Subjective Well-Being and Utility in Psychology and Economics

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

2. Specific Aims • Clarify the dynamic relationship between subjective well-being measures as measured by psychologists and concepts specified in economic theory such as flow utility and an individual’s overall objective function. 2. Analyze the empirical dynamics of subjective well-being in the HRS panel of individuals and in a panel of repeated cross-sections from different nations. 3. Identify the implications of that relationship for the use of subjective well-being data to inform public policy.

3. Specific Aims 4. Explore the details of the dynamic response of subjective well-being to events and the psychological correlates of individual differences in the magnitude and persistence of these responses. • Develop new measures of subjective well-being based on goals and goal attainment. • Develop a new measure of the incidence of extremely difficult life situations. 7. Develop new measures of the importance of social comparison, envy and positional concerns in various domains.

4. Specific Aims 8. Investigate the relative importance for subjective well-being of a. comparison to expectations, b. comparison to the past, and c. comparison to the experiences of others d. comparison to personal goals.

5. Specific Aims 9. Analyze the correspondences between different measures of subjective well-being and depression in the HRS and measure whether the incidence of depression is increasing over time in the HRS. 10. Use HRS data to analyze the relationship between time use and subjective well-being.

6. 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.

7. 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.

8. 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.

9. 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.)

10. 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.

11. 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.

12. 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.

13. 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.

14. Significance 9. Several observers have claimed that rates of depression have been increasing over time in the United States. But differences in methods and samples in the various cross-sections calls the comparability of existing evidence into question. The HRS has a consistent measure of depression administered to successive U.S. cohorts turning 50. During the period of the grant, enough time will have passed since the inception of the HRS to obtain a solid read on the trend in depression according to HRS data.

15. Significance 10. Many observers have claimed that time use has important, persistent effects on subjective well-being. For example, it has been claimed subjective well-being would be increased by spending a. less time working b. less time watching TV c. more time sleeping d. more time with friends Because of its panel data on time use, the HRS makes possible an investigation of these issues that controls for individual effects.

16. 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.

17. 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.

18. 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.

19. 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.

20. 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?

21. 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.

22. 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.

23. 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.

24. Previous Economic Studies 7. Research by Tom Juster and others on time use and well-being has the somewhat surprising finding that people are often happier at work than in most of their leisure-time activities. This kind of finding suggests that there is much to be learned from looking more carefully at time use and subjective well-being.

25. 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.

26. 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.

27. 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.

28. 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

29. 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.)

30. 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.

31. 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.

32. 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

33. 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.

34. 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.

35. 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.

36. 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.]

37. 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.

38. Methods: Empirical Analysis of a Panel of National Cross-Sections • The primary implication of the Elation Theory of Affect for empirical work is the imperative to focus on the time series aspects of subjective well-being. • In particular, it is important to separately identify the effects of the time series of circumstances on elation and the effects of the time series of circumstances on baseline mood.

39. Methods: Empirical Analysis of a Panel of National Cross-Sections 3. The determinants of baseline mood can be analyzed by an instrumental variables regression of subjective well-being on potential determinants using past information as instruments to identify predictable effects on affect. 4. In principle, the determinants of baseline mood identified by such a regression can be compared to choice behavior related to the household production of baseline mood in order to test whether people have accurate knowledge of the determinants of baseline mood.

40. Methods: Empirical Analysis of a Panel of National Cross-Sections 5.Elation can be approximated a residual that is the difference between subjective well-being and the predicted value of subjective well-being from the equation identified for baseline mood where here “prediction” is meant in the loose econometric sense, since one should use the actual current values of the variables found to affect baseline mood.

41. Methods: Empirical Analysis of a Panel of National Cross-Sections 6. Thus identified, elation can be used for event studies in much the way excess returns on stocks are used in the finance literature. If the unpredictable component of affect is in fact a function of news about the overall objective function, these event studies will provide information about the shape of the overall objective function, including its dependence on non-traded goods.

42. Methods: Empirical Analysis of a Panel of National Cross-Sections 7. In the use of elation measures for event studies, appropriate adjustments need to be made a. for the actual speed of information flows, if expectations are not fully rational, and b. for the evolution of the objective function over time if time-consistency is violated.

43. Methods: Empirical Analysis of a Panel of National Cross-Sections 8. Cross-sections of both life-satisfaction and happiness versions of subjective well-being have been collected in many nations and in many years. Combined, these constitute a panel of national cross-sections that has been used by a number of researchers to study the determinants of subjective well-being.

44. Methods: Empirical Analysis of a Panel of National Cross-Sections 9. The Elation Theory of Affect suggests certain biases in parts of the existing economic literature using subjective well-being data. a. To the extent the implicit objective is to identify what affects subjective well-being in a permanent way because subjective well-being is an important good in its own right, variables that tend to reflect recent events such as unemployment will have too high a coefficient. b. To the extent the objective is to identify the shape of the overall objective function, slow-moving, largely predictable variables will have too low a coefficient.

45. Methods: Empirical Analysis of a Panel of National Cross-Sections 10. Because life-satisfaction questions ask respondents to bring to bear judgments beyond current affect, these questions may be less strongly mean-reverting than questions asking about happiness. It is important to explore this possibility in order to clearly interpret the range of results in the literature that are based on these two different measures.

46. 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.

47. 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.

48. 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.

49. 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.

50. 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.