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Rationality, Utility and Happiness in Economics

Youssef Benzarti

Disclosure: Slides rely on David Laibson’s (Harvard) and Frank Schilbach’s (MIT) lecture notes.

The economic agent according to Econ 10A

In our class, we assume that economic agents have two main ingredients:

Preferences, which correspond to their utility function A budget constraint, which corresponds to the resources (money) they have access to

The agent maximizes her utility subject to the budget constraint In this lecture we will think about the real life counterpart of utility maximization In particular, we will think about what utility represents and how it relates to happiness... ... and also look into whether people actually try to maximize their happiness

Do people act in their best interest?

Economists assume there exists a strong relationship between a person’s choices (behavior) and the happiness such choices trigger (true well-being).

Economists believe that most of the time people act (approximately) in their best interest by making choices that will make them happier and avoiding ones that will make them unhappy. However, we all make choices that make us unhappy: eg, eating too much at an all you can eat restaurant, not studying hard enough for an exam, etc. How can we check whether this assumption is appropriate?

It would be great if we could measure behavior and the happiness such behavior brings (well-being).

Do people act in their best interest?

However, we all make choices that make us unhappy: eg, eating too much at an all you can eat restaurant, not studying hard enough for an exam, etc. How can we check whether this assumption is appropriate?

It would be great if we could measure behavior and the happiness such behavior brings (well-being).

Do people act in their best interest?

Economists assume there exists a strong relationship between a person’s choices (behavior) and the happiness such choices trigger (true well-being). Economists believe that most of the time people act (approximately) in their best interest by making choices that will make them happier and avoiding ones that will make them unhappy. However, we all make choices that make us unhappy: eg, eating too much at an all you can eat restaurant, not studying hard enough for an exam, etc. How can we check whether this assumption is appropriate?

It would be great if we could measure behavior and the happiness such behavior brings (well-being).

Do people act in their best interest?

It would be great if we could measure behavior and the happiness such behavior brings (well-being).

Decision utility

Economists use the word “utility" (or “utility function") to describe the preferences that make sense of observed choices.

Daniel Kahneman has worked extensively on the concept of utility (he received a Nobel Prize for this and other work). He calls these revealed preferences “decision utility."

Preferences that make sense of decisions

For example, for an addict the decision utility of drug consumption exceeds the decision utility of quitting.

Decision utility

Economists use the word “utility" (or “utility function") to describe the preferences that make sense of observed choices. Daniel Kahneman has worked extensively on the concept of utility (he received a Nobel Prize for this and other work). He calls these revealed preferences “decision utility."

Preferences that make sense of decisions

For example, for an addict the decision utility of drug consumption exceeds the decision utility of quitting.

Decision utility

Preferences that make sense of decisions

For example, for an addict the decision utility of drug consumption exceeds the decision utility of quitting.

Experienced utility

Kahneman also measures the hedonic consequences of choices.

He calls these hedonic experiences, “experienced utility."

Preferences that coincide with “doing"

This is how Jeremy Bentham (1748-1832) conceived of utility (pleasure and pain) How can we measure hedonic experiences (e.g. wellbeing)? How do people aggregate these experiences over time?

Experienced utility

Kahneman also measures the hedonic consequences of choices. He calls these hedonic experiences, “experienced utility."

Preferences that coincide with “doing"

This is how Jeremy Bentham (1748-1832) conceived of utility (pleasure and pain) How can we measure hedonic experiences (e.g. wellbeing)? How do people aggregate these experiences over time?

Experienced utility

Kahneman also measures the hedonic consequences of choices. He calls these hedonic experiences, “experienced utility."

Preferences that coincide with “doing"

This is how Jeremy Bentham (1748-1832) conceived of utility (pleasure and pain)

How can we measure hedonic experiences (e.g. wellbeing)? How do people aggregate these experiences over time?

Experienced utility

Kahneman also measures the hedonic consequences of choices. He calls these hedonic experiences, “experienced utility."

Preferences that coincide with “doing"

This is how Jeremy Bentham (1748-1832) conceived of utility (pleasure and pain) How can we measure hedonic experiences (e.g. wellbeing)? How do people aggregate these experiences over time?

Techniques for measuring experienced utility

Observer ratings Real-time self-reports of mood, pain, pleasure, or happiness (palm pilot) Facial measures Autonomic measures (autonomic nervous system, including electrodermal, respiratory, and cardiovascular) Vocal measures (pitch, loudness, tone, quality, timing) Left brain asymmetry (electroencephalogram – EEG) Responses to emotion-sensitive tasks

Example: “Would you like to talk with a good friend?” – “No? – Then you are probably in a bad mood."

Techniques for measuring experienced utility

Observer ratings Real-time self-reports of mood, pain, pleasure, or happiness (palm pilot) Facial measures

Autonomic measures (autonomic nervous system, including electrodermal, respiratory, and cardiovascular) Vocal measures (pitch, loudness, tone, quality, timing) Left brain asymmetry (electroencephalogram – EEG) Responses to emotion-sensitive tasks

Example: “Would you like to talk with a good friend?” – “No? – Then you are probably in a bad mood."

Techniques for measuring experienced utility

Responses to emotion-sensitive tasks

Example: “Would you like to talk with a good friend?” – “No? – Then you are probably in a bad mood."

Techniques for measuring experienced utility

Example: “Would you like to talk with a good friend?” – “No? – Then you are probably in a bad mood."

Why might decision utility and experienced utility differ?

A few examples

Inaccurate memories of past hedonic experiences Poor forecasts of preference dynamics Failures to anticipate adaptation (marriage, paraplegic injuries, winning the lottery, denied promotion) Emotional (visceral, impulsive) decision-making

Much of the issues are about disconnects between decision utility and experienced utility.

Why might decision utility and experienced utility differ?

A few examples

Much of the issues are about disconnects between decision utility and experienced utility.

Why might decision utility and experienced utility differ?

A few examples

Much of the issues are about disconnects between decision utility and experienced utility.

Does marriage increase happiness?

treadmill, meaning that the effects of substantial life changes on subjective well- being are temporary.

The economic counterpart of the hedonic treadmill is that large increases in the standard of living have almost no detectable effects on life satisfaction or happiness. Easterlin (1995), for example, finds that the average self-reported happiness level did not increase in Japan between 1958 and 1987, although real income increased fivefold. Figure 4 presents related results for China, based on a sample of 15,000 individuals interviewed by the Gallup Organization. China expe- rienced remarkably fast economic growth from 1994 to 2005, with real income per capita increasing by a factor of 2.5. This growth had substantial consequences for material well-being: ownership of color television sets rose from 40 percent of households to 82 percent, and the fraction with a telephone jumped from 10 percent to 63 percent. Yet Figure 4 indicates no increase in reported life satisfaction from 1994 to 2005; in fact, the percentage of people who say they are dissatisfied has increased, and the percentage who say they are satisfied has de- creased. Studies do find that income and life satisfaction are positively correlated in a cross-section of individuals, but the correlation is only around 0.20 (for example, Easterlin, 2001). One interpretation is that aspirations rise with income. Indeed, there is survey evidence that the level of income that an individual considers to be “sufficient” is primarily determined by his or her current income (van Praag and Ferrer-i-Carbonell, 2004). Frey and Stutzer (2002) estimate that adaptation offsets about two-thirds of the benefits of any increase in income.

Some changes in circumstances have more than transitory effects: for example, the effects of unemployment and chronic pain do not seem to attenuate fully with time (Lucas, Clark, Georgellis and Diener, 2004). Nevertheless, the frequent finding

Figure 3 Average Life Satisfaction for a Sample of German Women (by year of marriage t � 0)

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Source: Clark, Diener, Georgellis and Lucas (2003), using data from the German Socioeconomic Panel. Note: An asterisk indicates that life satisfaction is significantly different from the baseline level.

Developments in the Measurement of Subjective Well-Being 15

Remembered utility

Our memory of a hedonic experience remembered utility exhibits duration neglect.

You remember the quality, not the length of the experience. Remembered utility follows peak-end rule. Retrospective evaluations are predicted by an average of:

(i) peak affective response recorded during an episode, and (ii) end value recorded just before the termination of an

episode.

Remembered utility

Our memory of a hedonic experience remembered utility exhibits duration neglect. You remember the quality, not the length of the experience.

Remembered utility follows peak-end rule. Retrospective evaluations are predicted by an average of:

(i) peak affective response recorded during an episode, and (ii) end value recorded just before the termination of an

episode.

Remembered utility

Our memory of a hedonic experience remembered utility exhibits duration neglect. You remember the quality, not the length of the experience. Remembered utility follows peak-end rule.

Retrospective evaluations are predicted by an average of:

(i) peak affective response recorded during an episode, and (ii) end value recorded just before the termination of an

episode.

Remembered utility

Our memory of a hedonic experience remembered utility exhibits duration neglect. You remember the quality, not the length of the experience. Remembered utility follows peak-end rule. Retrospective evaluations are predicted by an average of:

(i) peak affective response recorded during an episode, and (ii) end value recorded just before the termination of an

episode.

Evidence of duration neglect and peak-end evaluations

Immersion of one hand in cold water: cold-pressor task Colonoscopy Plotless films of pleasant/unpleasant subjects, such as low-level flying over an African landscape or of amputation Aversive sounds of varying loudness and duration Shocked rats

Evidence of duration neglect and peak-end evaluations

Cold Pressor (Schreiber & Kahneman)

Short trial: hand in 14 degree water (60 sec) Long trial: hand in 14 degree water (60 sec), then temp rises to 15 degrees (30 sec) 65% of subjects chose to repeat the long trial (decision utility 6= experienced utility) Result replicated with aversive noise

Cold Pressor (Schreiber & Kahneman)

Short trial: hand in 14 degree water (60 sec)

Long trial: hand in 14 degree water (60 sec), then temp rises to 15 degrees (30 sec) 65% of subjects chose to repeat the long trial (decision utility 6= experienced utility) Result replicated with aversive noise

Cold Pressor (Schreiber & Kahneman)

Short trial: hand in 14 degree water (60 sec) Long trial: hand in 14 degree water (60 sec), then temp rises to 15 degrees (30 sec)

65% of subjects chose to repeat the long trial (decision utility 6= experienced utility) Result replicated with aversive noise

Cold Pressor (Schreiber & Kahneman)

Colonoscopy (Katz, Redelmeier, & Kahneman)

Control group: regular colonoscopy

Treatment group: procedure lengthened by one minute with colonoscope inside the body but stationary The nature of experiment was not explained to the subjects! Extra minutes was uncomfortable, but not very painful. Treatment group had significantly better memories of the overall experience

Colonoscopy (Katz, Redelmeier, & Kahneman)

Control group: regular colonoscopy Treatment group: procedure lengthened by one minute with colonoscope inside the body but stationary

The nature of experiment was not explained to the subjects! Extra minutes was uncomfortable, but not very painful. Treatment group had significantly better memories of the overall experience

Colonoscopy (Katz, Redelmeier, & Kahneman)

Control group: regular colonoscopy Treatment group: procedure lengthened by one minute with colonoscope inside the body but stationary The nature of experiment was not explained to the subjects! Extra minutes was uncomfortable, but not very painful.

Treatment group had significantly better memories of the overall experience

Colonoscopy (Katz, Redelmeier, & Kahneman)

Measuring happiness with survey questions

One approach: simply ask people directly how happy they are

Ladder question:

“How satisfied are you with your life as a whole these days?"

Affect question:

“Did you experience [insert emotion here] yesterday?"

Some researchers argue such happiness measures should form basis for judging well-being (and become policy objective). Lots of interesting graphs HERE.

https://ourworldindata.org/happiness-and-life-satisfaction/

Measuring happiness with survey questions

One approach: simply ask people directly how happy they are Ladder question:

“How satisfied are you with your life as a whole these days?"

Affect question:

“Did you experience [insert emotion here] yesterday?"

Some researchers argue such happiness measures should form basis for judging well-being (and become policy objective). Lots of interesting graphs HERE.

https://ourworldindata.org/happiness-and-life-satisfaction/

Measuring happiness with survey questions

One approach: simply ask people directly how happy they are Ladder question:

“How satisfied are you with your life as a whole these days?"

Affect question:

“Did you experience [insert emotion here] yesterday?"

Some researchers argue such happiness measures should form basis for judging well-being (and become policy objective). Lots of interesting graphs HERE.

https://ourworldindata.org/happiness-and-life-satisfaction/

Measuring happiness with survey questions

One approach: simply ask people directly how happy they are Ladder question:

“How satisfied are you with your life as a whole these days?"

Affect question:

“Did you experience [insert emotion here] yesterday?"

Some researchers argue such happiness measures should form basis for judging well-being (and become policy objective). Lots of interesting graphs HERE.

https://ourworldindata.org/happiness-and-life-satisfaction/

Life satisfaction around the globe

Life satisfaction and income: comparisons across countries

Life satisfaction and income: comparisons within countries

We think that that others are less happy than say they are.

Happiness and income: comparisons over time

Figure: Average happiness and real GDP per capita for repeated cross-sections of US citizens; Source: Andrew Oswald

Life satisfaction and income: comparisons over time

of adaptation challenges both everyday intuition and economic doctrine, by sug- gesting that in the long-run well-being is not closely related to one’s circumstances and opportunities. A possible resolution, which draws on the distinction between affect and judgment as separate elements of well-being, is that the hedonic tread- mill could instead be an aspiration treadmill. If people gradually adjust their aspira- tions to the utility that they normally experience, an improvement of life circum- stances would eventually lead them to report no higher life satisfaction than they did before, even if they were experiencing higher utility than previously. In this scenario, experienced utility could rise even while one’s global evaluation of life satisfaction remained constant.

An empirical test of this hypothesis requires separate measurements of expe- rienced utility and global life satisfaction. Although empirical tests of this sort are only in their infancy, initial findings yield little support for the aspiration treadmill.

The Kahneman, Krueger, Schkade, Schwarz and Stone (2004) study of women in Texas also collected data on satisfaction, both with life in general and with one’s work. It therefore affords an opportunity to compare the correlates of experienced affect with the correlates of the judgmental component of satisfaction. Measures of net affect from the Day Reconstruction Method were positively correlated with measures of general life satisfaction— but the correlations were often only moder-

Figure 4 Life Satisfaction in China as Average Real Income Rises by 250 Percent Overall, how satisfied or dissatisfied are you with the way things are going in your life today? Would you say you are very satisfied, somewhat satisfied, somewhat dissatisfied, or very dissatisfied?

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Source: Derived from Richard Burkholder, “Chinese Far Wealthier Than a Decade Ago— but Are They Happier?” The Gallup Organization, �http://sww.gallup.com/poll/content/login.aspx?ci�14548�. Notes: In 1997, 1999 and 2005, respondents were given four response categories: very dissatisfied; somewhat dissatisfied; somewhat satisfied; and very satisfied. In 1994, respondents were given a fifth response category: “neither satisfied nor dissatisfied.” The chart reports the percentage who were satisfied or dissatisfied. Thirty-eight percent of respondents chose the neutral category in 1994; those respondents were allocated in proportion to the number who responded that they were satisfied or dissatisfied in that year.

16 Journal of Economic Perspectives

Who reports higher levels of happiness?

Females People with large social networks Young adults everywhere Older adults (in rich countries) Married and cohabiting people Highly educated people Healthy people (including mental health) People with high income

Who reports higher levels of happiness?

Who reports lower levels of happiness?

Recently divorced/separated people People who are unemployed Citizens of countries with high blood pressure (Portugal) People who were under 18 when their parent died People whose parents quarreled frequently (unless the parents divorced)

Who reports lower levels of happiness?

Life satisfaction and life events