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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)
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 2 / 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)
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 2 / 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)
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 2 / 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 function
Necessary for Public Choice (Arrow impossibility theorem)
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 2 / 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)
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 2 / 18
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 )
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 3 / 18
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 )
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 3 / 18
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 )
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 3 / 18
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 )
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 3 / 18
Happiness and Utility
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
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 4 / 18
Empirical Determinants
Suitable for estimation as an ordered probit or logit:
h = a+ bZ + cY
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 5 / 18
Easterlin Paradox
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 6 / 18
Easterlin Paradox (cont�d)
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 7 / 18
Easterlin Paradox (cont�d)
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 8 / 18
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?
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 9 / 18
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?
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 9 / 18
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?
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 9 / 18
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?
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 9 / 18
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
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 10 / 18
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
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 10 / 18
Relative income (cont�d)
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 11 / 18
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
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 12 / 18
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
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 12 / 18
Relative Income (cont�d)
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 13 / 18
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 )
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 14 / 18
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.
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 15 / 18
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.
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 15 / 18
Adaptation (cont�d)
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 16 / 18
Adaptation (cont�d)
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 17 / 18
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�
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 18 / 18
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�
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 18 / 18
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�
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 18 / 18
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�
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 18 / 18
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�
Eugenio Proto () Lecture 1: Happiness and Growth March 13, 2009 18 / 18