ECON 432

Loss-aversion

- A loss in income is perceived considerably stronger than an increase in income in the same amount -Evidence: (Boyce et al 2013) Two panel data sets from Germany and Britain covering a period of 9-10 years

What conditions would you consider when constructing a survey for the happiness question?

- Avoid an bias on the question - Consider the order of questions before bringing up the happiness question - Stay away form double negative questions - Keep it consistent with low-to-high or high-to-low questions

Two reason why economist are looking beyond objective measures of well being

- Decision utility may not equal experienced utility - altruistic behaviors cannot be explained through objective measures - relative standing in society may have greater eeffect on well being that objective standing

What does the set-point model say about the influence of life circumstance on happiness?

- LS is set at a baseline level not related to life circumstance, but personality because personality is constant - Different to socio-demographic approach to LS - Difference in well-being are attributed to changing objective life circumstances, rather than constant individual personality traits

Which component of the Easterlin Paradox can be explained using the loss aversion concept?

- People are subject to an experiental asymmetry between gains and lossess (Loss aversion/endowment effect) - this asymmetry leads to "downward-stickiness" in aspirations (ie. no downward hedonic adaptation ) - When income (or GDP) falls aspiration remain high leading to a fall in LS. If later income recovers, so does LS (short term fluctuations in LS and GDP) In the long-term, as income increases so do aspirations (due to hedonic adaptation) leading to no change in LS

Explain two ways subjective well being measure can be collected

- Physical and biological indcators ( pulse rate) - Observed social behaviors ( activity level, friendliness) - Non verbal behaviors (smiling, slouching ) - Surveys (MOST COMMONLY USED BY ECONOMIST)

What makes subjective well being measures so important?

- Reliability, adequately stable for the same individuals over time - Validity, biases are random and doesnt affect aggregate levels ; appropriate survey design

How would you respond to a critique focused on cultural biases?

- comparability across nations; patterns accross nations indicate people are consistent in how they answer LS variables - LS is reflective of objective variables (inocme, health, employment rates) - Globally, LS can be explained by 3 life aspects: economic well-being (GDP per capita), Social support (friends, family, social networks), Health life expectancy - High consistency in how people rate their lives in different countries

Social Comparison

-The observed tendency for humans to determine their own self worth or subjective well-being depending on how thy stack up to other - over time, an increase in the income of any one individual may increase happiness, but increasing income of everyone would leave happiness unchanged - people are more likely to compare their income relative to their peers than with society as a whole

Hedonic Adaptation

-observed tendency for humans to return to a relatively stable level of happiness despite major positive or major negative events or life changes -"a reduction in the affective intensity of favorable and unfavorable circumstances" accompanied by shifting "the stimulus level that is perceived as neutral." -Provides possible explanation for why income and life satisfaction are correlated across people at a point in time but over time as personal income increases the life satisfaction of a person does not -Connects with the notion that people's aspirations continuous change/increase (people will always rate their future higher in LS and their past lower in LS)

Give two reasons why, economists care about what other factors influence utility ( or life satisfaction)

1. Analysis of economic growth and well-being 2. Policymaking

What has been shown about the easterlin paradox as newer data has become available?

As newer data has become available, there only further support for the Easterlin paradox

Explain and Illustrate the happiness over time in a transition country

As transition countries change from communism to capitalism, countries actually had a collapse in GDP per capita, and so did life satisfaction collapse. As GDP per capita recovered to more than where they started, but life satisfaction only went up to the level it was at during the captalist transtion

Some approaches to the analysis of the association between happiness and age find a U-shaped association, while others find a slight hill-shaped or M-shaped association. What is the principal reason for the difference between the two conclusions?

Blanchflower and Oswald U-Shape Changes in aspirations over the life cycle Older people learn to reduce the effect of negative events on their well-being Selective survival of "happier" people (probably does not have an effect until later in age Holding all life circustances constant, age displays a U shape M-Shape Allowing life circumstance to change over the life cycle First part of the M-Shape is explained by life transitions Example •Before age 30, young adults start cohabiting/get married and begin raising children. •Between ages 30 and 50, the (possibly financial) pressures of parenting and union dissolution exert a negative effect on LS. •Between ages 50 and 75, retirement increases LS. •After 75, poor health and widowhood negatively affect LS. Life Satisfaction decreases all the way to 50, then increases after The U shaped you include control variables age and life satisfaction M shape you allow other variables to come into changing For example, U shape you control income or if someone is married.

What explains the change in happiness over time in transition countries?

Choices: Loss aversion, hedonic adaptation, social comparison - Loss aversion explains initiall, and then hedonic adaptation takes over - social comparison does NOT play a role here. ONLY explains resluts in one point in time Loss aversion, whereby a loss in income is perceived considerably stronger than an increase in income in the same amount. In other words, "losses loom larger than gains." (Kahneman and Tversky 1979). There is a downward jump in well-being due to a loss and a 1 unit increase in log-income is accompanied by 0.05-SD increase in LS while a 1 unit decrease in log-income accompanied by 0.10-SD decrease in LS. (Boyce et al 2013, GSOEP) As income increases, people hedonically adapt and adapt to income increase, but they do not adapt to a decrease in income.

Explain the concept of libertarian paternalism.

Core idea: To design policies that encourage behavior that promotes individuals well-being while leaving the final decision in the hands of the individuals. Paternalism: design policies in a way that encourages people to determine their own well-being Libertarian: leave the final decision in the hands of the individual Example - Opt in (Libertarian) vs Opt Out (paternalism)

Explain the difference between decision and experienced utility. Use an example to illustrate this difference.

Decision utility is predicted utility of a person that can be inferred from observed choices (usual economic approach). Experienced utility is the pleasure and pain actually experienced after making a decision. A simple example was Professor's teacher who was allergic to chocolate, but yet still loved to eat it when given the opportunity. Decision utility would observe that the teacher chooses chocolate over an apple and concludes that the chocolate is better for him and thus gives him higher utility points. Experienced utility would state that since the teacher

What is the approach taken by domain analysis in explaining global life satisfaction?

Domain analysis used to study the extent to which global well-being can be seen as the net outcome of reported satisfaction with life circumstance. Life domains are groups of circumstances representing specific aspects of life

What data did Easterlin use to arrive at his paradox?

Easterlin used cross section analysis of happiness in GSS survey For country level analysis: - cross sectional data between life satisfaction and income for 14 countries in the 1960s

What are the four main life domains?

Economic, Health, Family, Work

Is there any evidence that makes it possible to choose between these two views? If yes, explain which view is support and why.

Empirical evidence: Zimmermann and Easterlin, 2006 Conclusion: 1. Once cohabitation and socio-economic differences are taken into account, there appears to be no "selection" effect of happier people into marriages. 2. Even after controlling for cohabitation, marriage has a short-run "honeymoon" effect on LS. (This part I am pretty much not sure, will ask professor in review session)

What are the implications of the set-point model for the evolution of happiness over time?

Events can move people above or below this baseline, but in time people will always return to this stable point

How does the explanatory variable listed in your answer above relate to the findings regarding the happiness and well-being in the four major life domains? Explain in detail.

Family: widowhood, isolation, divorce all have negative associations with LS, better to be surrounded by family and your spouse's family as a support network Work: work environment; better to work with others than work in isolated environment

Give two examples of objective measures of well being

GDP and GNP Advantages - based on econ theories, marginal utilities Disadvantages - relies on assumptions of the equilibrium. Method0logical issues. Anything that doesnt have a price tag.

Helliwell and co-authors use a multivariate regression model to analyze the association of happiness with corruption, freedom to choose, social support, and generosity. Describe their findings regarding the direction of the association between happiness and each of their explanatory variables.

Happiness & corruption: Happiness is negatively associated with corruption Happiness & freedom to choose: Happiness is positively associated with freedom to choose Happiness & social support: Happiness is positively associated with social support Happiness & generosity: Happiness is positively associated with generosity

How would you respond to each of these objections? Be specific and use references to empirical findings where possible.

Happiness cannot be measured There is growing availability of self-reported measures of SWB that can be used in economic and policy analysis. SWB measures are reliable and valid. Even though cultural differences may make cross-country comparisons difficult, some evidence shows that people around the world have similar concerns and "happiness functions." Happiness is of no value in and of itself Happiness and pleasure are distinctive and two different concepts. Happiness is strongly associated with other well-being factors such as good health. Happy people live longer and display more pro-social behaviors. The pursuit of happiness spoils by fostering consumerism In the long-term, increasing material well-being by rising incomes does not lead to higher happiness levels. The pursuit of happiness would have to focus on improvements in non-material life domains such as health, family life, and workplace satisfaction. the pursuit of happiness justifies a-moral means Freedom and respect for human rights are associated with higher happiness. The pursuit of happiness would focus on democratic values such as increasing freedom and promoting public choice.

What are the four typical objections to using happiness a policy objective?

Happiness cannot be measured, happiness is of no value in and of itself, the pursuit of happiness spoils by fostering consumerism, and that the pursuit of happiness justifies a-moral means.

Which concept is Loss Aversion more closely related too? Why?

Hedonic Adaptation - Downward-sticky aspirations - People adapt hedonically to an increase in income, but not to a following decrease in income -As income increases, people adapt and LS remains constant; as income falls, people do not adapt and their LS falls -In the long-term, as income increases so do aspirations (due to hedonic adaptation) leading to no change in LS

If you wanted to explain to your friends the life cycle pattern of happiness that they may expect to experience as they get older, which shape would you choose and why?

I would use the M-Shape because when you're growing up in age. You become more happier with your life because of marriage and kids. But, when you hit a certian age like parenting and financial pressures of providing for your family, that could decrease your LS. When you finish working you retire, you have grandkids, retirement, vacation, and hobbies to enjoy increasing your LS. As you grow older, your health becomes bad and etc. This creates an M-Shape

What is typically assumed as the main determinant of utility in economics?

Income -> U = f (Y)

Would you say the above view [ income -> U = f (Y) ] is complete or incomplete?

Incomplete: while income is associated with utility at a point in time and in the short term, in the long term and increase in income may not increase utility

What are the 2 main components of the Easterlin Paradox

Individual level analysis: 1. Need to know that at a point in time, people who are richer are happier by using cross section analysis of happiness in GSS survey 2. Applied cross-section relationship to life satisfaction of 1941-50 birth cohorts as their income increases over 28 years Actual results: the predicted relationship does not hold, the actual relationship between income and life satisfaction is flat Conclusion of individual level analysis: the positive relationship between an individual's income and life satisfaction found at a point in time within countries does not hold in time series. When a person's income and life satisfaction levels are followed through time, higher income does not lead to higher life satisfaction. Country level analysis: 1. Use cross-sectional relationship between life satisfaction and income for 14 countries in 1960s e.g Nigeria, Egypt, Cuba, Poland, India, USA, W. Germany, Japan 2. Apply cross-sectional relationship to the life satisfaction of one of the poorer countries in sample as its income experiences unprecedented growth between 1962 and 1987. Actual results: predicted relationship does not hold. As national income grew in Japan, life satisfaction remained flat. Conclusion of country level analysis: the positive relationship between national income and life satisfaction found at a point in time across countries does not hold in time series

What is the reasoning of those who sya that the causation runs from having a partner to happiness?

Marriage brings social connections, self-esteem and social supports which could give positive effect on many aspects of life. The circumstance for social eocnomic components are improved after marriage

What life circumstances may account for the M-shaped pattern found in Europe? What method and evidence do Switek and Easterlin use to support this conclusion?

Method •Step 1: estimate the overall change in life satisfaction for given age interval. •Step 2: estimate the association between each life transition and change in LS (holding other life transitions constant). •Step 3: predict the LS evolution using only information on consecutive life transitions only. Conclusions LS experiences a mild increase between ages 22 and 30-32 and corresponding mild drop between 30-32 and 40. The evolution of LS during young adulthood is highly a reflection of the consecutive life transitions. Allow life circumstances to change over the life cycle I was unable to life circumstances that may account for the M-Shape, but I am assuming the normal circumstances like marriage, job, kids, retirement, & etc.

Sacks, Stevenson, and Wolfers describe the Easterlin paradox as resting on "the belief that the relationship between wellbeing and income was stronger within countries than between countries" Is this explanation of the Easterlin paradox correct

No, this is incorrect, because it is critiquiing only the short term aspect of the paradox and completely disregards the fact that the Easterlin paradox has two parts If they were accurately criticizing Easterlin, they would acknowledge his statement that over a long period of time there is no correlation of well being and income

What does the set-point model say are the main determinants of happiness?

Personality traits: Set by a person's genes Positive Traits: Extraversion, Self Esteem, Optimism, Perceived Control Negative Traits: Neuroticism

Describe how the difference betwee the short-term and long-term association between income and life satisfaction has led some authors to conclude that they had refuted the Easterlin paradox.

Short Term Relationship between income and LS: led economist to wrongfully conclude that increasing income over time can increase LS . In contrast: Paradox says in a point of time not over time. Thus, refuted. In the WVS study by SSW, about half of the countries covered a time-span of less than 10 years, and one-third covered a time-span of 3 to 7 years. As Easterlin points out: "... mixing such short-term growth rates with long-term trend rates tends to tilt the happiness-GDP regression in a positive direction." (Easterlin, 2016)

Explain and draw a graph distinguishing the difference between the short term and long term association between income and life satisfaction

Short-Term: When income or GDP falls aspirations remain high leadign to a fall in LS. If later income recovers, so does LS (short-term fluctuations in LS and GDP) Long-term: as income increases so do aspirations (due to hedonic adaptation) leading to no change in LS

Example of Objective Measure of Well-Being

Social Indicators ( Human Development) Life expectancy etc. Disadvantages - unclear what mattters more, everyone is different

Which of the explanatory variables included in Helliwell's model has the strongest association with happiness? What is the approximate magnitude of this association?

Social support has the strongest association with happiness. The effect on LS of a 10% increase in social support is equivalent to the doubling GDP per capita.

Do you agree or disagree with the set-point model to how life circumstance influence happiness? Cite 2 sources

Support for the 'set-point' theory Costa et al 1987: Found that there was no main effect of time on total well-being (TWB), evidence for the stability of levels of well-being in adulthood Diener et al 1999: Personality traits exhibit some of the strongest relations with SWB, genes may be partly responsible for these relations Against 'set-point' theory Costa et al: Health Concern was higher and Positive Affect lower among older age groups, but there were also a cross-sectional decline with age in Negative Affect Rietveld et al: Find that only 5-10% of single-question subjective well-being measures (such as LS) can be explained by a person's genetic predispositions

What cautions would you advise survey collectors to follow in their interviews?

Survey collectors should be consistent! - in theory it would be best if they could switch between low-to-high and high-to-low

Which component of the Easterlin paradox can be explained using the hedonic adaptation concept?

The adaptation mechanism posits that relative incomes are calculated with respect to the individual's own income in the recent past. A one-off increase in our income would produce only a temporary effect in happiness; lasting only the time needed for individuals to get used to their new level of comfort. If incomes are growing at a constant rate, as they have done to a first approximation in countries such as the US, we would find that our current income is always higher than our income of the last few years, but the relative distance between the two would be constant. Happiness levels would also be constant, providing another reasonable explanation for the Easterlin Paradox. Increase in income has temporary effects: either because we adapt to the new level or because we revise the amount of income that we aspire to.

How is this approach different from the approach taken in Micro-econometric regression analysis? Are there nay links or similarities between the two approaches? Explain

The domain analysis is based on the different independent variables with the same dependent variable LS or Well-Being . Whereas, micro-econometric regression is focusing on many factors at the same time Domain analysis looks at global life satisfaction + other life factors Micro-econometric analysis doesnt een look at satisfaction variable, but actual life events and life circumstances

What is the mainstream critique of libertarian paternalism? How does Richard Thaler respond to this critique?

The mainstream critique of libertarian paternalism is that it's manipulative and disempowering to the individual. Thaler says is it is a false assumption that people always make choices that are in their best interest. People make systematic errors in predictions of future well-being. Evidence from lab experiments shows people's decisions are subject to a variety of biases and heuristics: · Overconfidence in own abilities · Self-control problems due to a myopic decision-making Misconception one is that paternalism can avoided. Planners are always forced to make some decision. May have to decide what attribute to support first or decide to pick at random. Misconception two is that paternalism always involves coercion. Design of decisions that are inevitable is not coercive. 'Nudging' does not force individuals to behave in their best interest, but it does encourage this type of behavior.

What is the meaning of "transition" in the term "transition country"?

Transition countries are countries or specifically economies that went throught the change from Communism and Capitalism

Explain and illustrate with a graph the (neo? In the slides it talks about neoclassical model) classical economic model of utility used to analyze consumers' decisions. What are the two main assumptions underlying this model?

Two assumptions implicit in the neoclassical model: 1. Preferences (aspirations) are constant and do not depend on current level of consumption. 2. Given constant preferences, people can perfectly predict how changes in life conditions affect their well-being.

Which component of the Easterlin Paradox can be explained using the social comparison concept?

Under the social comparison mechanism, the norm that individuals use to evaluate their income in relative terms is the income of a comparison group. There are many possible definitions of this comparison group: the average of the society, people of similar socioeconomic characteristics, neighbors, family, etc. Logic of mechanism is the same: we are happy if we have more than the others and unhappy otherwise. If this mechanism is present a proportional increase of all incomes in an economy would leave average happiness unaffected, in line with the Easterlin Paradox.

2 Examples of life evaluation measure through surveys

World Values Survey - "Taken all together, how happy would you say you are" Life Satisfaction - "On the whole are you very satisfied, fairly satisfied, not very satisfied, or not at all satisfied with the life you lead?'

Describe the Easterlin Paradox? What are the two main components? Why is there a paradox?

at a point in time happiness varies directly with income both among and within nations, but over time happiness does not trend upward as income continues to grow Paradox: A country People with high income are more likely to be happy, but this does not hold on the national level

What is the reasoning fo those who say that the causation runs form happiness to having a partner

happy people tend to be optimistic and more attractive to the different sex, more possibility to get married

What explains the final level of happiness following the transition in the transition countries?

if later income recovers in a transtion country, so does LS, but it may not exceed the level of LS at which the transition had take polace because of hedonic adaptation; People woul dhave increased their expectations, resulting in the same level of utility even if income increases

Ordinal Measures

measures revealed preference. Ex. life expectancy, education, human development, married

Objective Measure of Well-being

measures utility of cardinal and ordinal measures

Cardinal Measures

measures well being by income or money Ex. GDP, GNP