as the average of this total value, calculated by dividing it by the total length of the planning horizon (). This is expressed by the formula: Where: - is the expected number of weeks unemployed. - is the weekly utility while unemployed (unemployment benefit plus individual-specific utility). - is the remaining number of weeks in the planning horizon, spent employed. - is the net utility from the new job. - is the total length of the planning horizon in weeks.
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Learn After
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