Behavioral and Happiness Economics-Scott Thor

8/8/2019 Behavioral and Happiness Economics-Scott Thor

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Behavioral Economics and Happiness 1Running Head: BEHAVIORAL ECONOMICS AND HAPPINESS

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

Scott Thor

George Fox University

Edited Using APA 5th Edition


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Behavioral Economics and Happiness 2Abstract

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.


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Behavioral Economics and Happiness 3Introduction

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


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Behavioral Economics and Happiness 4& Loewenstein, 2004; Tideman, 2005), the foundation of rational thinking represented in

economic models may not be as accurate as once 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 societys 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,


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Behavioral Economics and Happiness 52009, 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 Easterlins early work, the

field has emerged into an exciting body of 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 EconomicsCamerer (2006) describes economics as a collection of ideas and conventions

which economists accept and use to reason with. Namely, its 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 EconomicsNo 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


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Behavioral Economics and Happiness 6combination 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 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 EconomicsWhy 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


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Behavioral Economics and Happiness 7economics. 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, 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


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Behavioral Economics and Happiness 8expected 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).

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.


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Behavioral Economics and Happiness 9Representativeness, 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 individuals 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 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


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Behavioral Economics and Happiness 10has 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 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 participants 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


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Behavioral Economics and Happiness 11and 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 participants 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.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


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Behavioral Economics and Happiness 12Tversky 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.jpgThe 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 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.


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Behavioral Economics and Happiness 13Several 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 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.


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Behavioral Economics and Happiness 14The 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 InfluencesDespite 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


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Behavioral Economics and Happiness 15may be quite 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 individuals 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-governmentis 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

morewhen 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


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Behavioral Economics and Happiness 16concept of loss aversion discussed previously. One can hardly argue against Smith

believing psychological factors influenced economic behavior.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 EconomicsDespite 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


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Behavioral Economics and Happiness 17critics 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).

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 EconomicsAristotle 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).


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Behavioral Economics and Happiness 18Graham (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 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 HappinessAs 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


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Behavioral Economics and Happiness 19striving scale. Representing the more complex method of measuring happiness,

Cantrils 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).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 Cantrils 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).


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Behavioral Economics and Happiness 20Evolution 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%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 ResponseEconomic 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.


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Behavioral Economics and Happiness 21Cantrils (1965) research provided some of the impetus for Easterlins (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.

Easterlins (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 average than the lower earners. Easterlins 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 Cantrils (1965) research studying 14 countries a


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Behavioral Economics and Happiness 22decade earlier in which a positive correlation was uncovered. Easterlins 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 Duesenberrys

(1952) relative income explanation, which suggests that unless an individuals 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 Easterlins 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).

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

Since Easterlins 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.


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Behavioral Economics and Happiness 23Using 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 Easterlins claim that an individuals

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.

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.


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Behavioral Economics and Happiness 24The 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 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.


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Behavioral Economics and Happiness 25

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 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).


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Behavioral Economics and Happiness 26If 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 EconomicsThe 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.

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,


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Behavioral Economics and Happiness 27education, 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 individuals control. An argument

can be made that an individuals 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 EconomicsCan 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 influence individual happiness. These areas include education,

financial planning, and health care. The focus is not so much on providing detailed


28/41

Behavioral Economics and Happiness 28solutions, 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 ones 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 ones 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


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Behavioral Economics and Happiness 29increase choice options, 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 peoples 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.


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Behavioral Economics and Happiness 30Nudging 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 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.


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Behavioral Economics and Happiness 31Personal 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 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


32/41

Behavioral Economics and Happiness 32affect 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 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 individuals 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.


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Behavioral Economics and Happiness 33Materialism 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 haveenough

(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, 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 societys measure of individual prosperity that is heavily rooted in


34/41

Behavioral Economics and Happiness 34material 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.


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