Behavioral Economics and Happiness 1

Running Head: BEHAVIORAL ECONOMICS AND HAPPINESS

Behavioral Economics and Happiness: Can the former impact the latter?

Scott Thor
 Behavioral Economics and Happiness 2

Abstract

The field of economics has progressed significantly over the last several centuries, beginning

with its establishment as a separate discipline by Smith in the 1700s, and evolving more recently

into numerous sub disciplines such as behavioral and happiness economics. The field of

psychology was yet to be established during the birth of economics, but an argument can be

made that early economic scholars did not exclude psychological factors into their thoughts on

the subject. A gradual transition to a purely quantitative approach emerged as the discipline

progressed, and psychological factors were considered irrelevant in the economic models that

assume individuals always act rationally. Recently, a transition has begun to take place

suggesting irrational behavior cannot be ignored, which has led to the field of behavioral

economics discussed in this paper. Behavioral economists argue that a greater understanding of

irrational behavior may lead to advancements in the field of economics. This paper also argues

that by increasing the understanding of irrational behavior we may also uncover opportunities to

increase happiness. Happiness economics has emerged as a sub discipline of economics over the

last several decades and seeks to understand what makes us happy. This paper also provides a

historical overview in the study of happiness, and offers suggestions on how behavioral

economic theory may help increase levels of happiness. The paper also explores the historical

influences in both fields of study. A final discussion point includes criticisms of behavioral and

happiness economics by many researchers and scholars who suggest the experimental and

subjective nature of both adds little value to economic thinking.

 Behavioral Economics and Happiness 3

Introduction

Little argument is needed to suggest that increasing happiness is a worthy endeavor. We

all strive to live a life in which we seek happiness through a variety of means. Even the founding

fathers of the U.S., who included the pursuit of happiness in the Declaration of Independence,

believed happiness was, and one could argue still is, a critical element to the foundation of the

country. The challenge then becomes understanding what makes us happy, and how we position

ourselves to maximize opportunities to create happiness.

The field of economics provides one potential source in understanding both how to

improve happiness, and the potential discovery of factors contributing to increasing levels of

happiness. The evolution of economics has progressed significantly since Smith helped to

establish the discipline in the 1700s. Over the past several centuries the field of economics has

evolved, transitioning from a study in which psychological factors were once considered, to a

primarily quantitative approach, placing a heavy emphasis on rational behavior represented by

statistical models (Camerer & Loewenstein, 2004).

The pursuit of perfection in the quantitative models used by economists make the

assumption that individuals always act in a rational manner, and have all available information

needed to make a correct decision when faced with several choices. Two psychologists, Tversky

and Kahneman (1974), argue that individuals do not always act rationally, and often rely on a

number of heuristics that sometimes lead to systematic errors when faced with making a

decision. If the arguments made by Tversky and Kahneman are valid, as many modern

economists believe (Ariely, 2008, 2009; Camerer & Loewenstein, 2004; Tideman, 2005), the

foundation of rational thinking represented in economic models may not be as accurate as once
 Behavioral Economics and Happiness 4

thought. The early work done by Tversky and Kahneman gave rise to what has become the

economic sub discipline of behavioral economics.

Camerer and Loewenstein (2004) describe behavioral economics as a way to increase the

“explanatory power of economics by providing it with more realistic psychological foundations”

(p. 3). The authors argue that behavioral economics provides a means for generating additional

economic insights, which result in better predictions of field phenomena, ultimately leading to

better policies. Camerer and Loewenstein suggest that behavioral economics is not meant to

replace the neoclassical approach, but does provide a basis on which to add to the foundations of

economic thought rooted in the neoclassical perspective.

During the same time in which behavioral economics was emerging as a sub discipline of

economics so to was the study of individual happiness. This research would eventually lead to

the development of another sub discipline of economics described as happiness economics.

Graham (2009) defines happiness economics as “an approach to assessing welfare which

combines the techniques typically used by economists with those more commonly used by

psychologists” (p. 6). Stated in more general terms, happiness economics can be described as a

combination of psychology and economic techniques for better understanding a society’s level of

happiness through quantitative analysis, typically assessed by individual surveys.

Easterlin (1974) conducted what has become seminal work in the field of happiness

economics that led to the development of the “Easterlin Paradox” (Graham, 2009, p. 12), which

argues that within a society the rich are happier than the poor, rich societies tend to not be

happier than poor societies once basic needs are met, and as countries become wealthier they do

not get happier. Since Easterlin’s early work, the field has emerged into an exciting body of
 Behavioral Economics and Happiness 5

research that has uncovered several elements that have been argued to have a relationship with

levels of happiness.

The primary focus of this paper is to explore behavioral and happiness economics. The

paper provides a historical overview and detailed discussion describing the evolution of

behavioral and happiness economics. Both fields of study are not without critics, and discussions

on the criticisms of both economic perspectives are also reviewed. A final aspect to the paper is a

discussion into whether or not the possibility behavioral economic thinking may have a positive

impact on increasing happiness.

Behavioral Economics

Camerer (2006) describes economics as “a collection of ideas and conventions which

economists accept and use to reason with. Namely, it’s a culture” (p. 2). Behavioral economics,

as Camerer states, “represents a change in that culture” (p. 2). One could argue the field of

economics has been in a constant state of change since it emerged as a separate discipline in the

1700s, but the rise of behavioral economics over the past few decades may represent one of the

most radical changes in economic theory since classical economic thinking emerged.

Defining Behavioral Economics

No standard definition of behavioral economics exists, but several researchers, scholars,

and authors have offered their perspectives on defining the developing body of knowledge.

Mullainathan and Thaler (2000) describe behavioral economics as a combination of psychology

and economics that seeks to understand what happens when individuals within a market display

human limitations and complications. Diamond and Vartiainen (2007) suggest behavioral

economics is an “umbrella of approaches” (p. 1) that seeks to build on the conventional

economic framework to account for human behavior not modeled into traditional economic
 Behavioral Economics and Happiness 6

designs. Angner and Loewenstein (2007) reinforce the aforementioned descriptions, adding the

emphasis that behavioral economics provides a means for improving the explanatory and

predictive power within economic thinking. Thus, behavioral economics can be summarized as a

melding of psychology, sociology, and economics that provides an approach to better

understanding why individuals make decisions, that in the view of traditional economic thinking,

are irrational.

The Need for and Benefits of Behavioral Economics

Why is behavioral economics a worthy endeavor? What benefits can be derived from a

better understanding into why individuals make decisions that are not based on rational thought?

Behavioral economists offer several answers and arguments to these questions, most of which

suggest that behavioral economics fills a critical gap left void by conventional economic

thinking.

Mullainathan and Thaler (2000) argue that conventional, or neoclassical, economic

thinking views the world as being populated by unemotional, calculating maximizers known as

“Homo Economicus” (p. 3). The Homo Economicus, what Thaler and Sunstein (2009) describe

as “economic man” (p. 6), suggests we all think and make choices without mistakes. This view

of economics argues for an “anti-behavioral” (Mullainathan &Thaler, p. 3) perspective long

considered a cornerstone in neoclassical economics. Mullainathan and Thaler suggest that

neoclassical economists who argue that markets will wipe out irrational behavior are optimistic.

They argue that based on recent empirical and experimental research, behavioral economists

suggest the power of irrational behavior cannot be eliminated based on what neoclassical

economists believe is a self-correcting “invisible hand” (Mankiw, 2008, p. 10) described by

Smith as the forces of supply and demand, self-interest, and competition.

 Behavioral Economics and Happiness 7

Behavioral economics, argue Camerer and Loewenstein (2004), also offers an

opportunity to create better policy. An argument can be made that if individuals frequently make

irrational acts, by better understanding this behavior economists have the potential to improve

not only markets, but also society as a whole. Mullainathan and Thaler (2000) provide a

summation to the need and benefits of behavioral economic research, which they describe in two

key elements. First, the field of research identifies ways in which actual behavior differs from the

standard models, and second, behavioral economics illustrates how this behavior matters to the

economic environment.

Evolution of Behavioral Economic Thinking

An argument can be made that behavioral economics was born out of research grounded

in the field of cognitive psychology. Tversky and Kahneman (1974), both psychologists, are

widely recognized as providing the impetus for which a number of behavioral economic

concepts and theories are based upon (Angner & Loewenstein, 2007; Camerer & Lowenstein,

2004; Diamond & Vartiainen, 2007). The psychologists suggest individuals are biased in their

judgments and often rely on a series of heuristics, often described as “rules of thumb”

(Mullainathan & Thaler, p. 5), which can lead to systematic errors in judgment. Kahneman and

Tversky (1979) have also challenged expected utility theory, which argues that decision makers

choose between uncertain or risky prospects by comparing their expected utility values (Davis,

Hands, & Maki, 1998), with a theory of their own which they define as prospect theory. Prospect

theory can be described as a theory that tries to model decisions an individual makes in real life

situations, unlike expected utility theory which models the optimal decision (Kahneman &

Tversky, 1979).
 Behavioral Economics and Happiness 8

In their early work Tversky and Kahneman (1974) describe three heuristics that include

representativeness, availability, and adjustment and anchoring. The researchers argue that

individuals rely on heuristics as a means to reduce complicated tasks of predicting values and

assessing probabilities into simple judgment activities. Tversky and Kahneman believe heuristics

can be useful in making decisions, but can also lead to choices conventional economists, and

perhaps people in general, would judge to be irrational.

The representativeness heuristic is a means to which individuals make a decision or

prediction based on the probability of comparable known events and/or objects. For example, if

Scott is described as a “quiet intellectual who is a superlative academic writer that is well read in

the subject of economics”, when asked for the probability of his occupation as that of a

consultant or an economist, one is likely to believe the description is more representative of the

latter than the former, even though it is quite possible he could be a consultant. Similarity, or

representativeness, Tversky and Kahneman (1974) argue, leads to errors because neither is

influenced by the factors that should be used to assess probabilities for making judgments.

Representativeness, Tversky and Kahneman (1974) posit, leads to a number of

systematic mistakes that include insensitivity to prior probability of outcomes, sample size, and

predictability. In experiments conducted by the researchers in which they asked participants to

determine the probability about an individual’s occupation based on a description of the person,

such as the previous one about Scott, in addition to the statistical composition of the sample

group from which the person was drawn (i.e. 30 economists and 70 consultants), participants

ignored the statistics, which suggest a .3 chance Scott is an economist and a .7 chance he is a

consultant, and instead based their decision on the description of Scott. Participants did,

however, make correct probabilities when given only statistical data related to the composition of
 Behavioral Economics and Happiness 9

the group. This, argue Tversky and Kahneman, demonstrates that when given irrelevant

information prior probabilities are ignored, but when given no specific evidence such as a

description, prior probabilities are correctly utilized.

The researchers found similar conclusions related to sample size in which the judgments

of participants failed to appreciate the need to evaluate sample size when making decisions.

Tversky and Kahneman also uncovered insensitivities to predictability related to predictions such

as the future value of a stock. Through their experimentation the researchers found that

participants based the value of a stock differently for two companies when only descriptive data

was given for each, which should have led to equal values for each company since descriptive

data has no relation to stock price or profitability.

The availability heuristic, argue Tversky and Kahneman (1974), is based on the theory

that the frequency of a phenomenon or the probability of an event that a person has foremost in

their mind will lead to mistakes in judgment. For example, the risk of becoming diabetic by men

over the age of forty may be assessed by recalling the number of acquaintances one has to such

individuals. The researchers also argue the availability heuristic can lead to biases due to the

retrievability of instances, such as the belief that the likelihood of a car accident is higher after

driving by an accident. Even though the chances for an accident have not changed, after

witnessing an accident individuals are more likely to believe the odds of being involved in one

are higher. Tversky and Kahneman suggest that individuals place a higher probability of an event

happening when it is foremost in their memory, which can lead to errors in judgment.

The final heuristic offered by Tversky and Kahneman (1974) is the belief that when given

a starting point individuals tend to make judgments based on that point even though it may have

no relationship with making a rational decision. The researchers define this heuristic as adjusting
 Behavioral Economics and Happiness 10

and anchoring. Ariely (2008) recently conducted a series of experiments based upon the

anchoring heuristic in which participants were asked to bid on a number of items. Before bidding

on the items, which included an assortment of electronics, books, food, and wine, participants

were asked to write the last two digits of their Social Security number in the upper corner of their

bid sheet. The participants then wrote this same number next to each item listed on their bid

sheet, and then answered with a yes or no whether they would pay that amount for the item. For

example, if the last two digits of a participant’s Social Security number were 62 would they pay

62 dollars for a bottle of 1996 Hermitage wine, or would they pay 62 dollars for a cordless

keyboard? Ariely, as would Tversky and Kahneman, argues that a rational person should not be

influenced by the Social Security number and should bid on the items based on their actual

value. The results of the experiment reveal a drastically different result. Ariely discovered that

participants with higher Social Security numbers outbid those with lower numbers. The

researcher also demonstrated a statistically significant correlation between a participant’s Social

Security number and the bid price for each item, suggesting arbitrary information has the

potential to distort the decision making process.

Emanating from their work with heuristics, Kahneman and Tversky (1979) sought to

develop a theory to better predict decision making under risk. In contrast to expected utility

theory that had previously dominated analysis of decision making under risk, Kahneman and

Tversky propose an alternative theory, which they label prospect theory. Prior to their work,

expected utility theory was generally accepted as the normative model of rational choice

(Keeney & Raiffa, 1976), and was widely applied as the descriptive model of economic behavior

(Arrow, 1971; Friedman & Savage, 1948). This led to the belief that individuals usually act in a

rational manner, modeled in the expected utility theory.

 Behavioral Economics and Happiness 11

In prospect theory Kahneman and Tversky (1979) challenge expected utility theory,

suggesting people tend to outweigh probable outcomes in comparison to outcomes that are most

certain. The researchers describe this as the certainty effect, which contributes to avoiding risks

in decisions that lead to sure gains, and taking unnecessary risks in decisions that lead to sure

losses. Kahneman and Tversky also believe that individuals eliminate elements that are common

to all prospects, which they argue leads to inconsistent preferences when the same options are

presented in different forms. They describe this as the isolation effect. In their theory Kahneman

and Tversky assign values to gains and losses instead of the asset, and probabilities are replaced

by decision weights. The result is what the researchers call the value function illustrated in

Figure 1. In the value function the curve is typically concave for gains and convex for losses, and

has a steeper slope for losses than for gains, suggesting a decrease in sensitivity for gains and

losses the larger they are, and the further they lie from the reference point.

Figure 1. The value function suggests individuals assign greater value to losses than they do to

gains. From Wikipedia (n.d.). Prospect theory. Retrieved November 29, 2010 from

http://en.wikipedia.org/wiki/File:Valuefun.jpg

The value function can be described by the concept of loss aversion, which argues that

individuals would rather avoid losses to increasing gains (Kahneman, Knetsch, & Thaler, 1991).

Kahneman, Knetsch, and Thaler conducted experiments with Cornell University students that
 Behavioral Economics and Happiness 12

illustrate the loss aversion concept in which some students were given coffee mugs and others

were not. The students were then given the opportunity to either sell or buy mugs from each

other. What the researchers discovered was that many of those with mugs were reluctant to sell

them, suggesting a greater loss of utility outweighs the increase in utility from either selling or

purchasing a mug, respectively.

Several other concepts have evolved from the foundational work conducted by

Kahneman and Tversky that include fairness, self-serving bias, and present bias. McDonald

(2008) describes fairness as a false assumption by conventional economists who believe

individuals are only interested in the volume of goods and services they get to consume, which

behavioral economists believe to be inconsistent with human behavior. A number of experiments

have challenged the notion of fairness, most notably the ultimatum experiment. In this

experiment one person plays the role of proposer and the other of responder. The proposer is

given an amount of money to divide between the two, which is done if the responder agrees to

the proposed share. If the responder does not agree neither participant receives any money. In

most experiments proposers offer on average 40 percent of the money, which is usually accepted,

and in cases where the offer is less than 20 percent the offer is typically rejected (McDonald).

This, argued by behavioral economists, is in contrast to what conventional economics would

suggest.

The self serving bias is demonstrated through surveys in which 90 percent of people

place themselves in the top 50 percent of managerial skills, driving ability, health, productivity,

and ethics (McDonald, 2008). Clearly many of them are wrong since only 50 percent can be in

the top 50 percent. Present bias contradicts conventional economic thinking that assumes

individuals discount the future using the rate of time preference, but experimental research
 Behavioral Economics and Happiness 13

suggests people tend to place more emphasis on the present, which may lead to bad decisions

(McDonald). Some examples include saving too little for retirement and eating an unhealthy diet.

The early work conducted by Tversky, Kahneman, and several others helped to establish

a consistent methodology that has continued to be the basis for much of the contemporary work

in behavioral economics. Camerer and Loewenstein (2004) describe this pattern of research

consisting of four steps that include evaluating normative assumptions used by economists,

identifying anomalies in the assumptions, creating alternative theories that address the

anomalies, concluding with the development of new theories and models that can be tested.

While the majority or early behavioral economic research focused on laboratory experiments,

recent work has evolved into field research, computer simulation, and a new emerging field of

neuroeconomics that may offer new insights into decision making through the use of brain scans.

Historical Influences

Despite the recent popularity in the field of behavioral economics, an argument could be

made that many of the thoughts in which the subject is based can be found in work conducted

throughout the classical and neoclassical periods. Psychological themes are abundant in the work

of many early economists, but the drive to develop the perfect economic model, and the

advancement of statistical analysis capabilities, drove the field of study away from a mixture of

qualitative and quantitative analysis to a purely mathematical approach (Camerer &

Loewenstein, 2004). Several prominent economists even suggested psychology had no part in the

study of economics, pushing the subjects even further apart. Perhaps the most vocal was Robbins

(1932) who stated:

Why the human animal attaches particular value in this behaviouristic sense to

particular things is a question, which we do not discuss. That may be quite

 Behavioral Economics and Happiness 14

properly a question for psychologists or perhaps even physiologists. All that we

need to assume is the obvious fact that different possibilities offer different

stimuli to behavior, and that these stimuli can be arranged in order of their

intensity. (p. 86)

With a clear link between psychology and economics developing with the behavioral

economic movement, contemporary economic researchers have begun looking back to early

influences that include the work of Smith and Keynes (Angner & Loewenstein, 2007; Ashraf,

Camerer, & Loewenstein, 2005; Camerer & Loewenstein, 2004; Pech & Milan, 2009).

Ashraf, Camerer, and Loewenstein (2005) explore “passions” and the “impartial

spectator” (p. 131) Smith wrote about in his early work. The researchers describe passions as

hunger, sex, emotion, fear, and pain, and the impartial spectator as a moral third person looking

over an individual’s shoulder. Ashraf et al. argue that Smith believed the impartial spectator

could be led astray by emotions. The researchers quote Smith (1759/2007) who states:

There are some situations which bear so hard upon human nature that the greatest

degree of self-government…is not able to stifle, altogether, the voice of human

weakness, or reduce the violence of the passions to that pitch of moderation,

which the impartial spectator can entirely enter into them. (p. 132)

Camerer and Loewenstein (2004) also quote Smith who stated, “we suffer more…when

we fall from a better to worse situation, than we ever enjoy when we rise from a worse to better”

(p. 4). The authors argue this is a clear demonstration of the concept of loss aversion discussed

previously. One can hardly argue against Smith believing psychological factors influenced

economic behavior.
 Behavioral Economics and Happiness 15

Keynes has also been the focus of many behavioral economists suggesting, like Smith, he

also considered behavioral factors important to economic thought. Pech and Milan (2009)

explore Keynes’ work for links to behavioral economics arguing his research is filled with

references to psychological underpinnings. One of the key findings the researchers argue is that

Keynes made numerous references to the concept of heuristics common to behavioral economic

theory. Pech and Milan cite Keynes (1964) who states:

It would be foolish, in forming our expectations, to attach great weight to matters

which are very uncertain. It is reasonable, therefore, to be guided to a

considerable degree by the facts about which we feel somewhat confident, even

though they may be less decisively relevant to the issue than other factors about

which our knowledge is vague and scant. (p. 148)

Pech and Milan (2009) argue this passage is a clear link to the availability heuristic. The

authors go on to argue Keynes’ work has ties to behavioral economics citing numerous passages

from Keynes’ writing using the word “psychological” and/or “psychology”. Pech and Milan also

argue Keynes’ thoughts had ties to other heuristics such as representativeness and anchoring.

Criticisms of Behavioral Economics

Despite the research suggesting behavioral economic thinking provides a new means of

contributing to the body of knowledge within the field of economics, criticisms still exist,

making behavioral economics a somewhat controversial field of study. The critics argue a

number of points such as, experimentally observed behavior does not accurately mimic the true

market (Myagkov & Plott, 1997), and that markets will cancel out individual psychology

(Stewart, 2005).
 Behavioral Economics and Happiness 16

Over the past several decades behavioral experiments have been replicated numerous

times with similar results, providing an argument the conclusions reached through early

experimentation have validity (Camerer, Loewenstein, & Rabin, 2004; Rabin, 1998).

Conventional economists continue to believe individual behavior is not significant enough to

shift markets, and behavioral economists agree (Stewart, 2005) more work is needed to push

their side of the argument further, suggesting the controversial nature of this research is likely to

continue into the future. What is abundantly clear is that both sides of the argument want to

continue to develop the field of economics in pursuit of greater understanding, which is likely to

result if existing theories continue to be challenged.

Happiness Economics

Aristotle was believed to have stated, “happiness is the meaning and purpose of life, the

whole aim and end of human existence” (Schwerin, n.d., p. 4). Little argument is needed that

living a happy life is desirable, but what can be argued is what leads to happiness, and whether

greater understanding of happiness is of value in the field of economics. Research on happiness

amongst economists was nearly non-existent three decades ago, but has since risen in popularity,

reaching over one thousand economic journal articles having “happiness” in the title as of 2007

(Clark, Frijters, & Shields, 2008).

Graham (2009) describes happiness economics as “an approach to assessing welfare

which combines the techniques typically used by economists with those more commonly used by

psychologists” (p. 6). Similar to behavioral economics in relation to psychological factors,

happiness was a focus of early philosophers and economists such as Aristotle, Bentham, Mill and

Smith, but as a transition to a more quantitative approach in economics progressed less emphasis

was put into understanding the subjective concept of happiness (Graham). Believing all humans
 Behavioral Economics and Happiness 17

act in a rational manner, neoclassical economists have been challenged in their assumptions

related to maximizing utility, which leads one to argue that choices such as those related to

selecting a job are based purely on quantitative measures such as salary. Happiness economists

have challenged this assumption suggesting that despite the opportunity to earn a higher salary

many individuals often choose a job with lower compensation that provides a greater level of

happiness. If, as happiness economists argue, individuals seek not to maximize utility, but to

balance utility with happiness, then the challenge becomes measuring and understanding what

leads to happiness.

Measuring Happiness

As the study of happiness has emerged several methods for measuring the construct have

been utilized. The primary method of measurement is through survey data represented by a

number of questions asked to participants related to their current level of happiness. The process

of surveying individuals has ranged from highly complex systems to simple multiple-choice

questions.

In early happiness research conducted by Cantril (1965) participants from 14 countries

were surveyed using what the researcher describes as a self anchoring striving scale.

Representing the more complex method of measuring happiness, Cantril’s approach began by

asking individuals to describe a life that they would be happy living in the future. The researcher

asked probing questions to help participants describe their hopes and dreams related to creating a

happy future. On the opposite end of the spectrum participants were asked to describe what

would make them unhappy. Using the two extremes as anchoring points, individuals were then

asked to rate their current level of happiness on a scale of zero (the worst life) to 10 (the best

life).
 Behavioral Economics and Happiness 18

Using a more simplistic approach, organizations such as Gallup and the National Opinion

Research Center (NORC) have utilized multiple-choice questions to gauge the level of happiness

in respondents from around the world. Early research by Gallup asked whether an individual was

very happy, fairly happy, or not very happy (Easterlin, 1974). NORC has used a similar question

since 1972 in the General Social Survey (GSS) that asks participants whether they are not too

happy, pretty happy, or very happy (Brooks, 2008). Whether a more complex evaluation such as

Cantril’s is used, or a more simplistic version such as that of Gallup, the concept of happiness

both measure is the same (Easterlin, 1974). In either case the individual is believed to be the best

judge of their own feelings.

The measurement of happiness is far from a perfect science. Issues can arise based on

where happiness questions are placed within a survey, but overall agreement of the

aforementioned methods have been widely accepted in the happiness economics literature

(Brooks, 2008; Graham, 2009; Hagerty & Veenhoven, 2003; Stevenson & Wolfers, 2008).

Evolution of Happiness Economics

The study of happiness economics has greatly evolved over the last half century, and

greater understanding into what leads to happiness has grown exponentially as data from

countries around the world has been collected an analyzed. Cantril (1965) offers some of the

earliest insights into happiness research. Studying the happiness of Americans in the 1960s,

Cantril uncovered common themes among participants as they described their hopes and dreams

during the process of establishing the aforementioned anchoring scale. Table 1 includes the most

frequently mentioned items leading to happiness. To summarize the results Cantril grouped the

items into categories shown in Table 2.

Item Percent Response

Own health 40%
 Behavioral Economics and Happiness 19

Decent standard of living 33%

Children 29%
Housing 24%
Happy family 18%
Family health 16%
Leisure time 11%

Table 1. Items most frequently mentioned by Americans when discussing their hopes and

dreams. From Cantril, H. (1965). The pattern of human concerns. New Jersey, NJ: Rutgers

University Press.

Category Percent Response

Economic 65%
Health 48%
Family 47%
Personal values 20%
Status quo 11%
Job or work situation 10%

Table 2. Categories of items most frequently mentioned by Americans when discussing their

hopes and dreams. From Cantril, H. (1965). The pattern of human concerns. New Jersey, NJ:

Rutgers University Press.

Cantril’s (1965) research provided some of the impetus for Easterlin’s (1974) seminal

work in happiness economics. Easterlin is largely credited as establishing the field of happiness

economics (Brooks, 2008; Graham, 2009; Hagerty & Veenhoven, 2003; Wolfers & Stevenson,

2008). In his early work the researcher sought to understand whether or not a positive

relationship exists between economic growth and happiness. Easterlin analyzed data from a

variety of surveys that included Gallup, NORC, and the American Institute of Public Opinion

(AIPO). In the analysis Easterlin first reviewed data from within countries before moving on to a

comparison between countries.

Easterlin’s (1974) findings suggest a positive correlation between income and happiness

exists within countries. In each of the surveys the higher earning respondents were happier on
 Behavioral Economics and Happiness 20

average than the lower earners. Easterlin’s analysis also uncovered a positive correlation

between happiness and years of education. The data also suggests married people are happier

than unmarried, younger individuals are happier than older ones, and whites are happier than

other races. Even though correlation does not mean causation, Easterlin argues, “I am inclined to

interpret the data as primarily showing a causal connection running from income to happiness”

(p. 104). The researcher bases his conclusion on the responses of participants who

overwhelmingly state personal economic concerns are directly tied to their levels of happiness.

In the comparison of countries Easterlin (1974) states, “if there is a positive association

among countries between income and happiness it is not very clear” (p. 108). This conclusion is

in conflict with Cantril’s (1965) research studying 14 countries a decade earlier in which a

positive correlation was uncovered. Easterlin’s final conclusion, working with time series data

from the U.S. from 1946-1970, creates the last element in what has become known as the

“Easterlin Paradox” (Graham, 2009, p. 12). Analyzing the time series data, Easterlin concludes

that even though income levels were higher in 1970 than they were in 1946 the percentage of

very happy people did not change significantly. In explaining this phenomenon Easterlin cites

Duesenberry’s (1952) relative income explanation, which suggests that unless an individual’s

income rises at a greater rate than those in which comparisons are made, a feeling of greater

wealth will not be realized. In a sense, argues Easterlin, individuals are constantly comparing

their wealth with that of others and when it is rising at the same rate as others a greater sense of

wealth is not achieved. From Easterlin’s work three elements have come to establish the

Easterlin Paradox. They include:

1. Within a society richer are happier than poorer.

2. Rich societies tend not to be happier than poorer (once basic needs are met).
 Behavioral Economics and Happiness 21

3. As countries get richer they do not get happier. (Wolfers, 2008)

Since Easterlin’s groundbreaking work, the field of happiness economics has been filled

with controversy related to the Easterlin Paradox. Some researchers have found small effects

between happiness and national income (Hagerty, 2000; Oswald, 1997) while others have found

none (Diener & Oishi, 2000; Easterlin, 1995). Recent research by Hagerty and Veenhoven

(2003) and Wolfers and Stevenson (2008) appear to be helping establish an argument suggesting

increased levels of happiness are related to rising national income levels.

Using the World Database of Happiness (Veenhoven, 1999) that includes data from 21

countries, 9 of which are developing nations, Hagerty and Veenhoven (2003) argue that

increasing national income is positively correlated to increasing happiness. Based on their

analysis the researchers reject Easterlin’s claim that an individual’s happiness is not dependant

on absolute income, but on their income relative to others. In a rebuttal to the Hagerty and

Veenhoven paper, Easterlin (2004) argues against their conclusions using the U.S. GSS data

illustrated in Figure 2. As the data clearly illustrates, argues Easterlin, despite a rise in GDP per

capita the percentage of individuals stating they are very happy has not changed.
 Behavioral Economics and Happiness 22

Figure 2. Trends in per capita GDP and percentage of individuals stating they are very happy.

From Davis, J. A., Smith, T. W., & Marsden, P. V. (2008). General Social Survey 1972-2006.

Chicago: National Opinion Research Center.

The reason Easterlin (2004) argues Hagerty and Veenhoven (2003) arrived at a different

conclusion is due to the use of survey data not included in the GSS from 1972-1974. Hagerty and

Veenhoven acknowledge the inclusion of the additional survey data in their paper stating that

sampling design and administration may have differed, which Easterlin does not agree with.

Easterlin suggests that the difference in results are due to seasonal and context effects (the GSS

is conducted in spring when happiness is higher).

The most recent challenge to the Easterlin Paradox has come from Wolfers and

Stevenson (2008). Their research that used recent data collected from the Gallup World Poll

argues against the paradox suggesting richer people are happier, richer countries are happier than

poorer countries, and as countries increase their wealth happiness also increases. Figure 3
 Behavioral Economics and Happiness 23

illustrates the relationship between average life satisfaction and per capita GDP. Although the

Gallup data measures life satisfaction, an overall measure of well-being, and not happiness,

Wolfers and Stevenson argue that correlations between life satisfaction and happiness show the

two are quite similar measures. With more data continuing to be collected, the argument between

happiness and wealth is likely to continue into the future. Perhaps, as the data set continues to

grow, happiness economist will begin to consolidate their views, and the argument for or against

the Easterlin Paradox will be settled. Until then energy may well be better spent focusing on non-

income related factors to happiness.

Figure 3. Relationship between average life satisfaction and per capita GDP. Size of circle is

relative to population of country. From Deaton, A. (2008). Income, health, and well-being
 Behavioral Economics and Happiness 24

around the world: Evidence from the Gallup world poll. Journal of Economic Perspectives,

22(2), 53-72.

Application of Happiness Economics

While significant debate continues related to income and happiness, most happiness

researchers agree that certain factors such as education, religion, marital status, age, health, and

employment are positively related to happiness (Graham, 2009). Certain activities such as

volunteering, charitable giving, and participating in religious events have also been shown to

increase happiness (Brooks, 2008).

If happiness economists are mostly in agreement with the aforementioned factors,

perhaps the next question facing researchers should be what to do with this knowledge. How can

society use happiness data to increase overall well-being? Graham (2009) argues that happiness

research should be used for better understanding inequality and poverty, and setting policy

related to individual welfare and controlling addictive substances. Studying happiness may also

provide exciting opportunities to improve worker productivity. Research suggests that happier

workers tend to perform better and have increased future earning potential (Diener, Sandvik,

Seidlitz, & Diener, 1993; Graham, Eggers, & Sukhtankar, 2004). With time, more research into

happiness is bound to uncover new opportunities to better understand what leads to increased

levels of happiness, and how capitalizing on this knowledge can help create a better society.

Criticisms of Happiness Economics

The study of happiness is not without criticisms. The subjective measurement of

happiness is perhaps the most significant criticism facing the field of happiness economics.

Nearly all happiness data is based on individual survey responses, and based on the time of year

(Easterlin, 2004) or even the time of day (Layard, 2004), levels of happiness tend to fluctuate.
 Behavioral Economics and Happiness 25

Despite these fluctuations and the subjectivity of happiness measures, an argument can be

made that the conclusions dating back to research conducted by Cantril (1965) in the 1960s

proceeding on through to the most recent research suggest a very consistent theme in what makes

individuals happy. In spite of its subjectivity, happiness research has been consistent in elements

such as wealth within a country, education, health, age, and marital status. New developments in

neuroscience have also provided further evidence that the subjective nature of happiness can be

measured through brain activity (Layard, 2004). Happy feelings tend to stimulate the left pre-

frontal cortex, while negative feelings stimulate the right. Moving forward, neuroscience may

offer a more quantitative method of measuring happiness, giving the field of study greater

credibility.

The bright spot in the happiness economics research suggests that many of the elements

leading to increased happiness are within an individual’s control. An argument can be made that

an individual’s behavior and the decisions they make play a significant role in determining their

current and future potential happiness. Bad decisions related to happiness factors such as

financial savings, education, physical and mental health, and employment may lead to lower

levels of happiness. Tideman (2005) argues that conventional economics does not help society in

the pursuit of happiness, having left out the psychological elements that arguably play a key role

in happiness. Perhaps one solution lies in using the concepts found in behavioral economics to

help individuals make better decisions that lead to a higher probability of creating happiness.

Increasing Happiness Through Behavioral Economics

Can behavioral economic thinking help make the world a happier place? While a paper

such as this cannot fully explore the answer to this question, an attempt will be made to provide

an argument for areas in which behavioral economic thinking has the opportunity to positively
 Behavioral Economics and Happiness 26

influence individual happiness. These areas include education, financial planning, and health

care. The focus is not so much on providing detailed solutions, although some suggestions are

offered, but more so on arguments related to the areas in which behavioral economists (or those

acting as behavioral economists) could have the potential to make a positive impact on

happiness. A final point of discussion is related to what is perhaps the most significant barrier to

sustained happiness-materialism.

Choice Architecture, Libertarian Paternalism, and Nudges

One could argue a great deal of unhappiness is related to bad choices individuals make

throughout their lives. Deciding not to finish high school or go to college, taking out a mortgage

that is beyond one’s means, not saving for retirement, eating an unhealthy diet, living a sedentary

life that leads to obesity and eventually health issues, and abusing drugs and alcohol are all

examples of poor choices. While many of these decisions may lead to short-term happiness they

are highly unlikely to garner happiness over the course of one’s lifetime.

Many of the bad decisions individuals make are due to heuristics, or rules of thumb,

discussed previously. The research conducted by Tversky and Kahneman (1974) clearly

indicates individuals often times take shortcuts in making decisions that lead to undesirable

results. To combat the probability of making bad decisions, behavioral economists have the

ability to become what Thaler and Sunstein (2009) describe as “choice architects” (p. 3). The

authors describe a choice architect as having “the responsibility for organizing the context in

which people make decisions” (p. 3).

A simple example in choice architecture can be described using the analogy of creating

elementary school lunch selections (Thaler & Sunstein, 2009). Designing a school lunch menu

can be based on several factors such as choosing food randomly to increase choice options,
 Behavioral Economics and Happiness 27

focusing on profit maximization by choosing low cost/high margin foods, or arranging food to

help students make healthy selections. From a conventional economic perspective one would

choose to maximize profit, although unhealthy eating in elementary school may lead to an adult

life of unhealthy eating, ultimately resulting in long-term health issues such as obesity. Thaler

and Sunstein argue that a choice architect will select the healthy choice for students, which is in

the best interest of the student, but does not necessarily prohibit them from making an alternative

selection such as bringing their own lunch or eating somewhere else. Choice architecture is

based in the concept the authors describe as “libertarian paternalism” (p. 4). Libertarian suggests

the freedom of individuals to make their own decisions, while paternalism centers on the idea of

paternalistic oversight that helps in making good decisions that lead to living healthier happy

lives.

At first the concept may seem like someone else is making decisions for individuals

without their input, but as Thaler and Sunstein (2009) suggest, “libertarian paternalists want to

make it easy for people to go their own way; they do not want to burden those who want to

exercise their freedom” (p. 5). The authors describe this process of helping individuals make

decisions as a “nudge” (p. 6). A nudge can be defined as “any aspect of the choice architecture

that alters people’s behavior in a predictable way without forbidding any options or significantly

changing their economic incentives” (p. 6). Choice architecture, libertarian paternalism, and

nudging may be one way in which behavioral economists can help increase happiness.

Nudging Toward Happiness

One can easily argue the U.S. could use a nudge when it comes to education, personal

financial management, and health care. The previously discussed happiness research suggests
 Behavioral Economics and Happiness 28

that each of these areas has an impact on individual happiness, providing three potential areas in

which behavioral economic thinking could help improve individual happiness.

As the old adage suggests, “higher learning leads to higher earning”, and what is

consistent throughout the happiness data is the relationship between happiness and income and

higher education. Higher earners and those with more education tend to be happier than less

educated lower earners (Graham, 2009). Despite the improvement in high school dropout rates in

the U.S., which have declined from 14 percent in 1980 to eight percent in 2008 (U.S. Department

of Education, 2010), there are still over one million students who dropout of high school each

year (Alliance for Excellent Education, 2009). Clearly, a nudge that could help entice students to

stay in school, and even better still go on to college, would help increase the chances for

happiness. One potential nudge could come in the form of tempting students who have graduated

high school and are in college to become mentors to those still in high school. Research suggests

that while parents play a key role in helping their children succeed in school a greater influence

to success is played by those they interact with the most (peers, teachers, etc.) (Levitt & Dubner,

2005). Providing a financial incentive to potential mentors, such as tuition reimbursement, may

also help nudge them to become mentors for high school students. An added side benefit may be

that the mentors also go on to graduate from college, which is highly likely to impact their future

level of happiness.

Personal savings is another area in which behavioral economic thinking may help to

increase happiness. Surprisingly, even though the mainstream media continues to bombard the

public with the challenges of funding Social Security and the need to establish individual

retirement savings accounts, 27 percent of individuals report they have less than $1,000 in

savings and 54 percent have less than $25,000 in investments (Employee Benefit Research
 Behavioral Economics and Happiness 29

Institute, 2010). Thaler and Sunstein (2009) offer two suggestions that may help provide the

nudge needed to increase personal savings. One suggestion is to make the default option for

employer funded 401(k) retirement savings programs to automatically enroll employees at a

level that takes advantage of company matched investment. Employees still have the option to

pull out of the plan, but by making enrollment the default Thaler and Sunstein argue more are

likely to stay in than opt out. Another suggestion by the authors is what they call the “save more

tomorrow” (p. 105) plan. This technique allows an employee to automatically invest future

increases in earnings into a savings plan. Since the employee never receives the increase on their

paycheck by selecting this option they never miss the added income.

Health care is another area in which behavioral economic thinking may provide an

opportunity to improve happiness. There is no question Americans have an obesity problem as

the number of individuals considered obese has risen dramatically since 1990 when no state had

an obesity level greater than 15 percent to what in 2009 has increased to only two states having

less than 20 percent, and 33 states greater than or equal to 25 percent (Centers for Disease

Control and Prevention, 2010). As the U.S. population grows larger, figuratively and literally,

health care costs are likely to continue increasing. One could argue the irrational behavior of

consumers has had a dramatic affect on their health, and behavioral economic thinking may

provide some answers into helping individuals make healthier choices. Some suggestions might

be to give healthy individuals the opportunity to pay lower health care premiums by completing

routine annual exams proving they are living a healthy lifestyle, and forcing those who do not

have the exams to pay higher premiums. This suggestion is no different than the process used to

price auto insurance policies for those who pose a greater risk. Better caloric labeling of foods

has helped to inform consumers as to what they are buying, but the temptation is still high when
 Behavioral Economics and Happiness 30

healthy choices are intermixed with unhealthy options. Another suggestion could be to mandate a

segregation of unhealthy food from healthy food in grocery stores to make it easier for

consumers to avoid high calorie foods. An even more radical proposition may be to enact an

“obesity tax” for airline travelers who are overweight. Stepping on a scale before getting on a

plane and having to pay an additional fee is bound to change some individual’s behavior.

There are certainly a multitude of others ways in which behavioral economic thinking

presents an opportunity to increase happiness solely on the choices individuals are faced with.

Many of the decisions individuals make are based on the default options given, which creates a

number of arguments as to who chooses the default options, and who determines which are the

best for society. There is no simple solution, but as Thaler and Sunstein (2009) argue, the goal of

choice architecture is not to force individuals into a decision, but to help them increase the

probability of choosing wisely. Even if individuals make better decisions as a result of

behavioral economic thinking, another ever-increasing hurdle to happiness continues to threaten

society-materialism.

Materialism and Happiness

Bogle (2009) describes an interesting conversation between Kurt Vonnegut and Joseph

Heller, both famous authors, at a party on Shelter Island that is hosted by a billionaire hedge fund

manager. Vonnegut tells Heller that their host has made more money in one day than he has

made over the entire history of his popular novel Catch-22, to which Heller responds, “yes, but I

have something he will never have…enough” (p. 1). The concept of enough Heller describes is

similar to what has become a common argument by happiness economists as to the reason

happiness has not significantly increased despite the twofold rise in GDP per capita in the past 34

years (see Figure 2). Economists describe the phenomenon as a “hedonic treadmill” (Graham,
 Behavioral Economics and Happiness 31

2009, p. 15), which suggests that once basic needs are met human aspirations continue to rise,

and changes in income are measured in relative rather than absolute terms. A more common

phrase used by many to describe this situation is “keeping up with the Joneses”. In effect, a point

of reaching enough is never achieved, thus, individuals continue to pursue more, always chasing

the elusive situation of having enough. This analogy leads to the question; if an individual can

never achieve or have enough will they ever be able to reach a maximum state of happiness?

It is unlikely that behavioral economics will be a panacea to all problems related to

happiness such as materialism, but the field of study offers some promising hope that by simply

helping individuals make better choices they can live a much happier life. Tideman (2005)

argues the bigger challenge for economists lies in changing the warped sense of progress that is

tied primarily to growing levels of GDP and corporate profitability, much like society’s measure

of individual prosperity that is heavily rooted in material wealth. Behavioral economics may not

be the solution Tideman is searching for, but it is likely to help emphasize those non-materialistic

elements that lead to happiness, which could someday help society focus less on material wealth

as the primary source of happiness and measure of success.

 Behavioral Economics and Happiness 32

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