The Economics of Happiness Miles Kimball 1 What

The Economics of Happiness Miles Kimball 1

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 After Major Life Events” by Miles Kimball and Daniel Silverman • “The Dynamics of Happiness: Evidence from Daily Panel Data” by Miles Kimball, Fumio Ohtake and Yoshiro Tsutsui • Conversations with Norbert Schwarz 2

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 one’s daily actions 3

Raising Baseline Mood: How to Raise Happiness in the Long Run 1. 2. • • • 3. • • Prozac and Talk Therapy Taking Care of Oneself Sleep Exercise Eating well Enjoyable Activities Spending time with friends An engrossing hobby 4

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

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The Problem with Happiness from Social Rank • The usual strategies for raising social rank are a zero sum game—anything 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 7

Emotions in the Utility Function Example 1: Anger • People care whether they feel angry or not. • The generation of anger is related to expectations and to preferences. 8

Emotions in the Utility Function 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 one’s preferences. (Expectations and preferences are arguments of the production function for happiness. ) 9

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. 10

Two Definitions of “Happiness” • The Greatest Good for an Individual • Feeling Happy 11

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=the greatest good for an individual as viewed by that individual 12

Measuring Utility: The Modern Tradition of Economics • Look at an individual’s 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 13

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? 14

Greater Happiness in the Narrow Sense is Not Always a Good Thing • Feeling extremely happy can make people overoptimistic and therefore careless • Too much sacrificed for the sake of feeling happier 15

Examples of Happiness Requiring Too Great a Sacrifice • Change political beliefs for the sake of additional happiness? • Charles Schulz – Bill Waterson (Calvin and Hobbes) reviews Schulz and Peanuts: A Biography “Knowing that his miseries fueled his work, he resisted help or change, apparently preferring professional success over personal happiness. ” • Join a Tibetan monastery? • The things that money can appropriately matter more than just for their contribution to happy feelings. 16

Do We Wish (Narrow) Happiness for our Children at any Cost? • Downs Syndrome • Give up a child for adoption into the world of today or into the world of 50 years ago if people were happier back then? 17

The Neobenthamites • Currently, the standard view among psychologists and most economists working with happiness data—articulated most forcefully by Daniel Kahneman—is that a present discounted value of measured happiness is a good indicator of what people should be maximizing. • To the extent that people are maximizing something else, it is viewed as a mistake. • Factual mistakes people make in predicting their own future happiness are thought to be an important reason people make these optimization mistakes. (Return to this below. ) 18

Our View • Bob Willis and I are questioning this orthodoxy. • When well-informed and thoughtful, we view people’s choices as the best indication of their individual welfare. • People do often make optimization errors. • But much of what this orthodoxy takes as evidence of optimization errors, we take as evidence that utility and “happiness” are not the same thing. 19

Evidence that Utility≠Happiness 1. People who knowingly, thoughtfully and without regret choose not to maximize long-run happiness indicate that utility≠happiness for them. People make choices eagerly that they never regret, but which have no long-run effect on how happy they feel. 2. – – 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 one’s child through college. Having a baby? Doing one’s duty. 20

The Nature of Happiness (What Makes Us Feel Happy) 21

Key Facts about What Makes Us Feel Happy #1: Easterlin Paradox #2: Hedonic Adaptation 22

The Easterlin Paradox 23

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. 24

Life Expectancy 25

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 1950’s. • Large numbers of Mexicans choose to migrate to the U. S. • Among the many costs of migration, their social rank often drops drastically when they migrate to the U. S. Despite this, they come. 26

Fact #1 • In the long run, people can become better off without feeling happier. 27

The Kimball and Willis Approach to Long-Run Happiness • Long-run happiness is a valuable commodity, but only one of many commodities that we desire. • Therefore, the demand for happiness depends on – the cost of happiness – how much someone wants to feel happy • Remember the two meanings of happiness. This is the narrow meaning. 28

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. 29

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. 30

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. 31

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 don’t people buy higher baseline mood as part of their expanding consumption bundle? 32

Why Doesn’t Rising Income Lead to Greater Happiness? 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 one’s happiness takes time. 33 1.

Fact #2 • There is a substantial transient component to happiness (“elation” or “dismay”) that is a response to recent news. 34

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 35

Two Points • There is a substantial component to happiness and unhappiness that goes away quickly. • Despite being short-lived, this transient component to happiness and unhappiness is interesting because it tells us something about what people care about and how much they care. 36

Unhappiness After Hurricane Katrina Miles Kimball Helen Levy Fumio Ohtake Yoshiro Tsutsui 37

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? )” 38

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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 Pakistan—more than one would suspect from the donation data. – Katrina and Rita: >$2. 65 Billion – South Asian Tsunami: >$1. 55 Billion 44

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. 45

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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. 49

Introduction • Exploring the relationships between dramatic life-events and happiness, using longitudinal data from the HRS. • Current work considers the death of one’s spouse, lifeinsurance, 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. 50

Non-parametric estimates, w/controls 51

Men: Non-parametric estimates, w/controls 52

Women: Non-parametric estimates, w/controls 53

Non-parametric estimates, w/controls 54

Non-parametric est. , Difference btw Men & Women (no controls) 55

Non-parametric estimates, with fixed effects 56

Non-parametric estimates, with FE & controls 57

Men: Non-parametric estimates, with fixed effects 58

Women: Non-parametric estimates, with fixed effects 59

With Life Insurance: Non-Parametric estimates (no FE) 60

Parametric estimates, no fixed effects: MEN 61

Parametric estimates, no fixed effects: WOMEN 62

Parametric estimates, no fixed effects: w/ LIFE INSURANCE 63

Parametric estimates, no fixed effects: NO LIFE INSURANCE 64

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. 65

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 nonmarketed good on the dynamics of happiness (lost area under the curve) by the effect of news about money on the dynamics of happiness. 66

The Dynamics of Happiness: Evidence from Daily Panel Data Miles Kimball, Fumio Ohtake and Yoshiro Tsutsui RA’s: Yuki Kosaka and Noah Smith 67

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 68

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Top of the First Page of the Paper Version 70

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Personal News 72

National News 73

Histogram of Average Happiness (averaged across individuals) 74

Histogram of Average Personal News Ratings 75

Histogram of Average National News Ratings 76

Scatterplot of Happiness vs. Same. Day Personal News 77

Scatterplot of Happiness vs. Same. Day National News 78

Average Happiness vs. Average Personal News Rating 79

Average Happiness vs. Average National News Rating 80

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. 81

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 today’s information is sometimes treated as “tomorrow’s expected news. ” • The theory then implies that today’s reported happiness should be correlated with tomorrow’s news ratings even after controlling for current and past news ratings. 82

Daily Happiness vs. Daily Personal News 83

Increments (Personal) 84

Cumulative Increments (Personal) 85

Daily Happiness and Daily National News 86

Increments (National) 87

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Whitening (Personal) 89

Whitening (National) 90

Impulse Response (Personal & National) 91

Impulse Response (Personal) 92

Impulse Response (National) 93

Component Impulse Responses (Personal News) 94

Component Impulse Responses (National News) 95

Impulse Response + Neg. Sensitivity (Personal) 96

Impulse Response + Neg. Sensitivity (National) 97

Fact #2 about Happiness • Happiness depends more on changes than on the absolute level of one’s circumstances. • Analogy: We have no altimeter in our brains, but we can tell whether we are going up or down. 98

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 one’s daily actions 99

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. 100

Why are Utility and Happiness Confused? • Because they are dramatic, elation and dismay dominate people’s 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. 101

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The Evolutionary Psychology of Elation and Dismay • Functionally, elation and dismay motivate cognitive processing—much like curiosity. – Elation: after good news, it pays to • think what you did right, so you can do it again • think how to take advantage of the new opportunities – Dismay: after bad news, it pays to • think what you did wrong, so you can avoid doing it again • think how to mitigate the harm of the bad news – Curiosity: after news that is neither clearly good nor bad, it pays to learn more for the sake of option value 103

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) 104

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? – Pinker’s cheesecake 105

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. 106

Implications for Policy • Happiness is valuable: should be fostered. • Happiness data are a reminder of tangible and intangible externalities in the utility function—especially social rank externalities. • Economic growth is of enormous value, despite the Easterlin Paradox. • Happiness data is not enough to diagnose optimization mistakes. 107

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. 108

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Would you want to go back to the way things used to be? – No computers or electronics – No Ben and Jerry’s – No Harry Potter – No Beatles music yet released – Jim Crow, strong male dominance – Cold War – Few modern drugs 110

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 one’s own emotions. • Here, the agent needs to understand happiness. 111

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 112

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. 113

Can Manipulating One’s Perceptions Raise Utility? • With elation in the utility function, manipulating ones perception of lifetime utility innovations becomes an issue. – Lowering expectations is mostly a wash because it lowers happiness now in order to raise happiness later. It may also interfere with optimization. – The greatest potential gain from manipulating one’s perceptions is to lower one’s memory of past expectations. (“Attitude of gratitude”) 114

Manipulating Perceptions of Locus of Control • • Elation may respond more to news about whether one’s choices worked out than to news about things beyond one’s control. This would make it possible to manipulate elation by labeling good events as due to one’s efforts, while bad events were beyond one’s control. 115

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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. 117

Evidence on Habit Formation Constantinides Form: 1. Joseph Lupton estimates θ≈. 75 based on portfolio choices 2. Impulse responses for consumption choices suggest θ 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. 118

Modeling Choice: Habit Formation or Just Hedonic Adaptation? Suppose and 1. Equivalent to and happiness=first difference of flow utility. 2. Let’s keep the economic theory simple and put the complexity in the utility-happiness relationship. a. It’s clearer and simpler. b. It avoids the misleading impression that there is anything wrong with the more traditional 119 functional form.

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. 120

(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 121

Utility≠Happiness 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 utility≠happiness for them. 122

The Standard View in Psychology • Currently, the standard view among psychologists and most economists working with happiness data—articulated most forcefully by Daniel Kahneman—is that a present discounted value of measured happiness is a good indicator of what people should be maximizing. • To the extent that people are maximizing something else, it is viewed as a mistake. • Factual mistakes people make in predicting their own future happiness are thought to be an important reason people make these optimization mistakes. (Return to this below. ) 123

Our View • We are questioning this orthodoxy. • When well-informed and thoughtful, we view people’s choices as the best indication of their individual welfare. • People do often make optimization errors. • But much of what this orthodoxy takes as evidence of optimization errors, we take as evidence that utility and “happiness” are not the same thing. 124

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). 125

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. 126

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. 127

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. 128

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. 129

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) 130

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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. 132

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. 133

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). 134

Arguments of Happiness beyond S, C, B Qt = control variables that do not matter directly for preferences, but affect household production of happiness (empty set? psychoactive and other medical drugs, recreational drugs? ) Jt = state variables that do not matter directly for preferences but affect household production: genes, underlying physical and psychological states, unknown parameter values and shocks. vt, vt-1, vt-2, … = the history of lifetime utility. (Note: B=B(S, J, C, Q)) 135

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. 136

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. 137

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 referencedependence and loss aversion as in Prospect Theory. 138

Lifetime Utility in the Additively Separable Case 139

The Innovation ι in Lifetime Utility v (Additive Separability, Observed K) Note about the lifetime utility innovation: so 140

News and Happiness Axioms + Additive Separability Imply Axiom 2→ Axiom 3→ 141

Baseline Mood M and Elation e 142

The Elation Theory of Happiness 143

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. ) 144

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. 145

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) +α 0 min(ιt, ιt/2) + α 1 min(ιt-1, ιt-1/2) + … 146

Elation-Independence: Additively Separable Happiness with Elation Linear in Lifetime Utility Innovations U(K, X, H)=u(K, X)+M(K, X) +α 0ιt + α 1ιt-1 + … 147

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Do People Know the Production Function for Baseline Mood? • • Just as people don’t know the true production function for health, they may not know the true production function for baseline mood. Lack of understanding of the dynamics of the elation mechanism could make it difficult for individuals to parcel out the determinants of baseline mood. The discovery and dissemination of facts about the determinants of baseline mood could have large positive welfare effects A big deal if the share of the money and time budget devoted to baseline mood trends up. 149

Do People Know Their Own Utility Functions? • Not perfectly. For example, I don’t know if I will like a new flavor of ice cream. • Lack of knowledge of one’s own utility function can be modeled as an internal informational constraint. (Rayo-Becker is an example. ) • The key distinguishing features of mistakes about one’s own utility function are – regret – changing one’s mind after learning more. 150

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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. 152