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The economics of happiness


Emily Vuong

By

August 28th, 2013


Emily Vuong analyses what factors contribute to one’s happiness and explores the emerging economic research that is increasingly explaining what is fundamentally such a philosophical concept.


The number of Americans who said, ‘yes, I am happy with my life’ peaked in 1956, but ever since then has fallen slowly but steadily. During this time our levels of world GDP per capita have increased dramatically, and according to the non-satiation principle of conventional microeconomics, our experience of higher utility means that should all be happier – yes?

We live in a finite world of perpetual economic growth. Levels of material wellbeing have never been so high. The walls between trading nations have been removed thanks to globalisation and technology. Why then does the economically paradoxical notion of ‘happy peasants and frustrated millionaires’ exist? Happiness economics takes a new approach to assessing welfare based on expansive notions of utility. Conventional economics has the aim of the efficient allocation of scarce resources to satisfy infinite needs. If increasing utility does not fundamentally achieve individual happiness, then what is the point of it all?

What did early economists and philosophers, ranging from Aristotle to Bentham, Mill, and Smith have in common? They incorporated the pursuit of happiness in their work, recognizing the importance of subjective wellbeing in their studies. Yet as economics grew more rigorous and quantitative, excessively frugal definitions of welfare took hold. Utility was taken to depend only on income as mediated by individual choices or preferences within a rational individual’s monetary budget constraint. Economists now realise that conventional notions of economic happiness, as defined by utility, have been largely replaced by more expansive notions of welfare, albeit more complicated – interdependent utility functions including health, marital and employment status and civic trust.

Microeconometric happiness equations have the standard form:

Wit = α + βxit + εit

  • W is the reported wellbeing of individual i at time t, x is a variety of known variables including socio-demographic, economic and cultural characteristics.
  • βx takes into account the measurable components of happiness, such as income, education and marital and employment status.
  • The error term captures the unobserved characteristics and measurement errors.

These regressions typically yield lower R-Squared values than economists are used to, reflecting the higher extent to which our emotions and other components of true wellbeing are driving the results.

The Easterlin paradox is similar to the idea of diminishing marginal returns, stating that income can only increase up to a point where it no longer contributes to increased happiness. Wealthier people are, on average, happier than poor people. However, happiness studies struggle to find a significant correlation between an increase in average levels of GDP per capita and average happiness levels. Obviously, income matters to the achievement of happiness – deprivation of basic needs and extreme poverty contribute significantly to unhappiness. But after the basic needs are met, and we add in other factors such as rising aspirations, political stability and relative income levels, happiness and income don’t display a statistically significant positive relationship.

If anything, happiness research has found that high levels of income drive excessive consumption and other perverse economic behaviors, all of which may not contribute to happiness.

The study of happiness economics has opened up a new world, where increased sophistication of econometric techniques and accuracy of data can put economists in a better position to assess welfare based on psychological needs, rather than just quantitative figures rigorous in their belief that ‘more is more’.

If economics, at its fundamental core, is about satisfying our unlimited needs and wants and doing so does not make each  and every one of us happy, what is the point of it all?

References

  1. Graham, Carol. “The economics of happiness.” World Economics 6, no. 3 (2005): 41-55.
  2. The Economics of Happiness, Documentary, directed by Steven Gorelick, Helena Norberg-Hodge (2011; Australia, The International Society for Ecology and Culture).

 

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

  • Hugh Oliver

    Fantastic article Emily!

    As you were discussing the lack of a statistically significant positive relationship between income and happiness beyond basic needs, I couldn’t help but think of concept of ‘affluenza’ as a possible explanation. What do you think? Also, I really liked the idea of utility functions that quantify a wider range of variables including marital and employment status as opposed to merely focusing on material factors such as income. Whilst I believe that such functions more accurately reflect the complex variables underlying happiness, on the other hand, adopting such idiosyncratic regression models of utility must be difficult to apply in practice? Moreover, would such a model require a whole new set of assumptions in itself i.e. marriage is positively correlated to happiness etc?

    Thanks,

    Hugh

    • Emily Vuong

      Hi Hugh, thankyou for your comment.

      It is interesting that you bring up affluenza. I like to think of it as similar to consumerism – the notion of affluenza however carries with it a certain negative connotation. Those in support of such a phenomenon believe that increases in material wealth lead to feelings of dissatisfaction and unworthiness, rather than a better life. This is outside the field of economics, venturing into psychological territory, where affluenza presents itself as a ‘debilitating illness.’ Unfortunately this is an area I have little expertise in. What I find interesting is how conventional notions of economic success (e.g. higher utility, greater wealth, the principle of non satiation) are being recognised so negatively in psychology.

      With regards to your second point, I have no doubt that adopting idiosyncratic regression models will be difficult to apply in practice. This is simply due to the fact that determining the variables which constitute happiness is problematic due to their inherent subjectivity. Economists are venturing into unknown territory, a slippery slope if you will. It will be difficult to quantify any of the results from these models as the conclusions drawn from them will only be as good as their original assumptions.

      Emily

  • Owen Wakely

    Yes interesting article Emily and very provocative. I am not a supporter of using utility functions and variables that by definition are complex and multivariate in themselves. I believe a more robust view is Maslows heirachy of needs theory, which places self-actualization and esteem well above those needs to which income and other tangible factors can contribute (e.g., physiological and safety needs). I found Hugh’s comments interesting too. Marriage may well fulfil needs that are income based as well as esteem based, while not conforming to contemporary ideas of happiness. Also remember the romantic notion of marriage is a very recent phenomenon originating in the 20th century. Prior to that one did not expect happiness out of marriage which was more a financial / business transaction that pooled resources or provided a social scaffold. Having said that alot of people find fulfilment and happiness in good marriages: lets not get too cynical. Nice article Emily. Owen

  • Peter C Joyce

    Well done Emily. You have undertaken a well thought through logic paradigm, and applied sound economic arguement to your thinking. One of the problems economists have faced since Alfred Marshall’s time is the notion of ‘relativity’. Earlier ‘economists’ understood relativity better than those of the 20th & 21st century.
    Everything we do in rational life is ‘relative’ in some way to one thing or another. Wealth included. ‘Scarcity’ is a relative term. Philosophers and more importantly psychologists understand this better than modern-day economists. The utility functions cannot include relative forces within their endogenous variables; therefore, they can only recognise relativity as an exodgenous variable. Hence relativity cannot be easily incorporated into econometric thinking. My wealth is relative to someone elses, my health is relative to someone elses, my happiness is relative to someone elses, etc. Therefore, changes in ‘others’ will impact upon me although I may not have experienced any absolute change. This is ‘relativity’ at work. It happens in all ecomiomic transactional markets, foreign ecurency exchange markets being the most obvious; but exactly the same principal applies in all economic markets, be they social, psychological, happiness, or whatever. Thanks for prompting my thoughts and bringing my ‘old world’ academic thinking to the fore. Well done Emily.

    • Emily Vuong

      Thankyou so much Peter.

      While I was writing, I had trouble explaining why this is an area modern economists often shy away from exploring. The reason is the notion of relativity and their inability to rely on the notion of ‘ceteris parabis.’ There is an absence of standards of absolute and universal application, especially in terms of determining the ‘optimum level of happiness’. In reality, relativity makes it difficult to establish this ‘standard’. Thank you for explaining it so succinctly, Peter.

      Emily

      • Peter C Joyce

        Thanks Emily, you have ‘got it’. The only absolute in economics was aptly stated by John Meynard Keynes when he said: ‘In the long-run we are all dead.’

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