1 Approaches to Behavioral Welfare Economics Building on the 20 th Century Economic Tradition More...

1 Approaches to Behavioral Welfare Economics Building on the 20 th Century Economic Tradition More than one agent per person e.g. hyperbolic discounting a problem of welfare aggregation across agents Confusion (Cognitive Economics) Preferences when well-informed and thoughtful are what counta data issue Preferences over emotions

2 Preferences Over Emotions (Emotions in the Utility Function) People care about how they feel Preferences over ultimate goods (including emotions) can be taken as totally standard Emotions can have complex household production functions Everything the person can control is an argument. The function itself cannot be chosen. Psychological data pin down the production function for the emotionthus, in principle there are no extra degrees of freedom beyond those in a standard utility function with the same number of arguments.

3 Example 1: Anger People care whether they feel angry or not. People want to be angry in certain situations. In other situations they want to not be angry. (Anger is an argument of preferences.) The genesis of anger is probably related to expectations and to preferences. If someone acts against our interests (=preferences) more than we would expect them to, we are more likely to feel angry. (Expectations and preferences are arguments of the production function for anger.) Note the circularity: angerpreferences indirect utility will be determined by a fixed-point mapping.

4 Example 2: Happiness People care whether they feel happy or not. Mostly, people would prefer to feel happier. (Happiness is an argument of preferences.) How happy one feels seems to involve (among other things) how well one is doing relative to expectations in relation to ones preferences. (Expectations and preferences are arguments of the production function for happiness.) Note the circularity: happinesspreferences indirect utility will be determined by a fixed-point mapping.

5 The Economics of Happiness Miles Kimball

6 What I Know about Happiness Utility and Happiness, by Miles Kimball and Robert Willis (Not your usual paper about happiness. We may be wrong, but we are definitely different.) Unhappiness After Hurricane Katrina by Miles Kimball, Helen Levy, Fumio Ohtake and Yoshiro Tsutsui The Dynamics of Happiness: Evidence from Daily Panel Data by Miles Kimball, Fumio Ohtake and Yoshiro Tsutsui The Dynamics of Happiness After Major Life Events by Miles Kimball and Daniel Silverman Conversations with Norbert Schwarz

7 Why Happiness Matters for Economics 1. Preference for Happiness: Many people value happiness, as evidenced by the fact that they will sacrifice other things for the sake of happiness. 2. News and Happiness: Short-run spikes and dips in happiness signal what people consider good and bad news, which in turn signals what they care about.

8 Two Definitions of Happiness The Greatest Good for an Individual Feeling Happy

9 Who Judges the Greatest Good for an Individual? An Authority Figure or the Speaker True Happiness used as a cudgel Economics Defers to the Individual Utility

10 Measuring Happiness, in the Narrow Sense of Feeling Happy On a scale from one to seven, where one is extremely unhappy and seven is extremely happy, how do you feel right now?

11 Greater Happiness in the Narrow Sense is Not Always a Good Thing Mania: too much happiness Too much sacrificed for the sake of feeling happier Example: changing ones political beliefs in order to be happier.

12 Distinguishing preferences and happiness as a matter of logic. Preferences (Represented by Lifetime Utility) = The extent to which people get what they want, where what they want is revealed by their choices. Happiness (Current Affect) = How positive peoples feelings are at a given time.

13 The Ethical Question Peoples own choices and feelings are the two non-paternalistic indicators we have for individual welfare (what makes an individual better off in the sense relevant for policy). A priori, both seem useful. What if public policy choice A accords with what people would choose, but policy choice B would make them feel best?

14 The Neobenthamites Currently, the standard view among psychologists and most economists working with happiness dataarticulated most forcefully by Daniel Kahnemanis 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. (Return to this below.)

15 Our View Bob Willis and I are questioning this orthodoxy. When well-informed and thoughtful, we view peoples 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.

16 Utilitarianism (Jeremy Bentham, John Stuart Mill) The greatest good of the greatest number Solving social problems is important because it is a miserable experience to be poor, sick or downtrodden. It is also important to make things better, wherever we can, even if they are already good. Utilitarianism is part of the philosophical foundation of economics.

17 Measuring Utility: The Modern Tradition of Economics Look at an individuals choices (preferences). What an individual chooses indicates what she wants, cares about and values. This works well when the individual is Well informed Thoughtful Not at war with self

18 Evidence that UtilityHappiness 1.People who knowingly, thoughtfully and without regret choose not to maximize long-run happiness indicate that utilityhappiness for them. 2.People make choices eagerly that they never regret, but which have no long-run effect on how happy they feel. Moving to a new city Buying a nice car 3. People thoughtfully make choices that they never regret, which lower their long-run felt happiness. Commuting further to a higher-paying job. Longer working hours to put ones child through college. Having a baby? Doing ones duty.

19 The Nature of Happiness (What Makes Us Feel Happy)

20 Key Facts about What Makes Us Feel Happy #1: Easterlin Paradox #2: Hedonic Adaptation

21 The Easterlin Paradox

22 The Evidence of Choices: Migration Flows Indicate that Income is Valuable to People Per capita GDP in Mexico is not far from what it was in the U.S. in the 1950s. 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.

Reevaluating the Easterlin Paradox Betsey Stevenson and Justin Wolfers challenge the facts behind the Easterlin Paradox, except for the U.S. Jean-Benoit Rousseau confirms these findings and adds insight about the U.S. However, Stevenson and Wolfers show that womens happiness has declined relative to mens, which is equally paradoxical. 23

24 Fact #1 In the long run, people can become better off without feeling happier.

25 Hedonic Adaptation: This, too, shall pass. 1. After time has passed, things that surely had a big effect on happiness right after the event have surprisingly little effect on happiness. (Not just money.) incarceration loss of the use of limbs serious burns death of a spouse winning the lottery 2. The dynamics of national happiness after news 3. The dynamics of happiness after major life events 4. The dynamics of happiness: evidence from daily panel data

26 Unhappiness After Hurricane Katrina Miles Kimball Helen Levy Fumio Ohtake Yoshiro Tsutsui

27 USA: The Happiness Index on the Reuters/UM Surveys of Consumers 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?)

33 Implications of the October Dip in Happiness It is difficult to explain this dip in happiness on the grounds that lifetime utility is seriously effected in terms of self-interest. If this dip in happiness is due to altruism, the happiness data told us something we might not otherwise have known: Americans cared quite a bit about those hurt by the earthquake in Pakistanmore than one would suspect from the donation data. Katrina and Rita: >$2.65 Billion South Asian Tsunami: >$1.55 Billion

34 What does it mean to say that lifetime utility has fallen permanently? Revealed Preference is the measure of lifetime utility. If there were a lever to magically undo the damage of Katrina, we would pull it. True for the harm to others. True for the harm to self, narrowly construed. True even if the past cannot be changed but only the harm from now on reversed.

38 The Dynamics of Happiness After Major Life Events June 5, 2007 Dan Silverman and Miles Kimball Using HRS data to observe the relationships between economically quantifiable life-events, such as the death of a spouse, and a quantifiable measure of happiness.

39 Introduction Exploring the relationships between dramatic life-events and happiness, using longitudinal data from the HRS. Current work considers the death of ones spouse, life- insurance, and associated levels of a happiness index. We define our happiness index using the Center for Epidemiologic Studies Depression Scale (CESD) questions in the HRS. We use data from individuals reports on dates of spousal death and information on spousal life-insurance. We consider men and women together and separately. We also consider those with and without life-insurance.

40 Non-parametric estimates, w/controls

41 With Life Insurance: Non-Parametric estimates (no FE)

42 Parametric estimates, no fixed effects: MEN

43 Parametric estimates, no fixed effects: WOMEN

44 Parametric estimates, no fixed effects: w/ LIFE INSURANCE

45 Parametric estimates, no fixed effects: NO LIFE INSURANCE

46 Findings Quick Hedonic Adaptation (Mean Reversion of Happiness) Men react more than women Those without life insurance react more than those who do have life insurance.

47 Two Strategies for Using Happiness Data to Value Non- Marketed Goods Divide the effect of the non-marketed good on the long-run level of happiness by the effect of money on the long-run level of happiness. Divide the effect of news about the non- marketed good on the dynamics of happiness (lost area under the curve) by the effect of news about money on the dynamics of happiness.

48 The Dynamics of Happiness: Evidence from Daily Panel Data Miles Kimball, Fumio Ohtake and Yoshiro Tsutsui RAs: Yuki Kosaka and Noah Smith

49 Japan: The Osaka University Panel Study of Happiness Dynamics 71 Osaka University Undergraduates 49 male, 22 female Answered daily web survey for 273 days (so far). Often used web-capable cell-phones High response rates Total of 17258 person-day observations

51 Top of the First Page of the Paper Version

53 Personal News

54 National News

55 Histogram of Average Happiness (averaged across individuals)

56 Histogram of Average Personal News Ratings

57 Histogram of Average National News Ratings

58 Scatterplot of Happiness vs. Same- Day Personal News

59 Scatterplot of Happiness vs. Same- Day National News

60 Average Happiness vs. Average Personal News Rating

61 Average Happiness vs. Average National News Rating

62 Empirical Strategy Estimate the time series effect of innovations in personal and national news on happiness. Allow for individual fixed effects Regress personal news ratings on their own lags and treat the residuals from this regression as true personal news innovations (whitened personal news) Do the same for national news ratings to construct whitened national news. Check for nonlinearities in the relationship between news ratings and happiness.

63 News Ratings vs. Lifetime Utility Innovations Our theoretical concept of news is innovations in information about lifetime utility. These innovations should be unpredictable. However, the ordinary language meaning of good news and bad news may be somewhat predictable. We will purge the component of the news ratings that are predictable by past news ratings. We expect some remaining predictability of news ratings as todays information is sometimes treated as tomorrows expected news. The theory then implies that todays reported happiness should be correlated with tomorrows news ratings even after controlling for current and past news ratings.

64 Daily Happiness vs. Daily Personal News

65 Increments (Personal)

66 Cumulative Increments (Personal)

67 Daily Happiness and Daily National News

68 Increments (National)

70 Whitening (Personal)

71 Whitening (National)

72 Impulse Response (Personal & National)

73 Impulse Response (Personal)

74 Impulse Response (National)

75 Component Impulse Responses (Personal News)

76 Component Impulse Responses (National News)

77 Impulse Response + Neg. Sensitivity (Personal)

78 Impulse Response + Neg. Sensitivity (National)

79 Fact #2 about Happiness Happiness depends more on changes than on the absolute level of ones circumstances. Analogy: We have no altimeter in our brains, but we can tell whether we are going up or down.

80 The Elation Theory of 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 depends on ones daily actions

Project 2: Well-Being and Utility in Economics Project Leader: Miles Kimball Co-Investigators: David Albouy, Daniel Benjamin, Dan Silverman, Robert Willis (+Jean-Benoit Rousseau)

A. Specific Aims 1.Continue to develop and validate the technique of using the short-run dynamics of happiness to gauge the size of shocks to lifetime utility. 2.Analyze the determinants of long-run happiness using the HRS psychosocial leave-behind. 3.Compare different methods for valuing non-market goods.

A. Specific Aims (cont.) 4. Examine the relationship between happiness literacy, degree of preference for happiness, time budget and happiness. 5. Test the implications of the elation theory for measuring marginal utility.

B. Background and Significance 1.Valuing Non-Market Goods 2.Dealing with the Possibility of Mistakes 3.The Claims of the Existing Economic Literature on Happiness a. Long-run happiness regressions can value non-market goods?? b. Happiness data can diagnose mistakes?? 4. Price Theory of Happiness 5. Marginal Utility in Empirical Economics

C. Preliminary Studies 1.Elation Theory of Utility and Happiness 2.Empirics of Elation Determination a.Financial and Non-Financial Dimensions of Major Life Events in the HRS b.Katrina c.Elections d.Daily Web Panel of News and Happiness 3.Happiness and Expectations

C1. Elation Theory of Utility and Happiness a. HappinessUtility 1.Utility = U(Happiness, Other Goods) 2.Maximizing Happiness is Not the Object b. Happiness Dynamics and Innovations to Lifetime Utility 1. Happiness = Baseline Mood(Genes, Time Use, Goods) + Elation(Recent News About Lifetime Utility) 2. Hypothesis: Size of Innovation to Lifetime Utility is Proportional to the Extra Area or Lost Area Under a Graph of Happiness Versus Time. 3. Intensity and Duration of Effects on Happiness

C1b4: Model of the Short-Run Dynamics of Happiness Happiness it = i + i f(V i,t) + it i = Individual Fixed Effect i = Emotional Sensitivity Parameter t = Time Lapse Since Shock V i = H(W) + J(Z); W=Wealth; Z=Non-Mkt Wealth Shock: V i = H(W 0 +W) - H(W 0 ) Non-Market Shock: V i = J(Z 0 +Z) J(Z 0 )

C2a. Empirics of Elation: Major Life Events in the HRS 1.Variation in both the financial and non- financial dimensions of dated shocks: widowing, divorce, health events 2.Imputing a value based on the dynamics of happiness in reaction to the financial and non-financial dimensions of shocks 3.Exponential: no evidence within HRS that duration depends on size of shock

Parametric Estimates, By Life Insurance Status Parameter With Life Insurance Point estimate (s.e.) Without Life Insurance Point estimate (s.e.) c 84.42 (1.21) 80.53 (2.05) -2.27 (1.61) -4.47 (2.68) -4.50 (3.72) -5.53 (6.19) -24.66 (5.26) -56.58 (12.62) 0.120 (0.045) 0.227 (0.076)

C2b. Empirics of Elation: Katrina 1.Important national news events can have a significant effect on average happiness in the U.S. 2.Even for Hurricane Katrinaa quite big eventthis effect was short-lived, lasting only a few weeks. 3.The dip in the average happiness in the U.S. after Katrina may provide non- market evidence of altruism.

C2c. Empirics of Elation: Elections 1.Partisan movements in happiness near elections reflect heterogeneity in preferences over non-market goods. 2.Happiness reaction depends on both intensity of political preferences and expectations. (2006 elections) 3.Potential for validation of happiness movements as a strength of preferences measure.

C2d. Empirics of Elation: Daily Web Panel 1.Subjective ratings of both personal and national news (-5 to +5 scale of bad news to good news) are tightly related to subsequent happiness dynamics. 2.News on a given day affects happiness for about two weeks. 3.Personal news has a bigger effect on happiness than national news. 4.Proportional: duration is indep. of size

C3. Happiness and Expectations a.Both the individual fixed effect component of happiness and variations in happiness are related to expectations reports b.Interesting variations in which types of expectations measures are affected most c.Weather can be used as an instrument to see if variations in happiness can cause shifts in expectations d.Are these shifts in expectations shifts that affect behavior? Sunny days and stock mkt.

D. Research Design and Methods 1.Continue to develop and validate the technique of using the short-run dynamics of happiness to gauge the size of shocks to lifetime utility. 2.Analyze the determinants of long-run happiness using the HRS psychosocial leave-behind. 3.Compare different methods for valuing non-market goods.

D. Research Design and Methods (cont.) 4. Examine the relationship between happiness literacy, degree of preference for happiness, time budget and happiness. 5. Test the implications of the elation theory for measuring marginal utility.

D1. Developing and Validating Techniques for Using Elation to Measure Utility Shocks a.Continue SCA data collection b.Daily Web Panel on the ALP in collaboration with Osaka University c.Experiments dosing people with money Vary amount, probabilities and time lapse Establish functional form of happiness dynamics in relation to monetary values probabilities and time. Feeds into design of MU elicitation

D2. Analyze determinants of long-run happiness with HRS psychosocial leave-behind. a.HRS Psychosocial Leave-Behind has rich data on hobbies; religious attendance, belief and prayer; quality of relationships with spouses, children, relatives, and friends; loneliness; positive and negative thinking; quality of local community, locus of control; perceived discrimination; past traumas; management of emotions; rank on social ladder; addictions;

D2. Analyze determinants of long-run happiness with HRS psychosocial leave-behind. a. anxiety; job quality; date of being robbed, death of child, natural disaster, assault, life-threatening illness or accident, physical abuse. b.Extra data on happiness. c.Preference for happiness makes the production function for long-run happiness matter. d.Feeds into subprojects D3 and D4.

D3. Compare different methods for valuing non-market goods. a.Elation-based measures on HRS b.Ratios of happiness regression coefficients as in the existing happiness literature. Use rich psychosocial leave-behind data doubles as an investigation of the determinants of baseline mood. c. Hypothetical-revealed-preference and predicted happiness measures using vignettes

D4. Happiness Literacy and Happiness a. Retirement Makes Possible the Major Input Into Long- Run Happiness: Time b. Factors That May Limit Happiness: 1.May Not Know the Household Production Function for Happiness 2.May Not Want to Make Feeling Happy a Priority c. Develop New Measures 1.Happiness Literacy 2.Preference (Motivation) for Happiness d. Implement New Measures as an HRS Module and Compare to HRS Measure of Happiness

D5. Test the implications of the elation theory for measuring marginal utility. a.Marginal utility of wealth a key concept for life-cycle C and labor supply; ALP planned to have C and labor data. b.Happiness does not measure utility, but the magnitude and duration of short-run spikes in happiness should be a useful indicator of marginal utility. c.We can elicit such an indicator of marginal utility on the ALP.

Reminder: Model of the Short- Run Dynamics of Happiness Happiness it = i + i f(V i,t) + it i = Individual Fixed Effect i = Emotional Sensitivity Parameter t = Time Lapse Since Shock V i = H(W) + J(Z); W=Wealth; Z=Non-Mkt Wealth Shock: V i = H(W 0 +W) - H(W 0 ) Non-Market Shock: V i = J(Z 0 +Z) J(Z 0 )

D5c. Collecting an Indicator of Marginal Utility on the ALP Measure Happiness Random doses of $5 to $50, with average expense of $15--$20 per respondent. Ask expectations questions to provide time lapse AND study the effects of exogenous movements in happiness on expectations Measure Happiness Again

112 An Integrated Theory of Utility and Happiness A. Preference for Happiness: Many people value happiness, as evidenced by the fact that they will sacrifice other things for the sake of happiness. B. News and Happiness: Short-run spikes and dips in happiness signal what people consider good and bad news, which in turn signals what they care about.

113 Preference for Happiness Axiom: Preferences depend on the joint stochastic process of S: vector of state variables C: vector of control variables H: current happiness (affect) B: other outputs of household production functions (e.g. health) There is an intertemporal expected utility representation over these ultimate goods at least weakly increasing in H at every date and in every state of nature.

114 Evidence in Favor of a Preference for Happiness The preference for happiness shows up in both household and firm behavior: Purchases of therapy, Prozac, self-help books, magazines featuring happiness. Advertising that tries to suggest that a product will make one feel happy.

115 Contrast with the Neobenthamite View People value happiness (and will sacrifice other goods for it) versus People should be maximizing happiness (often interpreted as saying that happiness is the true utility function).

116 Arguments of Happiness beyond S,C,B J t = state variables that do not matter directly for preferences but affect household production: genes, underlying physical and psychological states, unknown parameter values and shocks. Q t = control variables that do not matter directly for preferences, but affect household production of happiness (empty set? psychoactive and other medical drugs, recreational drugs?) v t, v t-1, v t-2, = the history of lifetime utility. (Note: B=B(S,J,C,Q))

117 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.

118 The News and Happiness Axioms 1.Happiness at time t is a function of the other ultimate goods, S, C and B, an additional state variable vector J (unobserved?) an additional control variable vector Q, and the history of realized lifetime utility v through time t. --Holding all other arguments of happiness fixed, the agent is 2. Happier if current expected lifetime utility is of a preferred future. 3. Less happy if past expected lifetime utility was of a preferred future.

119 Simultaneous Determination of Utility and Happiness News and Happiness Axiom 4 is an ordinal version of the kind of assumptions that guarantee a contraction mapping, so that there is a well-defined solution to the simultaneous determination of utility and happiness. Although preferences over ultimate goods exhibit intertemporal expected utility, the derived preferences over the fundamentals (S, J)=K and (C,Q)=X can exhibit reference- dependence and loss aversion as in Prospect Theory.

120 Lifetime Utility in the Additively Separable Case

121 The Innovation in Lifetime Utility v (Additive Separability, Observed K) Note about the lifetime utility innovation: so

122 News and Happiness Axioms + Additive Separability Imply Axiom 2 Axiom 3

123 Baseline Mood M and Elation e

124 The Elation Theory of Happiness

125 The Elation Theory of Happiness (In Words) 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 the output of a household production function (like health, entertainment, or nutrition.)

126 Key Implications of the Happiness and News Axioms A theory of happiness can be described in terms of the objects that are well-defined by revealed preference: The fundamentals (state and control variables and outputs of household production functions) that people care about and The history of which indifference curves for lifetime plans one has been on. Old news about the future matters less for happiness than recent news about the future.

127 Loss Aversion from Elation Theory: Happiness Additively Separable with Elation Concave in Lifetime Utility Innovations U(K,X,H,A)=F(K,X)+M(K,X) + 0 min( t, t /2) + 1 min( t-1, t-1 /2) +

128 Elation-Independence: Additively Separable Happiness with Elation Linear in Lifetime Utility Innovations U(K,X,H)=u(K,X)+M(K,X) + 0 t + 1 t-1 +

129 Factual Mistakes about Happiness Need Not Cause Decision Mistakes 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 harm to utility maximization. However, mistakes about the controllable determinants of baseline mood will cause material harm.

130 Elation and Hedonic Adaptation Because it is based on recent news, elation fades, News doesnt stay news for very long. The initial burst of elation dissipates once the full import of news is emotionally and cognitively processed. This can help explain why, in the long run, becoming better off may not lead to greater happiness.

131 The Evolutionary Psychology of Elation and Dismay Functionally, elation and dismay may motivate cognitive processingmuch 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

132 The Evolutionary Psychology of Hedonic Adaptation Analogy: Adjustments in the pupil of the eye protect the eye and enhance sensitivity. Protect: Being too happy or too sad has physical costs. Hedonic adaptation protects from these costs. Enhance Sensitivity: Hedonic adaptation may also increase our sensitivity to, and motivation to make, local changes in our objective circumstances. (Frederick and Loewenstein)

133 Speculations on The Evolutionary Psychology of Baseline Mood High social rank makes it safe to look more for opportunities than for dangers. Thus, it makes sense to stimulate the same machinery turned on by the receipt of good news. Optimists and pessimists need each other. Quirks in the system? Pinkers cheesecake

134 Raising Baseline Mood: How to Raise Happiness in the Long Run 1.Prozac and Talk Therapy 2.Taking Care of Oneself Sleep Exercise Eating well 3.Enjoyable Activities Spending time with friends An engrossing hobby

135 How to Raise Happiness in the Long Run (cont.) 4. Positive attitudes Gratitude Forgiveness Acceptance of ones situation 5.Raising ones social rank

137 The Problem with Happiness from Social Rank The usual strategies for raising social rank are a zero sum gameanything that works for one person makes everyone else worse off by lowering their social rank However, we can Choose the right pond Help the unfortunate Treat one another with dignity

138 Do People Know the Production Function for Baseline Mood? Just as people dont 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.

139 Do People Know Their Own Utility Functions? Not perfectly. For example, I dont know if I will like a new flavor of ice cream. Lack of knowledge of ones own utility function can be modeled as an internal informational constraint. (Rayo-Becker is an example.) The key distinguishing features of mistakes about ones own utility function are regret changing ones mind after learning more.

140 Why are Utility and Happiness Confused? Because they are dramatic, elation and dismay may dominate peoples perception of happiness. Everyone wants good news. That is, everyone wants what spikes in happiness signal. Not everyone values the emotional spikes per se, as distinct from what they signal. Not everyone will sacrifice other goods for the long-run happiness that remains even when there is no good or bad news.

141 A Non-Judgmental View of the Effect of Materialism on Happiness Materialism lowers happiness (weak, but interesting evidence). Tradeoff between happiness and other goods. Materialism means higher preferences for other goods compared to happiness.

142 Evidence in Favor of a Preference for Happiness The preference for happiness shows up in both household and firm behavior: Purchases of therapy, Prozac, self-help books, magazines featuring happiness. Advertising that tries to suggest that a product will make one feel happy.

143 Applying Price Theory to Baseline Mood: The Demand for Prozac If you learn more about the household production function for happiness, your behavior will change in a direction that takes advantage of that to raise happiness. Example: Demand for Prozac will go up if information arrives that it is more effective in raising happiness than previously thought (with no new information about side effects). Demand will go down if information arrives that it is less effective at raising happiness than previously thought.

144 Applying Price Theory to Baseline Mood: The Easterlin Paradox Revisited Normality of baseline mood leads to a version of the Easterlin Paradox even in the context of our theory: Why dont people buy higher baseline mood as part of their expanding consumption bundle?

145 Why Doesnt Rising Income Lead to Greater Happiness? 1. Lack of Understanding of Happiness? 2. More internal conflicts from greater income? obesity drug use 3. Negative externalities from others freedom? breakdown of community divorce 4. Resources spent on increased lifespan? 5. Raising ones happiness takes time.

146 Why Happiness Matters for Economics Preference for Happiness: People value happiness, as evidenced by the fact that they will sacrifice other things for the sake of happiness. News and Happiness: Short-run spikes and dips in happiness signal what people consider good and bad news, which in turn signals what they care about.

147 Implications for Policy Happiness is valuable: should be fostered. Happiness data are a reminder of tangible and intangible externalities in the utility functionespecially social rank externalities. Economic growth is of enormous value, despite the Easterlin Paradox. Happiness data is not enough to diagnose optimization mistakes.

148 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.

150 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.

151 Life Expectancy

152 Would you want to go back to the way things used to be? No computers or electronics No Ben and Jerrys No Harry Potter No Beatles music yet released Jim Crow, strong male dominance Cold War Few modern drugs

153 Elation and Loss Aversion There is evidence that happiness rises less with good news than it falls with bad news. Assume also that the duration of the effect of bad news on happiness is at least as long. The greater effect of bad news, combined with a preference for happiness, implies loss-aversion, a key aspect of Prospect Theory. Thus, loss aversion (=first-order risk aversion) can arise from rational preferences over ones own emotions. Here, the agent needs to understand happiness.

154 Applying Price Theory to Elation For given nonlinearity in happiness as a function of news, people should exhibit more first-order risk aversion if they 1.care more about happiness and 2.believe that their happiness will be affected a lot, for a long-time by events

155 Anticipation Effects Empirically, seasonals should capture most of the anticipation effects that are not idiosyncratic. Theoretically, anticipation effects can arise from a multiple-agent model of the psyche, where some agents have high utility discount rates. Different information sets? Model happiness for multiple agents in the same way as for a unified self. Even when an agent is not in charge, it cares about events. Happiness reporting: agent in charge, frequency weighted average.

156 Can Manipulating Ones 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 ones perceptions is to lower ones memory of past expectations. (Attitude of gratitude)

157 Manipulating Perceptions of Locus of Control Elation may respond more to news about whether ones choices worked out than to news about things beyond ones control. This would make it possible to manipulate elation by labeling good events as due to ones efforts, while bad events were beyond ones control.

159 Hedonic Adaptation is Not the Same Thing as Habit Formation Hedonic adaptation is a statement about happiness, as measured by psychologists. Habit formation is a statement about utility, as measured by economists. If happiness were equal to flow utility, data on hedonic adaptation would imply very strong habit formation.

160 Evidence on Habit Formation Constantinides Form: 1. Joseph Lupton estimates .75 based on portfolio choices 2. Impulse responses for consumption choices suggest close to zero unless the lags in the habit H are very long. 3. Because of the speed of hedonic adaptation, long lags are inconsistent with U=Affect.

161 Modeling Choice: Habit Formation or Just Hedonic Adaptation? 1. Equivalent to 2. Lets keep the economic theory simple and put the complexity in the utility-happiness relationship. a. Its clearer and simpler. b. It avoids the misleading impression that there is anything wrong with the more traditional functional form. Suppose and and happiness=first difference of flow utility.

162 Does Habit Formation Affect the Choice between 1955 and 2005? To include the effects of habit formation on the decision, imagine you had to give your newborn, whom you care a lot about, up for adoption. Which world you would want your newborn to grow up in? (cf. John Rawls) Beware of nostalgia. Remember the problems that have now been partly or wholly resolved. Hold relative social rank constant. Think about relative mortality rates.

163 (Long-Run) Happiness and Health Like health, happiness can be measured independently is only one argument of the flow utility function depends on different things than flow utility does (or on the same things with different weights) has a complex household production function

164 UtilityHappiness Summary of the Argument a.If only innovations in lifetime utility mattered for happiness, maximizing happiness and maximizing lifetime utility would be equivalent. b.Focusing on only changes leaves out Rawlsian preferences. c.Any predictable effect of choice variables on happiness implies innovations in lifetime utility are not the only component of happiness. d.People who knowingly, thoughtfully and without regret choose not to maximize long-run happiness indicate that utilityhappiness for them.

165 The Standard View in Psychology Currently, the standard view among psychologists and most economists working with happiness dataarticulated most forcefully by Daniel Kahnemanis 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. (Return to this below.)

166 Our View We are questioning this orthodoxy. When well-informed and thoughtful, we view peoples 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.

167 Relationship to the Orthodoxy of Other Happiness Researchers People value happiness (and will sacrifice other goods for it) versus People should be maximizing happiness (economists often interpret this as saying that happiness is the true utility function).

170 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.

171 Applying Price Theory to Baseline Mood: The Demand for Prozac If you learn more about the household production function for happiness, your behavior will change in a direction that takes advantage of that to raise happiness. Example: Demand for Prozac will go up if information arrives that it is more effective in raising happiness than previously thought (with no new information about side effects). Demand will go down if information arrives that it is less effective at raising happiness than previously thought.

172 The Validity of Self-Reported Happiness Correlated with observer ratings of happiness structured coding of facial expressions electrical measures of face muscle activation voice tone skin conductance, heart rate, blood pressure, etc. writing speed judgment of probabilities word association and word completion startle reflex left pre-frontal cortex activity (which can also be induced by seeing pictures of a smiling baby and reduced by seeing pictures of a deformed baby)

1 Approaches to Behavioral Welfare Economics Building on the 20 th Century Economic Tradition More...

Documents

Transcript of 1 Approaches to Behavioral Welfare Economics Building on the 20 th Century Economic Tradition More...