Friday, June 26, 2009

What makes you happy? Expectations

What makes people happy? This is a central question in economics, as much of the theory is centered on utility maximization or social welfare maximization. Unfortunately, there is little data that actually measures happiness, and it is impossible to assess relative happiness across individuals. However, one can try and assess relative happiness of an individual across time.

Martin Binder and Alex Coad do this using a British panel data set and taking a self-assessed indicator of mental well-being as a measure of happiness. Using a VAR framework, the natural thing is then study of various life events, like changes in income, marriage and employment impact happiness. Surprisingly, the impact in negative. Well, that may not necessarily be a surprise to some for marriage, but why would an increase in income make you less happy?

But what about a change in timing? It turns out that increases in happiness are followed by improvements in income, employment, health and marriage. In other words, it looks like expectations have an impact on happiness that is stronger than actual realizations. The econometrician cannot observe expectations, but it is reasonable to think that the latter are positively correlated with subsequent realizations. Quite obviously, we need to rethink utility.

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