Lecture 1: Happiness and Growth - University of Warwick · Implies cardinal Utility and...

Lecture 1: Happiness and Growth

Eugenio Proto

March 13, 2009

Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 1 / 18

Happiness and Utility

Implies cardinal Utility and Interpersonal Comparison

Ordinalism: utility determined by choices if I choose A to B I ranku(A) > u(B).

Cardinalism implies a objective measure of the Utility

Unnecessary to determine a demand functionNecessary for Public Choice (Arrow impossibility theorem)

Unnecessary to determine a demand function

Necessary for Public Choice (Arrow impossibility theorem)

Happiness and Utility (cont�d)

Pro-Ordinalism: How could you even tell if you like one bundle twiceas much as another?

But: Assume that: A is your current situation, B is A plus an AntBite, and C is A plus being eaten by a crocodile.

Ordinalism can say u(A) > u(B) > u(C )but not that u(A)� u(B) > u(B)� u(C )

Ordinalism can say u(A) > u(B) > u(C )

but not that u(A)� u(B) > u(B)� u(C )

The main idea is that there exists a reported well-being function

ri ,j = h(u(y , z , t)) + ei ,j

ei ,j individual speci�c error term, z demographic characteristics, ysocioeconomic determinants

Empirical Determinants

Suitable for estimation as an ordered probit or logit:

h = a+ bZ + cY

Easterlin Paradox

Easterlin Paradox (cont�d)

1 Regressions of happiness on income using cross-section survey datafrom one country generally produce a signi�cant positive estimatedcoe¢ cient on income. The income�happiness slope is larger indeveloping or transition than in developed economies.

2 Recent work has used panel data to control for unobserved individual�xed e¤ects, such as personality traits, and concludes that changes inreal incomes are correlated with changes in happiness

3 Recent detailed studies of the �macroeconomics of happiness� shownthat happiness co-moves with macroeconomic variables includingGDP, GDP growth, and in�ation

How to reconcile Easterlin Paradox with 1-3?

Theory: Relative Income

Individual Utility

Ut = U(u1(Yt ) + u2(Yt/Y �t ) + u3(T � lt ,Zt ))

For exampleUt = α ln(yt ) + β ln(yt/y �t ) + γZt

y�t reference income, example pc GDP

Theory: Relative Income

Individual Utility

Ut = U(u1(Yt ) + u2(Yt/Y �t ) + u3(T � lt ,Zt ))

For exampleUt = α ln(yt ) + β ln(yt/y �t ) + γZt

y�t reference income, example pc GDP

Relative income (cont�d)

Relative Income (cont�d)

Individuals�utility gain from living in a relatively successful country.

Ut = β1 ln(yi ,j ,t ) + β2 ln(yi ,j ,t/y�j ,t ) + β3 ln(yj ,t/y

�t ) + γZt

i .e. β3 is positive and signi�cant

Individuals�utility gain from living in a relatively successful country.

Ut = β1 ln(yi ,j ,t ) + β2 ln(yi ,j ,t/y�j ,t ) + β3 ln(yj ,t/y

�t ) + γZt

i .e. β3 is positive and signi�cant

Suboptimality with relative Income

If we consider non status activity:

Ut = β1 ln(yi ,t ) + β2 ln(yi ,t/yt ) + γ ln(T � yi ,t/ωt )

Adaptation

�a reduction in the a¤ective intensity of favorable and unfavorablecircumstances�.

Ut = β1 ln(yi ,t ) + β2 ln(yi ,t/y�t ) + γZt

y �t = (yt�1)α(yt�2)γ(yt�3)1�α�γ

short-run e¤ect of an increase in log income equals β1 + β2, whilstthe longrun e¤ect is only β1.

Adaptation

�a reduction in the a¤ective intensity of favorable and unfavorablecircumstances�.

Ut = β1 ln(yi ,t ) + β2 ln(yi ,t/y�t ) + γZt

y �t = (yt�1)α(yt�2)γ(yt�3)1�α�γ

short-run e¤ect of an increase in log income equals β1 + β2, whilstthe longrun e¤ect is only β1.

Adaptation (cont�d)

Growth and Happiness

Growth has little impact on happiness, in developing countries sinceincrease in U(c) is low for high c and the term u2(yt/y �t ) might notchange since they tend to move together (�keeping up with theJoneses�)

Importance of the income distribution during the growth process.

However we must consider other e¤ect of growth that do not changehappiness. Length of Life, Induced long run Progress, capacity ofwithstand foreign aggressor

Since u01(y) is decreasing individuals should supply less labour, butterm u2(yt/y �t ) may have the opposite e¤ect (�keeping up with theJoneses�).

Same reasoning for saving, if we assume that individuals have areference point increasing with their ages, they have an incentive tosave again to �keeping up with the Joneses�

Lecture 1: Happiness and Growth - University of Warwick · Implies cardinal Utility and...

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