Income and Happiness: Getting the Debate Straight

Carol Graham (2011) asks a really good question: does higher income go with greater happiness and, if so, under which conditions? It is perhaps difficult to under-estimate how central the answer to this question is to Social Science. In particular, if well-being is indeed relative in income, then greater GDP per capita will not necessarily raise average well-being in an economy. Somewhat less feted, yet to my mind just as important, is the fact that income comparisons of the kind that Carol Graham is talking about have enormous implications for the analysis of individual well-being. In a nutshell, standard Economic analysis says that we will buy a good (or supply hours of work, or do whatever it is that we do) up until the marginal benefit from doing so, what we Economists call marginal utility, equals the marginal cost (the price of the good, or the value of the hour of leisure foregone). We typically think that such consumption is subject to the Law of decreasing marginal utility: the more of a good you have, the less you value having one more unit of it. This explains why we all, at some point, stop buying cars, eating ice cream, buying shirts, and earning income in general: the marginal utility from doing so just isn't worth the marginal cost we have to pay. All well and good, but the kinds of comparisons that we are talking about here actually mount a serious challenge to this Law of decreasing marginal utility. If I compare to you, and you compare to me, then your buying an expensive car may increase my marginal utility of spending more on a new car. In general, my marginal utility of more income (or consumption) may rise with your income (or consumption). If this is the case, then your higher income will provide me with a greater incentive to increase my own income, which provides you with a greater incentive to increase your income, and so on ad infinitum. We are here then in the world of the rat race or the Arms Race. If I compare to you and you compare to me then the Law of decreasing marginal utility may well be weakened or indeed fail to hold at all. If so, we will all end up consuming too much, and not necessarily be any happier for it. Of course, the macroeconomic flipside of this is that greater income for all may not lead to greater happiness for all, as Dick Easterlin (1995) has pointed out. So these are very central questions indeed, from the points of view of understanding public policy and explaining individual consumption and labour-supply behaviours.1 They are well-worth studying, and indeed have led to what is now a considerable literature across the social sciences.