Well-Being and Utility in Psychology and Economics

1. Well-Being and Utility in Psychology and Economics Miles Kimball (Project Leader), Robert Barsky, Kerwin Charles, Fred Conrad, Randolph Nesse, Norbert Schwarz, Dan Silverman, Robert Willis

2. Specific Aims 1. Developing the theory of the relationship between affect and utility. • Use HRS data to test the theory and to study the dynamics of affect. • Develop new measures of well-being. • Design and implement affect-based, choice-based and perception-based measures of social rivalry in various domains.

3. Significance • 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.

4. 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 well-being increasingly important for welfare compared to further improvements in other areas.

5. 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.

6. 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.)

7. 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.

8. Significance 6.The “Hedonic Treadmill,” “Easterlin Paradox” and “Progress Paradox” all refer to the lack of secular improvement in subjective well-being in the face of major increases in per capita income, improvements in health, and improvements in many other social indicators. On its face, this paradox seems to present a serious challenge for Economics. A thorough-going resolution of this paradox is essential for effective integration of subjective well-being data into Economics.

9. Significance 7. Some of the leading candidates for explaining the Hedonic Treadmill involve comparison to expectations, the past, the experience of others, or to goals, as a key element in the determination of subjective well-being. The economic and policy implications of subjective well-being data depend on the relative importance of these different comparisons in the determination of subjective well-being.

10. Significance 8. If the importance of social comparison, envy, and positional concerns differs from one domain to another, effort and expenditure in domains with more intense social comparison will be overemphasized relative to domains with less intense social comparison from an overall welfare point of view. For example, if there is more social comparison for goods than for leisure, people will work too much compared to the overall community optimum.

11. Previous Psychological Studies • Judging overall life-satisfaction or happiness in life is a complex cognitive task. Evidence on the sensitivity 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.

12. Previous Psychological Studies • Experience data on subjective well-being asks how happy a respondent feels at the moment he or she is signaled. The objective is increase accuracy by focusing explicitly on information that should be immediately accessible to the respondent. In unpublished work, Kahneman and Schwartz find that experience data shows an even more severe version of the Hedonic Treadmill than typical subjective well-being data: experience data on subjective well-being ultimately reverts to its previous level even more completely than other data on subjective well-being.

13. Previous Psychological Studies • There is substantial reversion over time of subjective well-being toward its previous level even for non-traded goods such as health, marriage and divorce, and interstate migration. Thus, the dynamics of subjective well-being cannot be safely ignored in any domain. • Social rank has been found to affect many outcomes, such as subjective well-being, and in the famous White Hall study, morbidity and mortality.

14. Previous Economic Studies • The Ordinalist, or “revealed preference” revolution in Economics developed techniques for measuring individual welfare based on choice data alone, independent of any direct measure of well-being that are now a staple of economic research. These techniques can be applied to tradeoffs and preferences over seemingly incommensurable values.

15. Previous Economic Studies 2. The Ordinalist revolution also made it clear that the key philosophical issues in judging social welfare for purposes of public policy could not be avoided even if a perfect direct measure of individual welfare existed. Most notably, there is no easy escape from the difficulties surrounding interpersonal comparison. For example, should those with more refined tastes who can distinguish more minute differences in quality therefore be accorded greater weight in social choice?

16. Previous Economic Studies • Economic theory has drawn a distinction between a number of different concepts that each has some prima facie claim to the label “level of happiness”: • Felicity (flow utility); • The individual’s overall objective function (often modeled, for example, as the expected present value of flow utility for the individual, plus a constant times the overall objective function of children). • The part of the individual’s objective function that abstracts from altruistic caring about others.

17. Previous Economic Studies 4. Economic theory has studied the characteristics of expectations in great depth. A key result is that news--dynamic revisions to rational expectations--will be zero-mean and unpredictable. 5. Since Gary Becker’s pioneering work, much of the activity of a household outside of paid work has been reconceived as household production of goods.

18. Previous Economic Studies 6. A growing economic literature has made use of subjective well-being data. a. This literature lays out many provocative findings. b. With a few exceptions, the focus of this literature has been on the cross-sectional and trend properties of subjective well-being rather than on its detailed dynamic properties. c. Two key motivations for the use of subjective well-being data are (i) the desire to study the welfare implications of non-traded goods and (ii) the desire to study welfare implications in contexts where choice behavior is potentially inconsistent. d. Many economists are still skeptical of the use of subjective well-being data in economics.

19. Methods: Theory • The key issue is the relationship between the dynamic behavior of subjective well-being and standard economic concepts such as flow utility and the overall objective function. The strong tendency toward mean reversion of subjective well-being is the key fact that needs to be integrated in any adequate theory.

20. Methods: Theory 2. Identifying subjective well-being with either flow utility or the overall objective function comes uncomfortably close to violating revealed preference, since the advances in health care, plus other economic and technological improvements, and the accumulation of movies, music and books would be enough to cause most people to distinctly prefer modern life to life 50 years ago—yet average subjective well-being has not improved at all over that period.

21. Methods: Theory • It is clear that subjective well-being responds in an intuitive way to news about objective circumstances. For example, subjective well-being rises after experimental subjects discover a dime and falls after experimental subjects are given negative test results. 4. But the relationship of subjective well-being to levels of variables describing objective circumstances, such as income and health, is surprisingly weak.

22. Methods: Theory • The theory we propose to test builds on the two observations by positing that a major component of subjective well-being which can be labeled elation depends directly on news about objective life circumstances that has arrived over the last few months rather than on the level of circumstances: elation = f(news about life circumstances) news ≈ the expectation about the overall objective function given current information – the expectation about the overall objective function a few months ago

23. Methods: Theory • 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; thus the initial burst of elation dissipates once the full import of news is emotionally and cognitively processed. (Negative elation in response to bad news is labeled dismay. Dismay dissipates similarly.)

24. Methods: Theory • Although the definition of elation is motivated by the hypothesis that the reaction to recent news will be a major component of subjective well-being, the theory does not assume this. Instead, we posit that affect, a current happiness version of subjective well-being, is given by affect = baseline mood + elation.

25. Methods: Theory • Interpretation. a. This equation is close to being a decomposition of subjective well-being into predictable and unpredictable components. b. Baseline mood is the part of subjective well being that depends directly on the level of certain aspects of objective circumstances. c. Baseline mood is defined as that part of subjective well-being that can in principle be predicted well in advance to the extent that the aspects of objective circumstances that it depends on can be predicted.

26. Methods: Theory • We hypothesize that factors known to fairly directly affect brain chemistry are likely to be particularly important determinants of baseline mood. Things in this category include a. psychotropic drugs b. sleep c. exercise d. nutrition e. social rank

27. Methods: Theory • How does affect depend on standard economic concepts? a. Contrary to the implicit assumption in much of the literature, we hypothesize that affect (the current happiness version of SWB) is not equal to either flow utility or to the overall objective function. b. Elation is hypothesized to depend primarily on changes in the overall objective function. c. We hypothesize that baseline mood—the long-run part of affect--is not a global measure of welfare at all. It only reflects the level of certain aspects of an individual’s situation. d. If these hypotheses are true, the surprising implication is that, properly understood, the high frequency movements in affect that reflect the dynamics of elation are better indicators of what is happening to overall welfare than the permanent movements in affect that reflect movements in baseline mood.

28. Methods: Theory 11. How does flow utility (and therefore the overall objective function) depend on the components of affect? a. One possibility is that affect is an epiphenomenon—that is, affect depends on news about the overall objective function, but the overall objective function does not depend on affect. b. To the extent that, instead, flow utility depends on baseline mood, baseline mood simply acts like one more good generated by a household production function and can be handled in standard ways. c. A surprising theoretical result is that if elation enters flow utility in an additive linear way, choice behavior will be totally unaffected. d. The key aspects of prospect theory can be generated parsimoniously by a nonlinear dependence of flow utility on elation.

29. Methods: Theory • What are the implications of the Elation Theory of Affect for welfare economics? a. If affect is an epiphenomenon, or only elation enters flow utility, in a linear way, the only consequence of the elation theory of affect for welfare economics is adding a useful new source of data. b. If elation enters flow utility non-linearly, there are non-trivial consequences for the welfare effects of risk and news flows. c. We conjecture that baseline mood does, in fact, enter into flow utility. Moreover, we conjecture that baseline mood is a luxury good, which will become increasingly important as per capita income rises over time.

30. Methods: Theory 13. Possible extensions of the Elation Theory of Affect: a. If expectations are not fully rational, elation may not always be mean reverting. Also, it may then be possible to manipulate elation in positive ways if elation based on irrational expectations enters flow utility. b. Positive elation may motivate the acquisition of information about further opportunities, while negative elation (dismay) may motivate the acquisition of information on further dangers. Such directed information acquisition could affect probability assessments in systematic ways. c. [Curiosity and fatalism.]

31. Methods: Theory • Extensions to the theory of baseline mood. a. Individuals do not necessarily fully understand the production function for goods they produce themselves. For example, the degree of knowledge about the production function for health is highly variable across people. b. It is likely that many people do not know the true production function for baseline mood. In particular, lack of understanding of the dynamics of the elation mechanism could make it difficult for individuals to parcel out the determinants of baseline mood. c. If baseline mood enters flow utility as a luxury good that will become increasingly important over time, the discovery and dissemination of facts about the determinants of baseline mood could have large positive welfare effects over the course of the coming decades.

32. Methods: Analyzing HRS Data • Although it does not have the standard happiness or life satisfaction questions as part of the core survey, the HRS has a variety of measures for assessing subjective well-being: a. A subscale of the depression scale has been used successfully by Peter Ubel to study the relationship subjective well-being to health and income. b. A variety of measures exist on HRS modules, including the standard measures, which can be immediately compared with the measure available on every wave to validate it. c. The entire depression scale is also of considerable interest. In particular, its trend can address the question of whether depression is increasing.

33. Methods: Analyzing HRS Data 2.The same basic principles for separately identifying baseline mood and elation apply to HRS individual panel data as to the panel of national cross-sections. The same basic kinds of questions can be addressed. In addition, the HRS data presents a number of other opportunities not provided by the panel of national cross-sections.

34. Methods: Analyzing HRS Data 3. The HRS has detailed data on wealth, marital and health shocks, as well as choice behaviors such as retirement that can be used to analyze the impulse response functions of affect to changes. 4. In the individual panel of the HRS, it is possible to analyze the determinants of individual effects not only on the level of affect, but also on the sensitivity of affect to shocks and the persistence of the reaction of affect to a shock.

35. Methods: Analyzing HRS Data 5. An important methodological question is whether asking respondents about changes in happiness can add useful information beyond what is obtained by asking them about levels. While the HRS does not allow a direct answer to this question, questions asking respondents about both the level and the change in health status make it possible to study the parallel question of whether asking respondents about changes in health status adds useful information beyond what is obtained by asking about levels.

36. Methods: Analyzing HRS Data 6. The HRS mailout collects a considerable amount of information about consumption and time use. In addition, the HRS contains a variety of data on sleep quantity and quality. Because the HRS is a panel, it is possible not only to correlate this data with affect but also to correlate changes over two years in time use, sleep and consumption patterns with affect to control for individual effects. Corrections for recent events that might affect elation can be made in order to focus on the effect of consumption and time use on baseline mood.

37. Methods: Analyzing HRS Data 7. The HRS has detailed information on job characteristics. This makes it possible to study the effect of job characteristics on baseline mood and the interaction of these effects with the approach of retirement and the actual retirement transition.

38. Methods: New Measures of Goals, Goal Attainment 1. The determination of affect may be a nonlinear function of life situation in relation to goals rather than a simple function of life situation alone. It is possible to study these issues systematically by the adaptation to surveys of techniques developed by Randy Nesse.

39. Methods: New Measures of the Incidence of Extremely Difficult Life Situations 1. Because of the concavity of flow utility in both traded and non-traded goods, low values of a good can be particularly influential in determining flow utility---and therefore may be particularly influential in determining both elation and baseline mood. This provides an opportunity to economically capture a large portion of the variance of the determinants of subjective well-being.

40. Methods: New Measures of the Incidence of Extremely Difficult Life Situations 2. The incidence and timing of extremely difficult life situations can be measured on surveys such as the HRS by adaptation to surveys of the methods for assessing the incidence of extremely difficult life situations that have been developed by Randy Nesse.

41. Methods: New Measures of the Incidence of Extremely Difficult Life Situations 3. The measure of goals and goal attainment can be compared to the incidence of extremely difficult life situations to gauge the relative power of the two approaches and whether each has incremental power beyond what the other provides.

42. Methods: New Measures of Social Comparison, Envy and Positional Concerns in Various Domains • It is not easy, even in principle, to draw a clear distinction between social comparison, envy and positional concerns. In fact, it is possible to establish a variety of observational equivalence results among these three phenomonena. Therefore, our strategy will be to measure the aggregate of these three phenomena.

43. Methods: New Measures of Social Comparison, Envy and Positional Concern in Various Domains 2. Very little data on social comparison, envy and positional concerns in various domains on nationally representative samples currently exists. We will design and implement a survey instrument measuring social comparison, envy and positional concerns in various domains on the Survey of Consumers.

44. Methods: New Measures of Social Comparison, Envy and Positional Concern in Various Domains • We will use and compare two complementary strategies for measuring social comparison, envy and positional concerns: a. Asking about preferences over alternative worlds with different average levels of a good or bad and different levels of the good or bad for the respondent. b. Using the known survey methodology effect of bracketing levels on responses to guage the extent of social comparison.

45. Methods: New Measures of Social Comparison, Envy and Positional Concern in Various Domains • These measures will be implemented in a variety of domains: a. house size and quality b. commuting time c. work hours d. income e. etc.

46. Methods: New Measures of Social Comparison, Envy and Positional Concern in Various Domains 5. Having data on the importance of social comparison, envy and positional concerns in various domains makes it possible to see if there are differences in the importance of social comparison across domains that could tilt effort and expenditure toward certain domains at the expense of others in a way that is individually optimal given what everyone else is doing, but is social suboptimal.

47. Methods: New Measures of Social Comparison, Envy and Positional Concern in Various Domains 6. By also including a measure of affect and the actual level of the good or bad in the relevant domain on the Survey of Consumers, we can test whether individual differences in social comparison interact with actual levels of a good or bad in determining affect. The panel structure of the Survey Consumers makes it possible to use instrumental variable techniques to focus on long-lasting effects on affect. Conversely, it is possible to isolate the effect of news by looking at the effect of changes in the individual and population average levels of a good or bad on affect and separating out predictable from unpredictable changes.

48. Methods: High Frequency Movements in Affect 1. Evidence from psychological experiments suggests that that after all but the most serious shocks to circumstances, the regression of affect toward its previous value (“psychological adaptation”) takes a matter of months, or sometimes much less. Existing large-scale surveys typically provide subjective well-being data at most at an annual frequency, which hampers the study of exact speed and dynamics of the psychological adaptation process.

49. Methods: High Frequency Movements in Affect 2. Implementation of an affect measure on the Survey of Consumers will permit the analysis of responses to individual shocks at a six month interval and responses of the average American adult to national events at a very high frequency since Survey of Consumers is conducted monthly and within the month will make available to us the day and time of the interviews.

50. Methods: High Frequency Movements in Affect 3. Cooperation with the Osaka University Institute for Social and Economic Research Center of Excellence on the parallel implementation of an affect measure on a monthly survey in Japan may allow a cross-cultural study of the details of psychological adaptation.