Utility and Happiness Miles Kimball and Robert Willis

Utility and Happiness Miles Kimball and Robert Willis University of Michigan http: //www-personal. umich. edu/~mkimball/pdf/index. html 1

A Growing Economic Literature Uses Happiness Data • Provocative findings—see Layard’s Happiness • Mostly focuses on the cross-section and the long -run trend. • Motivations of the researchers: – to study the welfare implications of non-traded goods – to diagnose optimization mistakes and study welfare implications in contexts where choice behavior is potentially inconsistent. • Many other economists are skeptical: theoretical status of happiness is unclear. 2

What is Happiness? a. Flow utility? b. The individual’s overall objective function? c. The part of the individual’s objective function that abstracts from the desire to do one’s duty? d. The individual’s objective function plus pleasure from memory? e. None of the above? 3

Outline of Introduction A. Distinguishing utility and happiness as a matter of logic. B. Why we care about utility and happiness. C. Why the relationship between them can’t be simple (short version). D. Our take on the relationship between utility and happiness. 4

A. “Utility” and “Happiness” • Lifetime Utility = The extent to which people get what they want, where what they want is indicated by their choices. • Happiness (Current Affect) = How positive people’s feelings are at a given time. 5

B. Judging Individual Welfare • People’s own choices and feelings are the two nonpaternalistic indicators we have for individual welfare (what makes an individual better off in the sense relevant for policy). • A priori, both seem useful. 6

C. The Easterlin Paradox and Hedonic Adaptation Taking both feelings and choices seriously runs into the difficulty that affect and utility seem to behave quite differently. • Easterlin Paradox: Measured utility trends strongly upwards, while measured happiness has little trend. • Hedonic Adaptation: Utility is affected permanently by permanent changes in external circumstances, but the effects on happiness seem shorter-lived. 7

D. The Relationship Between Happiness and Utility is Unresolved Existing work in Economics largely either A. B. ignores happiness data, e. g. : “Happiness is irrelevant to Economics” OR assumes happiness=flow utility: “Happiness is a sufficient statistic for utility. ” 8

The Middle Way In this paper, we steer a middle course between these two extremes: • Happiness ≠ Flow Utility, BUT • Happiness has a systematic relationship to utility. 9

The Question: What is the Relationship? • Both felt happiness and choice-based utility are well-defined, observable concepts. It is easy to resolve many seeming paradoxes when one recognizes that these are two different things. • The nature of the relationship between the standard psychological concept of happiness (affect) and the standard economic concept of lifetime utility is an open empirical question. 10

Significance Establishing any systematic relationship between affect and utility would 1. provide an important bridge between psychology and economics. 2. allow psychological data and theory to be used in economics in a way that is complementary to standard economic data and theory. 3. allow all the tools of economics to be brought to bear toward understanding 11 happiness.

Sketch of our Integrated Theory of Utility and 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 is a subutility function (like health, entertainment, or nutrition. ) 12

Why Happiness Matters for Economics (Our View) • • First, short-run happiness in response to news can give important information about preferences. Second, long-run happiness is important for economic welfare in the same way as other composite goods such as health, entertainment, or nutrition. 13

The Core of the Paper 3. Measuring Happiness 4. Measuring Utility 5. Utility ≠ Happiness: Evidence 6. An Integrated Theory of Utility and Happiness 14

Bonus Features 7. Why Utility and Happiness are Often Confused 8. Elation in the Utility Function 9. Implications for Happiness Empirics 10. Implications for Policy 15

3. Psychologists Reliably Measure Happiness, But What Is It? • Some economists think happiness can’t be measured well. This is just not true. Current happiness (affect) is one of the easiest of all subjective concepts to measure. • What is true (that these economists are intuiting) is that once happiness is measured, we don’t know what it means in terms of economic theory. 16

Measuring Current Happiness (‘Affect’). “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? )” 17

The Validity of Self-Reported Happiness Correlated with • frequency of smiling. • others’ ratings of how happy someone is. • social rank. • high activity in the left pre-frontal cortex and low activity in the right pre-frontal cortex--which can also be induced by seeing pictures of a smiling baby and reduced by seeing pictures of a deformed baby. 18

Other Measures of Subjective Well. Being: Life Satisfaction On a scale from 1 to 10, how satisfied are you with your life? 19

World Values Survey Global Happiness Question "Taking all things together, would you say you are 1. Very happy 2. Quite happy 3. Not very happy 4. Not at all happy 9. Don’t Know [Do NOT READ OUT]” 20

Problems with these Alternative Measures of Subjective Well-Being • • Judging overall life-satisfaction or overall happiness in life is a complex cognitive task. Evidence on the sensitivity of of subjective well -being data to context indicates that respondents use shortcuts involving readily accessible information, such as – – How happy the respondent feels right now How happy the respondent thinks he or she should feel, given objective circumstances. 21

Advantages of Affect Measures (Current Happiness Measures) • By contrast, affect measures depend on much more accessible information: – How R feels right now. – How R felt the past week. • • Very little judgment is required. How R feels right now affects the overall lifesatisfaction or global happiness questions anyway. It is clearer to focus on that current happiness component directly. Then we know what we are getting. 22

4. Measuring Utility: Revealed Preference Over Choices • • The Ordinalist, or “revealed preference” revolution in Economics developed techniques for measuring individual welfare based on choice data alone. This clearly defines utility as a distinct concept from happiness. – Utility is the extent to which people get what they want. – Happiness is how people feel. 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

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 26

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. 27

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. 28

5. Happiness ≠ Flow Utility: Evidence • • • Assuming that current happiness is equal to flow utility immediately has many strong implications. In particular, a large amount of data on happiness exists, with many characteristics that do not match usual ideas about utility. Measured happiness 1. has no strong trend. 2. is strongly mean-reverting. 29

The Easterlin Paradox 30

Hedonic Adaptation (Mean Reversion of Affect) Cross-sectional evidence of hedonic adaptation for • incarceration • loss of the use of limbs • serious burns • death of a spouse • winning the lottery – winning £ 10, 000 raises affect by six times as much in the first year as £ 10, 000 per year in additional income. 31

Experience Data Show Even Stronger Hedonic Adaptation • • Data on felt happiness from experience sampling reverts to its previous level even more completely than life satisfaction and global happiness assessments (Kahneman and Schwartz, unpublished work). Why? Life satisfaction and global happiness assessments incorporate – – an element of autobiography people’s ideas about how they “should” feel 32

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. 33

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. 34

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 35 functional form.

Other Evidence that Utility≠Happiness 1. People make choices eagerly that they never regret, but which have no long-run effect on their affect. – – Moving to a new city Buying a nice car 2. With some misgivings at the tradeoff, people make choices that they never regret which lower their affect. – – Commuting further to a higher-paying job. Longer working hours to put one’s child through college. 36

6. Integrated Theory of Utility and Happiness happiness= baseline mood + elation. A. Elation B. Baseline Mood C. Formal Model D. Expectations and Happiness E-G. Evolutionary Significance -Elation -Hedonic Adaptation -Baseline Mood H. Implications of the Integrated Theory 37

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. 38

‘Elation’ and ‘Dismay’ • ‘elation’ = the component of happiness due to recent news about lifetime utility. • ‘dismay’ = -elation 39

Elation and Hedonic Adaptation • If expectations are rational, standard results about rational expectations imply that elation will be strongly mean reverting. Intuitively, – News doesn’t stay news for very long. – The initial burst of elation dissipates once the full import of news is emotionally and cognitively processed. – Relevance to the Hedonic Treadmill, a. k. a. the Easterlin Paradox. 40

‘Baseline Mood’ • baseline mood = M(Kt, Xt) • Xt = vector of control variables: time use, spending pattern, portfolio choice, etc. • Kt = vector of – state variables encoding every aspect of the past that matters for utility: wealth, weight, habits, level of fatigue, one’s spouse being alive, etc. – variables exogenous to the individual: weather, state of macroeconomy, consumption patterns of others in society, etc. CONTINUED ON NEXT SLIDE → 41

Baseline Mood and Flow Utility • flow utility = U(Kt, Xt, M(Kt, Xt)) • We think of baseline mood M(Kt, Xt) as the component of happiness produced by a household production function. • A good analogy is to health. Like health, baseline mood – can be measured independently of Kt and Xt – is only one argument of the flow utility function – depends on different things than flow utility does on the same things with different weights) – has a complex household production function (or 42

What does Baseline Mood Depend on? • • Any persistent aspect of happiness is part of baseline mood. Genes are the biggest factor. Also, there is some evidence that each of the following has a persistent effect on happiness: a. Prozac b. sleep c. exercise d. good eating habits e. social rank + pleasantness of one’s current activity 43

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. 44

Applying Price Theory to Baseline Mood • Is baseline mood a luxury good? • Even normality of baseline mood leads to a version of the Easterlin Paradox: Why don’t people buy higher baseline mood as part of their expanding consumption bundle? • Two potential answers: – Some uptrending negative externalities may be particularly bad for baseline mood. – The relative price of baseline mood may be trending up. (A large effect if the elasticity of substitution between baseline mood and other goods is high. ) 45

Formal Model of Utility and Happiness vt = lifetime utility U =flow utility M =baseline mood Et = rational expectation as of time t β = impatience Kt = state vector: wealth, weight, fatigue, being alive, spouse being alive, genes, weather, prices, tax rates, pollution average level of consumption in society… Xt = control vector: consumption, time use … 46

The Innovation in Lifetime Utility and Elation Note about the lifetime utility innovation: 47

Theory of Happiness (Current Affect) 48

Neurobiological Evidence that Expectations Matter for Affect • “These studies measured the firing of dopamine neurons in the animal’s ventral striatum, which is known to play a powerful role in motivation and action. • In their paradigm, a tone was sounded, and two seconds later a juice reward was squirted into the monkey’s mouth. • Initially, the neurons did not fire until the juice was delivered. 49

Neurobiological Evidence that Expectations Matter for Affect • Once the animal learned that the tone forecasted the arrival of juice two seconds later, however, the same neurons fired at the sound of the tone, but did not fire when the juice reward arrived. • These neurons were not responding to reward, or its absence … they were responding to deviations from expectations. • When the juice was expected from the tone, but was not delivered, the neurons fired at a very low rate, as if expressing disappointment. ” (p. 26) 50

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 • Economic implications of this functional role of elation: such directed information acquisition could affect probability assessments in systematic ways. 51

The Evolutionary Psychology of Hedonic Adaptation • “Adaptive processes serve two important functions. First, they protect organisms by reducing the internal impact of external stimuli…. Second, they enhance perception by heightening the signal value of changes from the baseline level…. ” • “Hedonic adaptation may serve similar protective and perception-enhancing functions…. persistent strong hedonic states (for example, fear or stress) can have destructive physiological concomitants … Thus, hedonic adaptation may help to protect us from these effects. ” • “Hedonic adaptation may also increase our sensitivity to, and motivation to make, local changes in our objective circumstances…. ” (Frederick and Loewenstein) • See also Rayo and Becker (2005). 52

Speculations on The Evolutionary Psychology of Baseline Mood • High social rank may make it safe to look more for opportunities than for dangers, so that it makes sense to stimulate the same machinery that is turned on by the receipt of good news. • Frequency dependence in the value of being an optimist or pessimist. • Quirks in the system? • Stephen Pinker’s view of cheesecake. 53

Three Implications of this Theory of Happiness • Happiness ≠ Utility. • Disputes the idea that temporary movements in affect are unimportant: a temporary movement in affect can signal important utility-relevant news related to the long-term welfare of the individual. • Baseline mood is not a summary measure of utility, but it is something people care about. 54

Bonus Features 7. Why Utility and Happiness are Often Confused 8. Elation in the Utility Function 9. Implications for Happiness Empirics 10. Implications for Policy 55

7. Why Utility and Happiness are Often Confused • If baseline mood is exogenous to the individual, and elation is linear in lifetime utility innovations, maximizing any positive linear combination of current and expected future happiness is equivalent to maximizing lifetime utility. 56

Why are Utility and Happiness Confused? (continued) • Elation and dismay dominate people’s perception of happiness, but without much conscious awareness of the resetting of the implicit reference point that depends on past expectations of lifetime utility. • The reference point is a sunk cost that does not affect maximization, so lack of awareness of it is not a problem. 57

8. Elation in the Utility Function So far, a. flow utility = U(Kt, Xt, M(Kt, Xt)) What if b. flow utility = U(Kt, Xt, M(Kt, Xt)) +b 0ιt+b 1ιt-1+b 2ιt-2+… c. or flow utility = U(Kt, Xt, M(Kt, Xt), e(ιt, ιt-1, ιt-2, …)) ) 58

Elation in the Utility Function Might Not Change a Thing • 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 material harm to utility maximization. 59

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”) 60

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. 61

Elation and Prospect Theory • In the nonlinear case, elation theory yields prospect theory very naturally. In particular, if a. Elation is roughly proportional to the rate of cognitive processing of news. b. Bad news requires more processing than good news. c. Within bad or good news, the total amount of processing needed is proportional or less than proportional to the magnitude of the news. • Thus, Prospect Theory can arise from rational preferences over one’s own emotions. 62

9. Implications for Happiness Empirics • The time series properties of happiness matter. • Price Theory can be used to study baseline mood (e. g. , value of happiness). • The Elation Theory is readily testable. • Elation provides information about preferences and expectations. – Like event studies in Finance – Need high frequency data on affect. 63

10. 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. 64

Reprise: Integrated Theory of Utility and 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 a subutility function (like health, entertainment, or nutrition. ) 65

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. 66

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The Integrated Theory of Utility and Affect: Axioms 1. Happiness and news: other things being equal, a. the agent will feel happier if current expectations are of a preferred future. b. the agent will feel less happy if past expectations were of a preferred future. 68

The Integrated Theory of Utility and Affect: Axioms 2. Preference for happiness. Between two fully anticipated life courses with the same outward circumstances, the agent prefers the one in which he or she feels happier. 3. Social Rivalry. The empirical possibility of social rivalry is represented by the absence of an axiom that preferences depend only on the agent’s own situation. 69

Preference for Happiness: Discussion 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. 70

Preference for Happiness: Discussion The preference for happiness axiom is a relatively cautious assumption. • It allows for the possibility that people have other pragmatic concerns beyond the extent to which those concerns show up directly in felt happiness. For example, they may care about satisfying basic drives, the happiness of family members, health, ethical concerns and other goals. 71

Preference for Happiness: Discussion • One could make stronger assumptions but the axioms above are enough for our approach. • Cautious assumptions have the advantage of being more likely to gain broad acceptance within Economics. 72

An Alternative, Stronger, Assumption • Sufficient Statistic Hypothesis: some combination of current and expected future happiness is a sufficient statistic for the agent’s preferences. • The Preference for Happiness Axiom allows for the Sufficient Statistic Hypothesis as a special case that, in principle, is empirically testable. -Happiness can be measured by feelings. -Preferences can be measured by choices whenever people are well informed and have time to make a careful choice. 73

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Significance 1. Even if economic progress continues unabated over the next 50 years in the U. S. advanced countries, whether the citizens of these countries end up rich and happy or rich and unhappy depends on whether money can buy happiness and on whether the additional economic resources will, in fact, be used to obtain additional happiness. 75

Significance 2. To the extent there is a tradeoff between subjective well-being and other values, the increases in income and wealth that accompany economic progress are likely to make improvements in subjective wellbeing increasingly important for welfare compared to further improvements in other areas. 76

Significance 3. Economists are increasingly using subjective well-being data to address economic and public policy issues that involve non-marketed goods or inconsistent preferences. Identifying the implications of subjective well-being data for economic issues requires attention to the details of the mapping between subjective well being data and standard economic concepts. 77

Significance 4. Given an adequate understanding of the mapping between subjective well-being data and standard economic concepts, the use of subjective well-being data has the potential to be especially important in the economics of aging, since many of the most important goods for retired people are non-marketed goods. (Consider, for example, health, marital and family relationships, sense of purpose, and quality of leisure time pursuits. ) 78

Significance 5. In the coming decades, advances in subjective well-being at work have the potential to alter people’s relationship to work in a way that significantly raise the average retirement age, with important implications for Social Security budget balance. 79