THE ECONOMICS OF HAPPINESS: ASSESSSING WELL-BEING THROUGH THE RELATIONSHIP BETWEEN INCOME AND HAPPINESS A THESIS Presented to The Faculty of the Department of Economics and Business The Colorado College In Partial Fulfillment of the Requirements for the Degree Bachelor of Arts By Keegan Flaherty Dollinger May 2011 THE ECONOMICS OF HAPPINESS: ASSESSSING WELL-BEING THROUGH THE RELATIONSHIP BETWEEN INCOME AND HAPPINESS Keegan Dollinger May 2011 Economics and Business Abstract The investigation of the relationship between income and happiness can provide important insights into human’s material aspirations. By redefining the application of the term utility, economics can be used to understand how money affects our happiness. Today and in past years at a given point in time those with higher incomes are indeed happier than those with lower incomes. However, raising the incomes of a nation does not make that nation any happier. These conclusions are suggested by data on reported happiness and income collected in the United States over the past forty years. The paradox that takes place in this relationship has important public policy implications and raises doubts on the primary economic goal of growth in GDP. This thesis hopes to stimulate a debate that questions some of the basic tenets of economic theory that regard the use of GDP as a measure of welfare and the simplistic and limiting role that is applied to individuals in behavior models. KEYWORDS: (Well-being, Happiness, Income, Utility) TABLE OF CONTENTS ABSTRACT ACKNOWLEDGEMENTS 1 INTRODUCTION……………………………………………………………….. 1 2 LITERATURE REVIEW………………………………………………………... 10 3 RELEVANT THEORY………………………………………………………….. 19 4 HAPPINESS IN OTHER FIELDS……………………………………………… 25 5 DATA……………………………………………………………………………. 31 6 METHODOLOGY………………………………………………………………. 36 7 RESULTS………………………………………………………………………... 44 8 CONCLUSION………………………………………………………………….. 50 9 APPENDIX……………………………………………………………………… 57 10 WORKS CONSULTED………………………………………………………..... 59 LIST OF TABLES 6.1 Distribution of Population by Happiness at Various Levels of Income, United States, 2006………………………………………………………………... 10 6.2 Regression with Happiness as Dependent Variable…………………………. 40 6.3 Happiness and Real GDP per Capita, United States, 1972 – 2008………….. 41 6.4 Regression of Happiness and Real GDP per Capita from, United States, 1972 – 2008……………………………………………………………………….. 42 6.5 Regression of Happiness and Real GDP per Capita with First Difference….. 43 Acknowledgements Esther Redmount My Family CHAPTER I INTRODUCTION ―The professed object of Dr. Adam Smith‘s inquiry is the nature and causes of the wealth of nations. There is another inquiry, however, perhaps still more interesting, which he occasionally mixes with it, I mean an inquiry into the causes which affect the happiness of nations.‖ Malthus, 1778/1996: 303-4 Philosophers, writers, politicians, and the general public have long been concerned with the question, ―Does money increase happiness?‖ Rational arguments have been advanced on both sides of the issue. The average person is consumed with the concern for accumulating more wealth. Even the wealthiest pursue incremental wealth despite the marginal utility of each additional dollar. Regardless of their respective economic situations, almost all humans are engaged in some sort of trivial pursuit of wealth. The capitalistic system has implanted into the human psyche a relentless drive to attain more money. With varying success, humans thus attempt to achieve happiness through the acquisition of more money. The study of happiness, as it relates to economics was largely dismissed as too subjective and unnecessary for the first part of the 20th century. The term utility was used to account for the satisfaction an individual received from a good or service. Now economists are looking at different ways to apply utility to analyze happiness through economic theory. How can economics be used to provide people more happiness? Can money buy happiness? Answering these questions is difficult, however it may be possible 1 2 through examining the relationship between income and happiness in a specific year and across a span of forty years. Over the course of time, many philosophers and thinkers have observed life and concluded it for the most part represents a great tragedy. Sophocles thought it better not to live at all, and wrote, ―Not to be born surpasses thought and speech. The second best is to have seen the light and then to go back quickly whence we came.‖ Nevertheless, studies across every social science, including psychology, sociology, philosophy, and economics have largely disagreed with Sophocles and found for the most part that people are generally happy, despite varying economic factors. This begs the question of economists and academics: how do people judge happiness and how happiness is related to income? As Malthus stated in the epigraph above, even Adam Smith inquired beyond economic growth and the wealth of a nation and conducted a more imperative investigation of the well-being or happiness of a nation. Scholars are generally in agreement about economic theories of supply and demand and how they drive consumer behavior. Economics as a discipline is based upon empirical research. This thesis will use empirical evidence to investigate the relationship between happiness and wealth, reconsidering the theory of utility in standard economic thought. There is general agreement that economic growth leads to the growth of well- being within a country. The United States appears to be a classic example of this hypothesis, given the apparent satisfaction of a materialistic and money-oriented society in the tangible gains of a capitalist economy. Both government and their populations have generally accepted economic indicators as measure not only of the economic condition but also of overall well-being of the country. Our capitalist economy has 3 reinforced the societal notion that money can buy happiness and that increases in income will ultimately lead to higher levels of happiness at the aggregate and individual level. The exclusive focus on economic growth that the United States and much of the world appear to share and the widespread belief that economic growth is the first priority in orchestrating economic policy has not come without its own problems. The capitalist economic system is successful to a certain extent but still maintains certain flaws. The way we construct our capitalist system should be adjusted to incorporate a more comprehensive and conscientious understanding of the positive and negative implications economic growth can have. The capitalist system that the United States adheres to focuses too heavily on GDP and accumulation of money. If the government and the people of the United States establish the importance of well-being before the primary goal of growth, the United States may become happier. The most significant complication in investigating happiness is determining an appropriate and standard definition of happiness. Given the subjectivity of happiness as experienced by the individuals and the variance of how each individual defines their own happiness make it difficult to apply or establish a consistent definition. The mind in its own place and in itself Can make a Heaven or a Hell, a Hell or a Heaven Paradise Lost John Milton An argument can be made in agreement with Milton that happiness is controlled exclusively by the mind; the conditions in which we live can be made into a Hell or a Heaven. But many still believe that it is not the mind that makes our world a paradise or 4 a purgatory, that makes us happy or miserable, but the conditions in which we live.1 Happiness is dependent on a combination of internal circumstances of a person‘s mind and the external conditions in which the person lives. The dependence on external or internal conditions is different for each person. Although each of our minds is distinct and our happiness is sensitive to our individual psychological circumstances, external conditions play a large role in our individual happiness. Happiness is very difficult to measure among people and difficult for people to even measure for themselves. The accuracy of measuring well-being has been under much scrutiny. Reliability and validity issues can occur depending on whether respondents report their true feelings or report feelings that may be impacted by biases resulting from the context in which the question is asked. Extensive research has been conducted in the study of psychology and economics attempting to test the validity of different well-being measures (see Diener (1984) and Veenhoven (1993)). Psychologists have been developing different measures of a person‘s happiness with the simple question of ‗Taken all together, how would you say things are these days.‘ Although the answers to these questions may not be completely accurate, they provide an important indicator to a society‘s well-being. The general conclusion of such assessments is that the subjective indicators can provide reliable reports of a person‘s general happiness due to the substantial amounts of valid variance between the respondent‘s reports (Diener, 1984).2 1 Angus Campbell and University of Michigan, "The sense of well-being in America : recent patterns and trends," (1980): 263. 2 R. A. Easterlin, "Income and happiness: Towards a unified theory," Economic Journal 111, no. 473 (2001): 465. 5 Happiness is conceived here as the degree to which an individual judges the overall quality of his life favorably.3 In other words