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Uhap Overheads
University of Michigan
http://www-personal.umich.edu/~mkimball/pdf/index.html
1
A Growing Economic Literature
Uses Happiness Data
• Provocative findings—see Layard’s Happiness
• Mostly focuses on the cross-section and the
long-run trend.
• Motivations of the researchers:
– to study the welfare implications of non-traded goods
– to diagnose optimization mistakes and study welfare
implications in contexts where choice behavior is
potentially inconsistent.
• Many other economists are skeptical: the
theoretical status of happiness is unclear.
2
“Happiness,” as Defined
Operationally by Psychologists
• On a scale from one to
seven, where one is
“extremely unhappy” and
seven is “extremely happy,”
how do you feel right now?
3
What “happiness” or “subjective
well-being” is NOT
• This is NOT the eudaimonia of Greek
philosophers.
• This is NOT utility.
• But, we argue, this kind of data carries
useful information.
4
The Standard View in Psychology
• Currently, the standard view among
psychologists and most economists working with
happiness data—articulated most forcefully by
Daniel Kahneman—is that a present discounted
value of measured happiness is a good indicator
of what people should be maximizing.
• To the extent that people are maximizing
something else, it is viewed as a mistake.
• Factual mistakes people make in predicting their
own future happiness are thought to be an
important reason people make these
optimization mistakes.
5
Our View
• We are questioning this orthodoxy.
• When well-informed and thoughtful, we
view people’s choices as the best
indication of their individual welfare.
• People do often make optimization errors.
• But much of what this orthodoxy takes as
evidence of optimization errors, we take as
evidence that utility and “happiness” are
not the same thing.
6
What is “Happiness” in Relation to
Economic Theory?
a. Flow utility?
b. The individual’s overall objective
function?
c. The part of the individual’s objective
function that abstracts from the desire
to do one’s duty?
d. The individual’s objective function plus
pleasure from memory?
e. None of the above? 7
Our Answer
• Part of happiness is a temporary response to changes in
utility or news about utility.
– Handled with care, these bursts of happiness give useful
information about overall utility.
• The more persistent, predictable part of happiness is a
valuable commodity like health, but is not a measure of
overall utility.
– People care about how they feel, but it is not the only thing they
care about.
– Because people care about how they feel, having more
knowledge about how to feel happy is extremely valuable. Many
of the policy issues about happiness are the issues that always
arise in relation to valuable knowledge.
– If people care about how they feel, so that happiness is in the
utility function, policy issues also arise when any externality
affects happiness.
8
Outline of Introduction
A. Distinguishing utility and happiness as a
matter of logic.
B. Why we care about utility and happiness.
C. Why the relationship between them can’t
be simple (short version).
D. Our take on the relationship between
utility and happiness.
9
A. “Utility” and “Happiness”
12
D. The Relationship Between
Happiness and Utility is Unresolved
Existing work in Economics largely either
14
The Question: What is the
Relationship?
• Both felt happiness and choice-based
utility are well-defined, observable
concepts. It is easy to resolve many
seeming paradoxes when one recognizes
that these are two different things.
• The nature of the relationship between the
standard psychological concept of
happiness (affect) and the standard
economic concept of lifetime utility is an
open empirical question.
15
Significance
Establishing any systematic relationship
between affect and utility would
1. provide an important bridge between
psychology and economics.
2. allow psychological data and theory to be
used in economics in a way that is
complementary to standard economic
data and theory.
3. allow all the tools of economics to be
brought to bear toward understanding
16
happiness.
Sketch of our Integrated Theory of
Utility and Happiness
Experienced happiness is the sum of two
components:
• elation: short-run happiness that depends
on recent news about lifetime utility
• baseline mood: long-run happiness that is
a subutility function (like health,
entertainment, or nutrition.)
17
Why Happiness Matters for
Economics (Our View)
• First, short-run happiness in response to
news can give important information
about preferences.
• Second, long-run happiness is important
for economic welfare in the same way as
other composite goods such as health,
entertainment, or nutrition.
18
The Core of the Paper
3. Measuring Happiness
4. Measuring Utility
5. Utility ≠ Happiness: Evidence
6. An Integrated Theory of Utility
and Happiness
19
Bonus Features
7. Why Utility and Happiness are
Often Confused
8. Elation in the Utility Function
9. Implications for Happiness
Empirics
10. Implications for Policy
20
3. Psychologists Reliably Measure
Happiness, But What Is It?
• Some economists think happiness
can’t be measured well. This is just
not true. Current happiness (affect) is
one of the easiest of all subjective
concepts to measure.
• What is true (that these economists
are intuiting) is that once happiness is
measured, we don’t know what it
means in terms of economic theory.
21
Measuring Current Happiness (‘Affect’).
“Now think about the past week and the feelings you have
experienced. Please tell me if each of the following was
true for you much of the time this past week:
1. Much of the time during the past week, you felt you
were happy. (Would you say yes or no)?
2. (Much of the time during the past week,) you felt sad.
(Would you say yes or no?)
3. (Much of the time during the past week,) you enjoyed
life. (Would you say yes or no?)
4. (Much of the time during the past week,) you felt
depressed. (Would you say yes or no?)”
22
The Validity of Self-Reported
Happiness
Correlated with
• frequency of smiling.
• others’ ratings of how happy someone is.
• social rank.
• high activity in the left pre-frontal cortex and low
activity in the right pre-frontal cortex--which can
also be induced by seeing pictures of a smiling
baby and reduced by seeing pictures of a
deformed baby.
23
Other Measures of Subjective Well-
Being: Life Satisfaction
24
World Values Survey Global
Happiness Question
"Taking all things together, would you say
you are
1. Very happy
2. Quite happy
3. Not very happy
4. Not at all happy
9. Don’t Know [Do NOT READ OUT]”
25
Problems with these Alternative
Measures of Subjective Well-Being
• Judging overall life-satisfaction or overall
happiness in life is a complex cognitive task.
• Evidence on the sensitivity of of subjective
well-being data to context indicates that
respondents use shortcuts involving readily
accessible information, such as
– How happy the respondent feels right now
– How happy the respondent thinks he or she should
feel, given objective circumstances.
26
Advantages of Affect Measures
(Current Happiness Measures)
• By contrast, affect measures depend on much
more accessible information:
– How R feels right now.
– How R felt the past week.
• Very little judgment is required.
• How R feels right now affects the overall life-
satisfaction or global happiness questions
anyway. It is clearer to focus on that current
happiness component directly. Then we know
what we are getting.
27
4. Measuring Utility: Revealed
Preference Over Choices
• The Ordinalist, or “revealed preference”
revolution in Economics developed
techniques for measuring individual
welfare based on choice data alone.
• This clearly defines utility as a distinct
concept from happiness.
– Utility is the extent to which people get what
they want.
– Happiness is how people feel.
28
The Trend in Utility:
Choose between 1955 and 2005
• The electronics revolution and the Internet have
vastly expanded access to a rapidly growing
quantity of culture and science.
• Crime, teenage pregnancy and drug abuse
worsened at first but now trend downward.
• Greater equality between races and sexes.
• War on Terror better than Cold War.
• Better medical care and greater longevity.
29
Life Expectancy
30
Would you want to go back to the
way things used to be?
– No computers or electronics
– No Ben and Jerry’s
– No Harry Potter
– No Beatles music yet released
– Jim Crow, strong male dominance
– Cold War
– Few modern drugs
31
Revealed Preference:
Migration Flows
• Per capita GDP in Mexico is not far from
what it was in the U.S. in the 1950’s.
• Large numbers of Mexicans choose to
migrate to the U.S.
• Among the many costs of migration, their
social rank often drops drastically when
they migrate to the U.S. Despite this, they
come.
32
Do People Know Their Own Utility
Functions?
• Not perfectly. For example, I don’t know if I will
like a new flavor of ice cream.
• Lack of knowledge of one’s own utility function
can be modeled as an internal informational
constraint. (Rayo-Becker is an example.)
• The key distinguishing features of mistakes
about one’s own utility function are
– regret
– changing one’s mind after learning more.
33
Can Happiness Data Alone
Diagnose Optimization Mistakes?
• No. Happiness data alone cannot diagnose a
mistake without strong assumptions about the
relationship between utility and happiness.
• Even the relevance of mistakes in predicting
future happiness depends on the relationship
between happiness and utility.
• In Section 8 C, we illustrate how people could
make mistakes in the impulse response pattern
of future happiness without impairing
optimization at all.
34
5. Happiness ≠ Flow Utility:
Evidence
• Assuming that current happiness is equal to
flow utility immediately has many strong
implications.
• In particular, a large amount of data on
happiness exists, with many characteristics
that do not match usual ideas about utility.
• Measured happiness
1. has no strong trend.
2. is strongly mean-reverting.
35
The Easterlin Paradox
36
Hedonic Adaptation
(Mean Reversion of Affect)
Cross-sectional evidence of hedonic adaptation for
• incarceration
• loss of the use of limbs
• serious burns
• death of a spouse
• winning the lottery
– winning £10,000 raises affect by six times as much in
the first year as £10,000 per year in additional
income.
37
Experience Data Show Even
Stronger Hedonic Adaptation
• Data on felt happiness from experience
sampling reverts to its previous level even
more completely than life satisfaction and
global happiness assessments (Kahneman
and Schwartz, unpublished work). Why?
• Life satisfaction and global happiness
assessments incorporate
– an element of autobiography
– people’s ideas about how they “should” feel
38
Hedonic Adaptation is Not the
Same Thing as Habit Formation
1. Equivalent to vt = Et ∑ β j f (Ct + j )
j =0
42
Other Evidence that
Utility≠Happiness
1. People make choices eagerly that they never
regret, but which have no long-run effect on
their affect.
– Moving to a new city
– Buying a nice car
2. With some misgivings at the tradeoff, people
thoughtfully make choices that they never
regret, which lower their affect.
– Commuting further to a higher-paying job.
– Longer working hours to put one’s child through
college.
– Having a baby?
43
6. Integrated Theory of Utility and Happiness
happiness= baseline mood + elation.
A. Elation
B. Baseline Mood
C. Formal Model
D. Expectations and Happiness
E-G. Evolutionary Significance
-Elation
-Hedonic Adaptation
-Baseline Mood
H. Implications of the Integrated Theory
44
News and Happiness
• The relationship between circumstances
and happiness is weak in the long run,
BUT
• No one disputes that in the short run
happiness responds in an intuitive way to
news about lifetime utility.
• Thus, we argue that an important
component of happiness is due to recent
news about lifetime utility.
45
‘Elation’ and ‘Dismay’
• ‘elation’ = the component of
happiness due to recent
news about lifetime utility.
• ‘dismay’ = -elation
46
Elation and Hedonic Adaptation
• If expectations are rational, standard
results about rational expectations imply
that elation will be strongly mean
reverting. Intuitively,
– News doesn’t stay news for very long.
– The initial burst of elation dissipates once
the full import of news is emotionally and
cognitively processed.
– Relevance to the Hedonic Treadmill, a.k.a.
the Easterlin Paradox.
47
‘Baseline Mood’
• baseline mood = M(Kt, Xt)
• Xt = vector of control variables: time use,
spending pattern, portfolio choice, etc.
• Kt = vector of
– state variables encoding every aspect of the past that
matters for utility: wealth, weight, habits, level of
fatigue, one’s spouse being alive, etc.
– variables exogenous to the individual: weather, state
of macroeconomy, consumption patterns of others in
society, etc.
CONTINUED ON NEXT SLIDE →
48
Baseline Mood and Flow Utility
• flow utility = U(Kt, Xt, M(Kt, Xt))
50
Do People Know the Production
Function for Baseline Mood?
• Just as people don’t know the true production
function for health, they may not know the true
production function for baseline mood.
• Lack of understanding of the dynamics of the
elation mechanism could make it difficult for
individuals to parcel out the determinants of
baseline mood.
• The discovery and dissemination of facts about
the determinants of baseline mood could have
large positive welfare effects
• A big deal if the share of the money and time
budget devoted to baseline mood trends up.
51
Applying Price Theory to
Baseline Mood
• Is baseline mood a luxury good?
• Even normality of baseline mood leads to a
version of the Easterlin Paradox:
Why don’t people buy higher baseline mood as
part of their expanding consumption bundle?
• Two potential answers:
– Some uptrending negative externalities may be
particularly bad for baseline mood.
– The relative price of baseline mood may be trending
up. (A large effect if the elasticity of substitution
between baseline mood and other goods is high.)
52
Formal Model of Utility and Happiness
T −t
vt = Et ∑ β jU ( Kt + j , X t + j , M ( Kt + j , X t + j ))
j =0
vt = lifetime utility
U =flow utility
M =baseline mood
Et = rational expectation as of time t
β = impatience
Kt = state vector: wealth, weight, fatigue,
being alive, spouse being alive, genes,
weather, prices, tax rates, pollution
average level of consumption in society…
Xt = control vector: consumption, time use … 53
The Innovation in Lifetime Utility
and Elation
ιt = vt − Et −1vt
55
Neurobiological Evidence that
Expectations Matter for Affect
• “These studies measured the firing of
dopamine neurons in the animal’s ventral
striatum, which is known to play a powerful
role in motivation and action.
• In their paradigm, a tone was sounded,
and two seconds later a juice reward was
squirted into the monkey’s mouth.
• Initially, the neurons did not fire until the
juice was delivered.
56
Neurobiological Evidence that
Expectations Matter for Affect
• Once the animal learned that the tone
forecasted the arrival of juice two seconds later,
however, the same neurons fired at the sound of
the tone, but did not fire when the juice reward
arrived.
• These neurons were not responding to reward,
or its absence … they were responding to
deviations from expectations.
• When the juice was expected from the tone, but
was not delivered, the neurons fired at a very
low rate, as if expressing disappointment.” (p.26)
57
The Evolutionary Psychology of
Elation and Dismay
• Functionally, elation and dismay may motivate cognitive
processing—much like curiosity.
– Elation: after good news, it pays to
• think what you did right, so you can do it again
• think how to take advantage of the new opportunities
– Dismay: after bad news, it pays to
• think what you did wrong, so you can avoid doing it again
• think how to mitigate the harm of the bad news
– Curiosity: after news that is neither clearly good nor bad, it pays
to learn more for the sake of option value
• Economic implications of this functional role of elation:
such directed information acquisition could affect
probability assessments in systematic ways.
58
The Evolutionary Psychology of
Hedonic Adaptation
• “Adaptive processes serve two important functions.
First, they protect organisms by reducing the internal
impact of external stimuli…. Second, they enhance
perception by heightening the signal value of changes
from the baseline level….”
• “Hedonic adaptation may serve similar protective and
perception-enhancing functions…. persistent strong
hedonic states (for example, fear or stress) can have
destructive physiological concomitants … Thus, hedonic
adaptation may help to protect us from these effects.”
• “Hedonic adaptation may also increase our sensitivity to,
and motivation to make, local changes in our objective
circumstances….” (Frederick and Loewenstein)
• See also Rayo and Becker (2005).
59
Speculations on The Evolutionary
Psychology of Baseline Mood
• High social rank may make it safe to look
more for opportunities than for dangers, so
that it makes sense to stimulate the same
machinery that is turned on by the receipt
of good news.
• Frequency dependence in the value of
being an optimist or pessimist.
• Quirks in the system?
• Stephen Pinker’s view of cheesecake.
60
Three Implications of this
Theory of Happiness
• Happiness ≠ Utility.
• Disputes the idea that temporary
movements in affect are unimportant:
a temporary movement in affect can signal
important utility-relevant news related to
the long-term welfare of the individual.
• Baseline mood is not a summary measure
of utility, but it is something people care
about.
61
Bonus Features
7. Why Utility and Happiness are
Often Confused
8. Elation in the Utility Function
9. Implications for Happiness
Empirics
10. Implications for Policy
62
7. Why Utility and Happiness
are Often Confused
• If baseline mood is exogenous to the
individual, and elation is linear in lifetime
utility innovations, maximizing any positive
linear combination of current and expected
future happiness is equivalent to
maximizing lifetime utility.
⎧ T −t j ⎫ T −t j −1
Et ⎨∑ β At + j ⎬ = ∑ β Et M t + j +b0,t (vt − Et −1vt ) + ∑b ι .
j ,t t + j
⎩ j =0 ⎭ j =0 j =− n
63
Why are Utility and Happiness
Confused? (continued)
• Elation and dismay may dominate
people’s perception of happiness, but
without much conscious awareness of the
resetting of the implicit reference point that
depends on past expectations of lifetime
utility.
• The reference point is a sunk cost that
does not affect maximization, so lack of
awareness of it is not a problem.
64
8. Elation in the Utility Function
So far,
a. flow utility = U(Kt, Xt, M(Kt, Xt))
What if
b. flow utility = U(Kt, Xt, M(Kt, Xt))
+b0ιt+b1ιt-1+b2ιt-2+…
c. or flow utility
= U(Kt, Xt, M(Kt, Xt),e(ιt,ιt-1,ιt-2,…)) )
65
Elation in the Utility Function Might
Not Change a Thing
• Given rational expectations, adding a
linear combination of lifetime utility
innovations to the utility function has no
effect on the preferences represented.
• In this case, mistakes about the rate of
hedonic adaptation cause no material
harm to utility maximization.
66
Can Manipulating One’s
Perceptions Raise Utility?
• With elation in the utility function,
manipulating ones perception of lifetime
utility innovations becomes an issue.
– Lowering expectations is mostly a wash
because it lowers happiness now in order to
raise happiness later. It may also interfere
with optimization.
– The greatest potential gain from manipulating
one’s perceptions is to lower one’s memory of
past expectations. (“Attitude of gratitude”)
67
Manipulating Perceptions of
Locus of Control
• Elation may respond more to news about
whether one’s choices worked out than
to news about things beyond one’s
control.
• This would make it possible to
manipulate elation by labeling good
events as due to one’s efforts, while bad
events were beyond one’s control.
68
Elation and Prospect Theory
• In the nonlinear case, elation theory yields
prospect theory very naturally. In particular, if
a. Elation is roughly proportional to the rate of cognitive
processing of news.
b. Bad news requires more processing than good news.
c. Within bad or good news, the total amount of
processing needed is proportional or less than
proportional to the magnitude of the news.
• Thus, Prospect Theory can arise from rational
preferences over one’s own emotions.
69
9. Implications for Happiness
Empirics
• The time series properties of happiness
matter.
• Price Theory can be used to study
baseline mood (e.g., value of happiness).
• The Elation Theory is readily testable.
• Elation provides information about
preferences and expectations.
– Like event studies in Finance
– Need high frequency data on affect.
70
10. Implications for Policy
• Happiness is valuable: should be fostered.
• Happiness data are a reminder of tangible
and intangible externalities in the utility
function—especially social rank
externalities.
• Economic growth is of enormous value,
despite the Easterlin Paradox.
• Happiness data is not enough to diagnose
optimization mistakes.
71
Reprise: Integrated Theory of
Utility and Happiness
Happiness is the sum of two components:
72
Conclusion: Integrating Happiness
into Mainstream Economics
• Happiness needs to be integrated in a way
that respects the canons of Economics.
• Two key dimensions for integrating
happiness into economics:
– First, the short-run responses of
happiness to news provide important
information about preferences.
– Second, long-run happiness is important
in its own right.
73
74
The Integrated Theory of
Utility and Affect: Axioms
77
Preference for Happiness:
Discussion
The preference for happiness axiom is a
relatively cautious assumption.
• It allows for the possibility that people
have other pragmatic concerns beyond the
extent to which those concerns show up
directly in felt happiness. For example,
they may care about satisfying basic
drives, the happiness of family members,
health, ethical concerns and other goals.
78
Preference for Happiness:
Discussion
• One could make stronger
assumptions but the axioms above
are enough for our approach.
• Cautious assumptions have the
advantage of being more likely to gain
broad acceptance within Economics.
79
An Alternative, Stronger,
Assumption
• Sufficient Statistic Hypothesis: some
combination of current and expected future
happiness is a sufficient statistic for the agent’s
preferences.
• The Preference for Happiness Axiom allows
for the Sufficient Statistic Hypothesis as a
special case that, in principle, is empirically
testable.
-Happiness can be measured by feelings.
-Preferences can be measured by choices
whenever people are well informed and have
time to make a careful choice.
80
81
Significance
1. Even if economic progress continues
unabated over the next 50 years in the
U.S. advanced countries, whether the
citizens of these countries end up rich
and happy or rich and unhappy depends
on whether money can buy happiness
and on whether the additional economic
resources will, in fact, be used to obtain
additional happiness.
82
Significance
2. To the extent there is a tradeoff between
subjective well-being and other values,
the increases in income and wealth that
accompany economic progress are likely
to make improvements in subjective well-
being increasingly important for welfare
compared to further improvements in
other areas.
83
Significance
3. Economists are increasingly using
subjective well-being data to address
economic and public policy issues that
involve non-marketed goods or
inconsistent preferences. Identifying the
implications of subjective well-being data
for economic issues requires attention to
the details of the mapping between
subjective well being data and standard
economic concepts.
84
Significance
4. Given an adequate understanding of the
mapping between subjective well-being data
and standard economic concepts, the use of
subjective well-being data has the potential to
be especially important in the economics of
aging, since many of the most important goods
for retired people are non-marketed goods.
(Consider, for example, health, marital and
family relationships, sense of purpose, and
quality of leisure time pursuits.)
85
Significance
5. In the coming decades, advances in
subjective well-being at work have the
potential to alter people’s relationship to
work in a way that significantly raise the
average retirement age, with important
implications for Social Security budget
balance.
86