Home > Behavioural Economics > Money, happiness and hedonic adaptation.

Money, happiness and hedonic adaptation.

December 10, 2015 Leave a comment Go to comments

The Economist ‘Free Exchange’ column had a piece on money and happiness in which they looked at research into how peoples level of happiness is relative to reference groups. In the mid 1970s Richard Easterlin drew attention to studies that showed that, although successive generations are usually more affluent that their parents or grandparents, people seemed to be no happier with their lives. It is an interesting paradox to study when you are writing about measuring economic welfare and the standard of living.

Easterlin ParadoxWhat is the Easterlin Paradox?
1) Within a society, rich people tend to be much happier than poor people.
2) But, rich societies tend not to be happier than poor societies (or not by much).
3) As countries get richer, they do not get happier. Easterlin argued that life satisfaction does rise with average incomes but only up to a point. One of Easterlin’s conclusions was that relative income can weigh heavily on people’s minds.

Recent studies that looked at countries over time concluded that more income leads to greater levels of happiness. However it wasn’t clear as to whether money leads to happiness or happiness leads to money.

The Busara Centre for Behavioral Economics in Nairobi, Kenya, runs experiments with people from the depressed and rural areas of the country. Their researchers looked at the results of a lottery-like scheme in rural Kenya, in which a random sample of 503 households spread over 120 villages was chosen to receive cash transfers of up to $1,525. The average transfer, $357, was almost enough to double the wealth of a typical villager. After this had taken place researchers measured the well-being of villagers before and after the transfer of money. As expected those that received money reported an increase in happiness but those that did not receive any money fell sharply when they saw their neighbors livelihood improve. It transpired that the reduction in satisfaction by seeing your neighbour getting richer was greater than the increase in satisfaction from receiving the cash transfer. So therefore:

The bigger the handouts to others in their village, the greater the dissatisfaction of non-recipients

Hedonic Adaptation
Over a period of time the effects of the increase in a person’s income wears off over time as the recipient gets used to the norm. Economists refer to this as ‘Hedonic Adaptation’. There were big differences in the levels of satisfaction but after a year the level of happiness of both the recipient and non-recipients returned close to its original level prior to the windfall gain.

One interesting result was that villagers were not so concerned about inequality but the decline in their own wealth relative to the mean. Therefore a village could have great inequality as one group has got richer and another group poorer but the actual mean income remains unchanged.

A study by Ada Ferrer-i-Carbonell entitled ‘Income and Well-Being: an empirical analysis of the comparison income effect’ shows that there is an asymmetry in the way people compare themselves with others. There is a tendency for people to compare themselves to those who are better off so we shift our reference group as our income goes up. Because of this we are never satisfied, since we quickly become accustomed to our own achievements.

Increases in family income accompanied by identical increases in the income of the reference group do not lead to significant changes in well-being; the larger an individual’s own income is in comparison with the income of the reference group, the happier the individual is. Ada Ferrer-i-Carbonell

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