1. 1 New Directions in Happiness Research Miles Kimball

2. 2 Cognitive Economics Definition: Taking seriously data other than actual choices in the wild. Must be linked back to actual choices in the wild. Analogous to Cognitive Psychology vs. B.F. Skinner. Complementary to Psychological Economics, since loosening the constraints on the utility function raises the value of additional data.

3. 3 Examples of Cognitive Economics Experimental Economics. Neuroeconomics. Survey measures of expectations. Survey measures of preference parameters based on hypothetical choices. Happiness research.

4. 4 “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?

5. 5 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)

6. 6 The Happiness Measure on the Michigan 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?)”

7. 7

8. 8

9. 9 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]”

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

11. 11 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.

12. 12 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.

13. 13 The Easterlin Paradox

14. 14 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.

15. 15 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?

16. 16 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.)

17. 17 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.

18. 18 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.

19. 19 Why the Story about Preferences and Happiness Can’t be Simple: Easterlin Paradox Hedonic Adaptation

20. 20 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”

21. 21 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.)

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

25. 25

26. 26

27. 27

28. 28

29. 29 Possible Explanations Response of Happiness to News about Lifetime Utility –Altruism –Self-Interest (elk) Direct Effect of Graphic Images of Suffering –Definition: Even if an individual watched video clips of a long-ago disaster, their happiness would still go down.

30. 30 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.

31. 31 Serious Harm to Self-Interest? The Index of Consumer Sentiment

32. 32

33. 33

34. 34 Arguments Against the “Graphic Images” Explanation Heavy news coverage of Katrina continued for 4 weeks, but happiness returned to normal after two weeks. This can’t reflect simple desensitization to graphic images, since heavy coverage of the suffering associated with the Iraq War had been going on for years, yet happiness fell after Katrina. Thus, the meaning—or at least the details—of the images seems to matter.

35. 35

36. 36

37. 37 Implications of the Greater Dip in Happiness in the Katrina Region The greater effect on the South Central region helps demonstrate that the dip in happiness is due to Katrina rather than to an extraneous circumstance. To the extent there was saturation coverage throughout the U.S., the “graphic images” explanation cannot explain the stronger negative effect on happiness in the South Central region.

38. 38

39. 39

40. 40

41. 41

42. 42 Cautions about Regression of Happiness on Income Measurement error in judgements of better/worse financial circumstances. – Classical –Correlated Recent news versus old news Cross-sectionally, the level of income seems to have a strong effect on happiness even apart from the news effect. (Not a totally clean test.)

43. 43

44. 44

45. 45

46. 46

47. 47 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

48. 48 Linking Happiness and Preferences 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.

49. 49 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.

50. 50 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.

51. 51 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.

52. 52 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.

53. 53 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).

54. 54 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.

55. 55 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.

56. 56 The Innovation ι in Lifetime Utility v (Time-Separable Intertemporal Expected Utility Preferences) Note about the lifetime utility innovation: so

57. 57 Happiness Function Implied by Happiness and News Axioms + Standard Additively Separable Expected Utility

58. 58 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.

59. 59 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,…

60. 60 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.

61. 61 Special Case #1: Preferences do not depend on happiness (but happiness depends on preferences) U(K,X,H)

62. 62 Special Case #2: Additively Separable Happiness U(K,X,H,A)=F(K,X,H)+Ψ(A)

63. 63 Baseline Mood M and Elation e.

64. 64 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,…)

65. 65 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 + …

66. 66 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.

67. 67 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) + …

68. 68 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. (cf. Benartzi-Thaler) Agent’s understanding of happiness matters

69. 69 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.

70. 70 (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

71. 71 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.

72. 72 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.

73. 73 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.

74. 74 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.

75. 75 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.

76. 76 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 on 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.) Baumol’s curse: like services

77. 77 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

78. 78 Using Elation to Find the Structure of Flow Utility U Maintain the hypothesis of additive time- separability. If happiness is additively separable, then good and bad news will not affect consumption decisions. If happiness is not additively separable, then –good news will raise consumption of complements to happiness and lower consumption of substitutes. –bad news will raise consumption of substitutes to happiness and lower consumption of complements.

79. 79 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.

80. 80 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.

81. 81 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.

82. 82 Empirical Projects Tracking spikes and dips in happiness in response to news. –National (Katrina, Koizumi) –Individual (Kimball-Silverman) –Multiple Indicator Estimation Distinguishing anticipated from unanticipated happiness. Testing whether happiness Granger causes other variables. Testing if preference for happiness is a source of loss-aversion.

83. 83 Multiple Indicator Estimation It does not really make sense to simply add together Happy (Y it1 ), Not Depressed (Y it2 ), Enjoy Life (Y it3 ), and Not Sad (Y it4 ) to get a Happiness Index. Instead, model the Y itk as indicators of the N(μ it,σ i 2 ) latent variable Affect (A it ). For k=1,2,3,4, Y itk =1 if A it + ε itk > 0; Y itk =0 otherwise. ε itk ~N(μ k,σ k 2 ), where μ 1 =0, σ 1 2 =1.

84. 84 Distinguishing Anticipated from Unanticipated Happiness (Kimball-Michaels) Annual Aggregate Data A t =M t +e t e t =ι t (Thus, e t is a rational expectations error.) M t =X t β A t = X t β+e t e t is correlated with X t : OLS is not consistent As an RX surprise, e t is uncorrelated with X t-1. Thus, IV with X t-1 as instruments is consistent.

85. 85 Testing whether happiness Granger causes other variables (Kimball-Michaels) The claim that happiness depends on predictions of the future is a testable difference between saying –happiness spikes in responds to news about lifetime utility instead of –happiness depends on first differences This can be tested by straightforward Granger causality tests on aggregate data.

86. 86 Does preference for happiness account for loss aversion? Is Happiness 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) + … Do people understand the production function for elation? In particular, do they realize the speed of hedonic adaptation?

87. 87 The Personal News Question

88. 88 Personal News and Happiness (U.S.)

89. 89 Personal News and Happiness (Japan)

90. 90 An Experiment Modifying People’s Perception of the Speed of Hedonic Adaptation (Benjamin-Kimball) Take as a maintained assumption that people think happiness is concave in news. Suppose people think the impact of news on happiness will last longer than it does. This could add to loss- aversion Measure loss-aversion (first-order risk aversion) before and after educating people about how fast most people get over things. That is, test if people are more willing to take risks-- especially small risks--after realizing the speed of hedonic adaptation.

91. 91 Other Theoretical Issues Hedonic Adaptation vs. Habit Formation Anticipation Effects Can Manipulating Perceptions Raise Utility? The Evolutionary Psychology of Happiness

92. 92 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.

93. 93 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.

94. 94 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.

95. 95 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.

96. 96 Summary: Can an Exotic Utility Function make Utility=Happiness? a.If only innovations in lifetime utility mattered for happiness, maximizing happiness and maximizing lifetime utility would be equivalent. b.EXCEPT: 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.

97. 97 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.

98. 98 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”)

99. 99 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.

100. 100 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.

101. 101 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)

102. 102 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.

103. 103 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).

104. 104 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.