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The Marginal Utility of Income

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  • Richard Layard
  • Guy Mayraz
  • Stephen Nickell

Abstract

In normative public economics it is crucial to know how fast the marginal utility of income declines as income increases. One needs this parameter for cost-benefit analysis, for optimal taxation and for the (Atkinson) measurement of inequality. We estimate this parameter using four large cross-sectional surveys of subjective happiness and two panel surveys. Altogether, the data cover over 50 countries and time periods between 1972 and 2005. In each of the six very different surveys, using a number of assumptions, we are able to estimate the elasticity of marginal utility with respect to income. We obtain very similar results from each survey. The highest (absolute) value is 1.34 and the lowest is 1.19, with a combined estimate of 1.26. The results are also very similar for subgroups in the population. We also examine whether these estimates (which are based directly on the scale of reported happiness) could be biased upwards if true utility is convex with respect to reported happiness. We find some evidence of such bias, but it is small—yielding a new estimated elasticity of 1.24 for the combined sample.

Suggested Citation

  • Richard Layard & Guy Mayraz & Stephen Nickell, 2007. "The Marginal Utility of Income," CEP Discussion Papers dp0784, Centre for Economic Performance, LSE.
    • Handle: RePEc:cep:cepdps:dp0784
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    More about this item

    Keywords

    Marginal utility; income; life satisfaction; happiness; public economic; welfare; inequality; optimal taxation; reference-dependent preferences;
    All these keywords.

    JEL classification:

    • I31 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - General Welfare, Well-Being
    • H00 - Public Economics - - General - - - General
    • D1 - Microeconomics - - Household Behavior
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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