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

2. 2 “Happiness,” as defined operationally by psychologists On a scale from one to seven, where one is “extremely unhappy” and seven is “extremely happy,” how do you feel right now?

3. 3 Distinguishing preferences and happiness as a matter of logic. Preferences (Represented by 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.

4. 4 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. 2.People make choices eagerly that they never regret, but which have no long-run effect on how happy they feel. –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.

5. 5 The Ethical Question People’s own choices and feelings are the two non-paternalistic indicators we have for individual welfare (what makes an individual better off in the sense relevant for policy). A priori, both seem useful. What if public policy choice A accords with what people would choose, but policy choice B would make them feel best?

6. 6 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.)

7. 7 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.

8. 8 The Scientific Question: What is the Relationship Between Preferences and Happiness? Both felt happiness and choice-based preferences are well-defined, observable concepts. The nature of the relationship between the standard psychological concept of happiness and the standard economic concept of preferences is an open empirical question.

9. 9 Why the relationship between them can’t be simple: Easterlin Paradox Hedonic Adaptation

10. 10 The Easterlin Paradox

11. 11 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. Dynamics of national happiness after big news: “Unhappiness after Hurricane Katrina”

12. 12

13. 13 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?)”

14. 14 Significance Any known, systematic relationship between happiness and preferences 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 happiness.

15. 15 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 the output of a household production function (like health, entertainment, or nutrition.)

16. 16 Why Happiness Matters for Economics (Our View) Preference for Happiness: Other things being equal, people prefer to be happy. News and Happiness: Short-run spikes and dips in happiness –signal what people consider good and bad news, –which in turn signals what they prefer.

17. 17 Preference for Happiness Axiom: Part 1 Preferences depend on the joint stochastic process of K: vector of state variables X: vector of control variables H: vector of outputs of household production functions other than happiness A: current happiness (affect). The current and past values of these variables are all observable to the agent.

18. 18 Preference for Happiness Axiom: Part 2 Consider two information trees Y 1 and Y 2 induced by two different strategies in the game against nature over the same time. If f 1 (t,p) and f 2 (t,p) map to nodes in the two trees so that –the measure of p gives subjective probabilities –f i (t-h,p) maps to the ancestor node of f i (t,p) –(K,X,H)(f 2 (t,p))=(K,X,H)(f 1 (t,p)) w.p. 1 –A(f 2 (t,p))≥A(f 1 (t,p)) w.p. 1, then Y 2 (weakly) preferred to Y 1.

19. 19 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.

20. 20 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).

21. 21 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.

22. 22 ‘Elation’ and ‘Dismay’ ‘ elation’ = the component of happiness due to recent news about lifetime utility. ‘dismay’ = -elation

23. 23 Elation and Hedonic Adaptation Because it is based on recent news, 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.

24. 24 The Happiness and News Axioms a.Happiness is a function of K and X and - additional state variable vector J - additional control variable vector Q - the history of lifetime utility. Fixing K, X, J and Q, b. Happier if current expected lifetime utility is of a preferred future. c. Less happy if past expected lifetime utility was of a preferred future.

25. 25 The Innovation ι in Lifetime Utility v (Time-Separable Intertemporal Expected Utility Preferences) Note about the lifetime utility innovation: so

26. 26 Happiness Function Implied by Happiness and News Axioms + Standard Additively Separable Expected Utility

27. 27 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.

28. 28 The Integrated Theory with Additively Time-Separable IEU Preferences v t = lifetime utility E t = rational expectation as of time t β = utility discount factor U =flow utility K = state vector: individual wealth, weather, prices, tax rates, pollution, average level of consumption in society… X = control vector: consumption, time use,… H = outputs of household production functions: subjective health, weight, fatigue, being alive, spouse being alive,…

29. 29 The Integrated Theory with Standard Preferences (cont.) J=state variables that do not matter directly for preferences but affect household production: genes, underlying physical and psychological states, unknown parameter values, unknown shocks,… Q=control variables that do not matter directly for preferences, but affect household production: psychoactive and other medical drugs, recreational drugs,… ι=lifetime utility innovation.

30. 30 Special Case #1: Preferences do not depend on happiness (but happiness depends on preferences) U(K,X,H)

31. 31 Special Case #2: Additively Separable Happiness U(K,X,H,A)=F(K,X,H)+Ψ(A)

32. 32 Baseline Mood M and Elation e.

33. 33 Special Case #2: Additively Separable Happiness U(K,X,H,A)=F(K,X,H)+M(K,X,J,Q) +e(K,X,J,Q, ι t, ι t-1,…)

34. 34 Special Case #3: Additively Separable Happiness with Elation Linear in Lifetime Utility Innovations U(K,X,H,A)=F(K,X,H)+M(K,X,J,Q) +α 0 ι t + α 1 ι t-1 + …

35. 35 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.

36. 36 Special Case #4: Add. Sep. Happiness, Elation Concave in Lifetime Utility Innovations U(K,X,H,A)=F(K,X,H)+M(K,X,J,Q) +α 0 min(ι t, ι t /2) + α 1 min(ι t-1, ι t-1 /2) + …

37. 37 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.

38. 38 Why are Utility and Happiness Confused? Because they are dramatic, elation and dismay may 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.

39. 39 (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

40. 40 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 (e.g., time spent with friends is usually a high happiness activity) Many of these inputs to long-run happiness are time- intensive.

41. 41 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.

42. 42 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.

43. 43 Applying Price Theory to Baseline Mood Materialism lowers happiness (weak, but interesting evidence). Tradeoff between happiness and other goods. Materialism means higher preferences for other goods compared to happiness.

44. 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? Three potential answers: –Some uptrending negative externalities may be particularly bad for baseline mood. –Lack of knowledge of baseline mood production fn. –Resources spent increased lifespan. –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. 45 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

46. 46 The Evolutionary Psychology of Elation and Dismay Functionally, elation and dismay may 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.

47. 47 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).

48. 48 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.

49. 49 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.

50. 50 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.

51. 51 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.

52. 52

53. 53 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.

54. 54 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)

55. 55 Other Measures of Subjective Well- Being: Life Satisfaction On a scale from 1 to 10, how satisfied are you with your life?

56. 56 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]”

57. 57 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.

58. 58 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 life- satisfaction or global happiness questions anyway. It is clearer to focus on that current happiness component directly. Then we know what we are getting.

59. 59 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.

60. 60 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.

61. 61 Life Expectancy

62. 62 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

63. 63 Revealed Preference: Migration Flows 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.

64. 64 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.

65. 65 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.

66. 66 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.

67. 67 The Easterlin Paradox

68. 68 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. Dynamics of national happiness after big news: “Unhappiness after Hurricane Katrina”

69. 69 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 Schwarz, unpublished work). Why? Life satisfaction and global happiness assessments incorporate –an element of autobiography –people’s ideas about how they “should” feel

70. 70 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.

71. 71 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.

72. 72 Modeling Choice: Habit Formation or Just Hedonic Adaptation? 1. Equivalent to 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 functional form. Suppose and and happiness=first difference of flow utility.

73. 73 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.

74. 74 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.