Behavioral economics

DEWEY

Massachusetts

Institute

of

Technology

Department

of

Economics

Working

Paper

Series

BEHAVIORAL

ECONOMICS

Peter

A.

Diamond

Working

Paper

08-03

March

15,2008

Room

E52-251

50

Memorial

Drive

Cambridge,

MA

02142

This

paper

can be

downloaded

without

charge

from

the Social

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Collection at

http://ssrn.com/abstract=11

08588

HB31

Page

1 of1

Behavioral

Economics

Peter

Diamond'

Abstract

This

comment

was

writtenfor a special issueofthe Journal

of

Public

Economics which

containspaperswritten fora conference.

The

papers coverarangeoftopics

and

approachesinbehavioral economics,including issuesofindividual behavior,

of

the

measurement of

the

consequences

of

individualbehavior,

and

ofincorporating these

pictures

of

individualbehaviorintonormative analysis.

The

comment

touches

on

three

topicsinbehavioralanalyses: (1)theroles of equilibrium

and

context/situation; (2) issues

indoing normativeevaluations;

and

(3) happiness studies.

'

I didnot attend the conference,but readthepaperswithinterest afterbeinginvitedtosubmita comment

for thisspecialissue. I

am

gratefulforcommentsonanearlierdraftfromHenryAaron,AlanAuerbach, NickBarr,AngusDeaton,BengtHolmstrom,Richard Layard,GeorgeLoewenstein, Antonio Rangel, Johannes, Spinnewijn,NickStem, and RichardThaler.

Page

1 of10

Behavioral

Economics

Peter

Diamond

What

has

been happening

inbehavioraleconomics, broadlyinterpreted, has

been

very

exciting.

And

Iexpectthe excitementtocontinue.^

The

papers in thisspecial issue coverarange

of

topics

and

approaches inbehavioral economics, including issues of individualbehavior, ofthe

measurement

ofthe

consequences

of

individual behavior,

and

ofincorporating these picturesofindividualbehavior intonormative analysis.

They

are verywell

worth

reading.

There

isa

wide

range ofbehavioral

economics

papers generally.

Some

paperspursue

betterunderstanding of

how

individuals decide,particularlyabout

economic

transactions.

Others pursuethe properties of

economic

equilibriumgiven a

model

of

how

people decide(possibly withheterogeneity inindividualbehavior)

and

a

model

ofthe underlying

economic

environment. Otherspursuepolicy implications.

Some

ofthese are in areas

where

there

must be

policy(for example,taxation)

and

ask

how

the insights

from

behavioral

economics might change

existingpolicy analyses. Others

open up

new

areas

where government

intervention might be successful (for

example

legislating defaults in

401k

plans).

With

thelatter,

one

shouldthink

whether

encouraginga

new

realmof regulationis likely to result ina successfuloutcome.

While

a similar question

may

arise inthe former(e. g., a

new

type oftaxexpenditure), often the issue istryingto get a legislature to

do

better

what

itwill

do

in

any

event,suchas settingtaxrates

on

existing tax bases.

Learning

from

studiesinthisarea, as

from

studies in allof economics, should

come

from

drawing

inferences as aresultof consideringthe applicabilityofthe findingsofastudy

beyond

itstheoretical

model

or

beyond

itseconometric formulation

and

estimation. Policyadvice shouldnot

come

from

takingformalimplications literally. It

seems

to

me,

as it

seemed

toAlfredMarshall, thatthe researchprocess involvesboth formalanalyses

and

informal

combining

ofvarious insights:

it [is] necessaryfor

man

with his limited

powers

to

go

step

by

step;breaking

up

a

complex

question, studying

one

bit ata time,

and

at last

combining

his partial solutionsintoa

more

orless complete solutionofthe

whole

riddle. ...

The more

the issue isthusnarrowed, the

more

exactly canitbe handled: but also the less

closelydoes itcorrespondto real life.

Each

exact

and

firm handling ofa

narrow

issue,

however,

helpstowardstreatingbroaderissues, in

which

that

narrow

issue

Idid not attend theconference,but readthepapers withinterest afterbeinginvitedtosubmitacomment for thisspecialissue. I

am

grateful forcommentson an earlierdraftfromHenryAaron, AlanAuerbach,

Nick Barr,AngusDeaton,BengtHolmstrom,Richard Layard,George Loewenstein, Antonio Rangel, Johannes Spinnewijn,Nick Stem,and RichardThaler.

^_Itisthat belief,andthehopeofcontributingtoitsdevelopment,thatled

me

toco-organizetheconference

Digitized

by

the

Internet

Archive

in

2011

with

funding

from

Boston

Library

Consortium

IVIember

Libraries

Page

2 of10

is contained,

more

exactly than

would

otherwise

have been

possible.

With

each step ... exact discussionscanbe

made

less abstract, realisticdiscussions can be

made

less inexactthan

was

possibleatan earlier stage. (Marshall, 1948,

page

366.)

I

do

not think

we

have

"a

more

orless complete solution

of

the

whole

riddle" that behavioral

economics

addresses, or pretty

much

any

broad issuethat

economics

addresses.

But

policy

making, and

so policy

recommendations,

cannotwait fora

complete solution.

Moving

ahead

with

what

we

think

we

know, and

moving

in

recognition ofthe limitationsof

how much

we

do

know

is appropriate.

And

doing sois

betterthan

making

policywhileignoringthe understandingof

economics

we

do

have.

For

continuing

and

improved

success,behavioral

economics

needs to preserve

some

aspects

of

traditional

economic

analyses

and

avoid others. For example, with survey questionnaires,

which

economists

have

a longhistory ofusing, behavioralanalyses

need

tocontinuetorecognize thatanswers often

have

interestingcontent

even

though

theyare not necessarily accurate, exact

answers

tothe questions the researchers (orthereadersof the researchreport)

had

inmind. This holds for questionsaboutfacts (e. g.,

how

much

wealth

do

you

have),questions aboutbeliefs (e. g.,

what

istheprobability

you

will live to 85),

and

questions about condition(e. g.,

how

happy

areyou).

Economists

are

more

aware

ofthe importance

of

theconstraints

coming

from

equilibrium thantypical noneconomists,an awareness thatmatters forbehavioral

economics

as well.

Awareness

of equilibrium

(sometimes

going

from

unintended

consequences

to undesired

consequences

thatcan

be

partof anevaluation) isan importantpart ofthinkingabout bothpositive

and

normative dimensions of outcomes. Constraints

from

equilibrium

come

ina varietyofforms. Individuals

have

budget constraints

-

there cannotbe atotal

absenceofquantityresponses toa single price

change

ofa

good

being purchased,

and

some

policiesto lower

consumption

today (e. g., ofpositional goods)

may

increase their

consumption tomorrow. Governments

also

have

budget constraints

-

today'sdeficits

have

real implications, fortaxesand/orspending in thefuture.

Economic

agents react to

changes

inthe

economic environment

(e. g.,rules

on

disclosure)

and

agentsreact to the

changes

inthe behavior

of

others. It is importanttopreserve awareness of equilibrium responses

when

consideringpolicy changes

by governments

orotherinstitutions or individuals. Behavioral analyses

need

tobe as

aware

oftheroles of equilibrium constraints asnon-behavioralanalyses.

While

these

common

elements in

economic

analysis

have

servedthe professionwell

and

shouldbe continued, thereare other aspectsofpositiveanalysis that

need

tobe adaptedto

work

wellwiththe insights ofbehavioral economics.

And

beyond

the changes that behavioral analysis brings to descriptions ofthedetermination

of

equilibrium, there are

new

challenges

and

new

opportunities fordoing normativeevaluations ofequilibrium.

*

AsBeshears,Choi,Laibson andMadrian(this issue)put it:

"We

agreethat self-reportscan'tbetakenat

Page

3 of10

Context/Situation

Instandardmodeling,

we

assume

consistentbehavioracross

economic

environments, capturedinpreferencesthat aredefinedonlyintermsof

commodities

acquired(absent externalities). In addition, these

same

preferences aregenerallytakento

be

a suitable basis fornormative analysis in

many

settings, although this

common

approach hasnot

been

applieduniversally.''

One

ofthe

key messages of

behavioral

economics

isthat context(also referredto as situation)mattersin

ways

that are notrecognized instandard modeling.^ Purchasingcontext(e. g., typeofstore)matters forwillingnessto

pay

to acquire aparticulargood. Context(anticipateduse

by

others)matters forthe

demand

forpositional goods. Context (presence ofincentivesthat arenotnarrowly

self-oriented)matters fortherole offinancialincentives. Contextmatters forthetradeoff

between

current

and

futureconcerns (e. g., tradingoffchocolatecake today forhigher weight

tomorrow

is differentifthe cakeis infront of

you

or

merely

nearby). Context, as

capturedinthe concept

of

mental accounts, matters forspending.^ Eventuallythere

may

be

enough

understanding of

how

context mattersto

do

well in

moving

inferences

from

one

setting to another. For

now,

carryingestimated parameters (e. g., /?

from

quasi-hyperbolic modeling)

unchanged from one

contexttoanother isnot likely to

be

a

good

estimate. Thatis, the descriptionofthe setting

where

an

economic

decision is being

made

needs to includefar

more

information than the usual description ofthe setting.

And

behavioris likely to vary with elementsofthe description thatplay

no

role intheusual formulation.

'

Normative

evaluations

Using

behavioral insightswell forpolicypurposes willoftenbe hard.

My

message

isnot thatthesepolicy issues areunimportantornot

worth

working

hard on,butthat

much

more

hard

work

is warranted.

Where

the standard

model

ofindividual choiceis an

adequatebasis forpositive analysis,itoften lends itselfto normativeanalysis since,

on

many

issues,there is

no

good

reason fornot incorporating the individualpreferences into

normativeanalysis, either

of

Pareto optimality orwithasocial welfarefianction.

But

''

Theconceptofmeritgoods(Musgrave, 1959)isalong-standing exception. Sotoo areanalysesbasedon presumptionsof behaviorsthatdonotsucceedinbeingindividuallyoptimal, particularlyinconsidering mandatorypensionsystems.

And

governmentshaveinstituteda varietyofmeasures ofconsumer

protectionthatdraw onthesameunderlyingideasthatare

now

makingthemselvesfeltineconomic

analyses,suchmeasuresascooling-off periodsafterpurchasesfromdoor-to-doorsalesmenor thebanning ofsomeconsumerproducts. Whileregulationof product design can havemultipleunderlyingsources,

someofthemfitthiscategory.

^_{Koszegi and Rabin(this issue)discusspreferencesdependingonthecontextofthechoice}

set.

*_{Consider beer purchase}

intheexperimentinThaler, 1985.

'_{AsinpositionalgoodsdiscussedbyFrank(thisissue).}

Asinthe studiesdiscussedbyBowles(thisissue). Itmatterswhetheracircumstanceisviewedasan opportunityforgenerosity oras a possibility forbeingmadeasucker.

'_{ShefrinandThaler, 1988.}

'"_As

anexampleofcontext mattering, considerthisspoof responsetoanactualstudy(Plassmanetal.,

2008)fromironictimes.com:

KStudy:Consumers Get

More

Pleasure

From Same Wine

atHigherPrice Oilcompaniesraisegas pricestoenhancedrivers'enjoyment.

Page

4 of10

when

the standard

model

is too far

from

accurate,

and

we

have

empirically supported

alternativemodels,

we

should considerpolicy

recommendations

based

on

these alternatives.

As

withstandardanalysis,going

from

considerationofpolicytoa

recommendation

requiresapositive evaluation of

what

thepoliticalprocesswill

do

with such a

recommendation.

One

realm of behavioral analysis isthe identificationof circumstances

where

people are

making

"mistakes."" This is a wonderfullabel since itsuggeststhatwelfare improvements, possibly

even

Pareto improvements, arepossible

and

simultaneously suggests an approachtonormativeanalysis,

by

assessing

outcomes

as individuals

would

ifthey

were

not

making

mistakes. In ordertoproceed with normative analysis

and

policy

recommendations,

one needsto identifymistakes

and

needstoevaluate alternative

outcomes

thatthe policy

may

mandate

orinduce. Considerationof

outcomes

needs to includechanges inthe behaviorofothers asequilibrium changes, asnoted above.

Support for aconclusion of mistake

from

analysis ofthedecision processis valuable

and

would

be

reassuring. Nevertheless,

we

shouldnot ruleoutreachinga conclusion of mistake

from

simply consideringthe

outcome

forthe individual.

Sometimes

people

change

theirbehavior

when

an allegedmistakeis pointedout tothem.

But

people can alsobe convincedto

change

theirbehaviorin settings that

might

notbe mistakes.

So

responsesto advice, along with reluctancetodecide,

may

be helpftilin identifying mistakes butarenotnecessarily conclusive.

Common

sense

may

suggestthat amistake

is afar

more

likely interpretationthantastes that

seem

unusual or peculiarinan attempt

toclaim a standard revealed preference interpretation.

And

furthertests

may

strongly supportan interpretationofmistake,e.g., experienceutility

measurement.

""

The

historic

weight given

by

the

economics

profession torevealed preference isnot a

good

reason for rejectingallclaims ofmistake. General skepticism about themultiplepolitical sourcesof

government

interventions should

make

one

cautious about labelingmistakes. Thatis,

perceptionsofplausiblepolitical use ofpossible policy

recommendations

based

on

behavioral

economics

findings should playarole

when

deciding

whether

to

push

a

recommendation.

Sometimes

itwill

seem

likely that

good

usewillbe

made

ofa

recommendation and sometimes

not.

Mistake

probably cannot be "proved"in

many

interesting settings.

But

then the absence of mistake can not be

proved

either. Contrasting

models

ofaddiction are an

example

where

plausibilitycanplay arole indeciding

on

a basis forpolicy

recommendations.

And

mistake

seems

to

me

a

more

plausible interpretation in

some

addiction settings.

Analysts

need

toconclude

what

interpretation is

most

likely,while recognizingthe possibilityof an erroneous interpretation.

Not

everyfindingofthepresence of mistakes shouldleadto political

recommendations.

Having

recognized

widespread

mistakes, considerationofequilibriumresponses (the fiill

setofchanges as a

consequence

of anintervention)

and

additionalconcerns (e. g.,

" Koszegi and Rabin(this issue)andBeshears,Choi,LaibsonandMadrian(thisissue)discuss

how

to

identifymistakesand

how

toconstructnormativepreferences.

^_{For example,when}

actions arebasedon memoriesof experiencesthathavesystematic biasesrelative to

Page

5 of10

individual heterogeneity, thevalue of choiceperse) can leadto mandates, incentives, regulations, givingadvice orproviding information. In therealm ofretirement income,

we

have

mandatory

systems of

payments from

individuals

when

younger and

to

them

when

older;

we

have

special taxrules forsavingthatisnot spent before

some

age;

we

have

regulation

of

privateretirement savings plans;

we

have

advice

on

how much

to save;

and

we

have

information

on

the implicationsofalternativesavings plans.

And we

fruitfiilly

have

all five atthe

same

time.

Mandatory and

voluntary (tax-favored)

retirement savings plans

have

restrictions

on

portfolio choice

and on

the

form

ofpayout witha varietyof degrees ofrestriction, includingall ofthe list

above

-mandates, tax incentives, defaults,advice

and

information.'^ All ofthese requirean evaluationof induced

changes

in behaviorifthe design isto be evaluatedwell. This

even

holds for

simply providing information as

Loewenstein and

Ubel

(this issue) note: "people

who

learn firstabout therisksofatreatment followed

by

itsbenefits

make

differentchoices than people

who

firstlearn aboutitsbenefits

and

thenits risks. Decisionaid developers

have

no

choicebuttopresentinformation in

one

order or another, but unfortunately the order they choosewillalmost inevitablyaffectpeople's decisions."

A

second

realm of normativebehavioral

economics

arises withconcerns for others,

which

may

involve

non-market

interactions with others.

A

prime

example

ofthisis in charitable donations

and

the use of

income and

estate taxincentives to encourage donations.

How

to

form

asocialwelfare function

from

agiven

model

ofindividual behavioris

open

todebate.'*

And

athirdrealm ariseswiththe goal ofchangingpreferences, as Stem,Dethier,

and

Rogers

(2005) argueisthe heart

of

economic

development.

"Changing

preferences" isa

term

withseveral

meanings and

differentuses, resultingin

some

confusion. Iexplore three

examples

interms ofchoices.

For

allthree examples,

assume

that all fourof

A

and

B

atbothdates cost the

same

inpresentdiscountedvalue.

(1)

A

might

be chosen over

B

and

consumed

attimet, while

B

is chosen over

A

and

consumed

attime t+1,

even

thoughthe situations aresimilar(e. g., identical relative prices).

One

might

describethisas preferencesthat

changed

between

t

and

t+1.

(2) If

A

is

consumed

attimet,

A

willbe chosen over

B

and

consumed

attimet+1.

Yet, if

B

is

consumed

attime t,

B

willbe chosen over

A

and

consumed

attime

t+1.

And

ifboth areavailable attime t,

A

ischosen.

One

might

describe this as

consumption

attimet changingpreferences attime t+1

.

(3)

At

time t,

A

might

be chosen over

B

for

consumption

attime t+1,while ifthe

choiceis

made

attime t+1,

B

would

be chosen over

A

for

consumption

attime t+1.

One

might

describethisas preferences that

changed

between

t

and

t+1

.

All three

examples

couldbe consistentwith

Arrow-Debreu

preference

modeling

orcould be the resultofa mistake,with verydifferentnormative implications.

Arrow-Debreu

'*

_An

_example

intherealmofbenefitform isthe

US

requirement ofnotarizedagreementbyaspouse ifa single lifeannuityischosenfromapensionplan.

'"

Page

6of 10

theory isdefined interms

of

the vectorof

consumptions

atalltimes

and

statesofnature. In(1),with all sequencescostingthe same, an

Arrow-Debreu consumer might

simply preferthe sequence

{A

attime t,

B

attime t+1} to

any

ofthe other three sequences. This

might

be theresult ofdecliningmarginal utility intotal

consumption

of

A

or preferences that are differentatdifferentages (asthey surely are).

Such

preferencesare different

overtime,butnot"changing"ina sensethatmatters fornormative analysis.

Alternatively, as a behavioralinterpretation, it

may

be thatthe

consumer

has trouble deciding

and

the contextinfluenced the choices, forexample,

A

might have been

the default attime t

and

B

attimet+1,

and

possibly

A

(or

B)

was

thebetterchoice atboth times.

In (2),the choice inthe firstperiod

might

be

made

withfullawareness oftheimplications forpreferences intimet+1 (as in

Arrow-Debreu

theory). Different choicesatt+1

might

come

from

the absenceofintertemporal additivity inpreferences,whilethe preferences are acted

upon

ina time-consistentway.

An

individualwill

do

more

ofactivities that

have

become more

enjoyable

from

previousexperience (e. g., getting

good

attennisor the clarinet)

and

less ofthosethat

become

less interesting (or

even

tiresome)with

more

use, a

form

of diminishing marginalutility

when

viewing

consumption

aggregatedover time.

With

individualawareness of such intertemporal links, thereis

no need

for standard theoryto

be

used

any

differentlybecause ofnon-additivityofpreferences. Alternatively, the choiceattimet

might

be

made

witha

myopic

ignoringoffuture

implications forpreferences or a

more

general failure to fully appreciate

what

the fliture

willbe like. Indeed,

some

decisions, suchas going touniversity orhavinga child, are

known

to affect futurepreferences,butin

ways

that

may

notbe fully appreciated

by

the decisionmaker.

For (3),

which

is the

prime

example

forquasi-hyperbolicmodeling, tobe consistentwith

Arrow-Debreu

theory,

some

circumstanceneeds to

change

between

t

and

t+1,

which

might

bethe arrival of information about

which

state ofnatureis occurring. For fully

complete markets (no

asymmetric

information), withcomplete

Arrow-Debreu

markets

one

would

be ableto

make

purchases conditional

on

the informationset atdifferent

fliture dates.

But

markets arenotcomplete.

Part ofthe confiisionintheterm changing preferences

comes

from

the differentbasic

modeling

ofpreferences instandard

economics

and

in

some

behavioral economics. In

Arrow-Debreu

theory, preferences (thebasisofchoice) aredefinedrelative to

goods

at

different dates. In

some

behavioral economics,preferences (thebasisofchoice) are

definedrelative to the distance over time

from

the time at

which

a decisionisbeing

made

to

when

the

consumption

actually occurs.'^ Thisdifference liesbehind

some

confiasion abouttherole

of

exponentialdiscounting in time-consistent choice. In

Arrow-Debreu

theory, there is

no need

forexponential discounting fortime-consistentbehavior since the discounting appliesto dates. Indeed,without intertemporal separability,the preferences

may

not lendthemselvestothe existence of

something

readily interpreted asadiscount factor. In

modeling

quasi-hyperbolic preferences, discounting is appliedin the

same

way

" _{InArrow-Debreutheoryallchoices aremadeonce andforall}

at thestartoftime. Butthat isnot

how we

experiencepurchasing.

Page

7 of 10

tothe"fiature" as

measured from

differentdecisiondates, implyingthat

we

need

exponential discountinginorderto avoidtime-inconsistent behavior.

Individualchoicesresultingin effects spreadover time

may

be

particularlysubjectto mistake.

Beyond

this,

and

atthe heart ofthe Stem,Dethier,

and Rogers

view, it

may

be

good

to

change

individual preferences in

ways

the individuals

do

not contemplate.

Governments have

arange of

ways

ofaffectingchoices, asdiscussed above,

and

suitable

responseswillbe differentin different settings. Similarly,

norms

matterforbehavior

and

norms

canbe influenced

by

governments.

Normative

evaluationof

government

interventionsinthesesettings requires evaluatingpeople with different(changed) preferences asa

consequence

ofapolicy intervention.

And

thatrequires

moving

beyond

traditional normativeanalysesthatrespect revealed preference.

In

sum,

analyzing

how

to

make

good

use ofpositivebehavioral

economics

forpolicy purposes is a

major and

important

ongoing

topic.

Happiness'^

Three

ofthepapersin this issuerelate to happiness, including analysisof survey questionsabout happiness in general(Layard,

Mayraz

and

Nickell ''), _analysis of

happiness

moment

by

moment

(Krueger

and

Schkade

)

and

discussionof

how

touse the

contentofthese sources ofdata fornormativeanalysis (Loewenstein

and

Ubel).

My

beliefsaboutthe different literatures

echo

what

Isaidatthe start

-

studies likethese containreal information,but

even

afteradjustingfor

measurement

issues, as thepapers do, theanswers tosurveyquestions shouldnot

be

takenliterally,but

used

forplausible inferences.

How

should

we

interpretanswerstothe question

"How

happy

are

you

thesedays?"

Or

answers to questionsasking about life satisfaction? (These

may

tap

somewhat

different

underlyingperspectives, as

one might

be satisfiedwithalifedevotedto an activity that

doesnot generate happiness;probablytheseshouldnotbe treatedas interchangeable questions.)

The

papers considersourcesofnoise

and

errorin attemptsto

answer

the questionthe investigators

have

inmind.

But

we

shouldconsiderthattherespondents

may

have something

relatedbut

somewhat

different inmind. Ifpeople

answer whether

theyare satisfiedwith theirlives interms oftheirperceivedrelativeposition in happiness, thatdoesnot necessarily

mean

thathappinessis based

on

relativeposition, ratherthanthatthe questionbeing

answered by

therespondentis arelativehappiness question.

And

ifitisarelative

comparison

thatatleastpartially lies behindthe answer, thendifferentpeople

may

be using differentbases for

comparison

-

their

own

past, their

Ihave been onlyacasualfollowerofthehappinessliteratures.

My

willingnesstowritethiscomment,

nevertheless,camefromseeing the strongsimilarity to

my

basicmethodologyinLoewensteinandUbel

(thisissue).

'^_{Thispaper focusesonanswerstothe}

questions"Takingallthingsintoaccount,

how

happyareyouthese

days?"and "All things considered,

how

satisfied areyouwithyourlifeas awholethesedays?"

'*

Thispaperconsidersaffectmeasurescollectedfromadiary method. Italsoincludesalifesatisfaction

Page

8 of 10

perception of

some

set ofothers, possiblya particularpeergroup, orpeople locally, nationally,

somewhat

internationally, ortheir

own

prior expectations.

And

this

may

lie

behindthe lack

of

consistencyintime-series

and

cross-section relations of happiness answers relative toincome. '^ _{Consider asking people}

_how

tall or

how

old they are

on

a scale

from

zero toten.

Would

cross sections

and

time seriesof repeated surveys

match

respondents'

measured

heights

and

ages consistently? I doubtit. I suspectthat for

some

purposes

we

would

want

tousetheir answers (e. g.,behaviorthat relates to self-image)

and

for

some

their

measurements

(e.g., the effectsofnutrition

on

height

and

mortality).

Some

explorationhas

been

done

ofthe impact

on

reportedhappiness ofthe grovv1:hof

incomes

and

the

incomes

ofneighbors.

But

suchstudies

may

notshedlight

on

the questionof

how

much

well-being

depends

on

one'srelativestanding

and

how

much

the respondent lookstorelative standinginorderto

answer

thesurveyquestion.

A

happiness

answer

reflects

some

periodof time

-

thisinstant in

some

typesofstudies,

an intent to

have

awider time

frame

in others.

And

differentrespondents

may

be

implicitlyreflecting differenttime frames,perhaps becausethey areconsidering different elements. For example, havingjustcut

consumption

totake advantageofaparticular retirementsavings opportunity,

one might

answer

ahappiness question

based

on

current reduced

consumption

or

on

the satisfaction

from

having providedbetter for the future. If

one

were

to try touse happiness

measures

forretirement savings policy,

one

would

need

to

know

what

isunderlying an

answer

ataparticularpointintime.

And,

as always, correlationdoesnot necessarily

imply

causation.

Given

a large individual (personality?)

component

inhappiness,

one

can

wonder

how much

happierpeople earn

more

orsave

more

(forhigher

income

later)as well as viceversa.

Experienceutilitystudies

have

an obvious role inlooking formistakes.

And

happmess

studies

may

play arole innormative evaluationsgiven theordinalnature ofstandard preferences.^'

Even

if

one

were

to accept

some

particular

answer

relatinghappiness to

income,thatstill leaves several questions. Is

measured

happiness theappropriate basis

"

_{That timeseriesand cross-sectionrelationsofanswersrelative toincome donotmatchisafamiliar}

patternineconomics,mostvisiblyinstudiesofsavings.

^^_{Asnoted above,insomesettingsmemories ofthe}

utilityof an experiencehavesystematic biasesrelative toevaluationsofutilitycollectedduringtheexperience(Kahneman,etal., 1993).

"'

It is

common

toassert thatchoiceunderuncertaintygivessomedegree ofcardinality(uptoanaffine

transformation). Butisthe"utility" inexpectedutilitythesameas theutility

we

seekfornormative purposes? Ithinkthisisasemanticsleightof hand. Consistentwithmaximizingexpectedutilityis

maximizinganyincreasing functionof expectedutility. But convertingthatformulationintochoiceunder

certaintygivesapreferenceknownupto anincreasingtransformnotrestricted tobeinganaffinetransform.

Thatis,drawingthe

common

inferenceinvolvesanassumptionthat "utilities" indifferentstatesofnature aretheutilities

we

areconcernedwith,andnotsometransformofthem. Similarly,iflifetimeutilityof consumptiontoday andconsumptiontomorrowforperson n is w, [x,_]

+

S^Uj[X2],isthisthefunctionthat

shouldbeaddedacrosspeoplebya utilitarianor,theordinallyequivalent, m, [x,1/(5^-I-w, [x,1,or

somethingelse?

^^

Layard, MayrazandNickellfocusonestimating a single

CRRA

parameter. Theyfind thatlog-linearfits

fairlywell exceptattheendsoftheincomedistribution,which

may

or

may

notreflectmeasurementissues.

Forsomepoliciesitistheendsthatare particularlyimportant(povertyrelief,taxationof very high incomes).

Page

9 of10

fornormative evaluations? Ifhappinessis

measured

on

a scale ofzero to ten,

what

transform oftheseanswers is theright

measurement

of happiness for autilitarian to

aggregate? Sincehappiness

measures

for

an

individualwillvaryovertime,

how

should thesebe aggregatedto obtain lifetimehappiness?

And

there remainsthe issue ofthe extentto

which

concerns aboutinequality inhappiness should entera socialwelfare fiinction (if atall).

That

is,

would

we

want

to simply

add

up

happiness

measures

across thepopulationorconsidera

concave

ftinction of

them?

Using

happiness

measures

for normative purposeswill involveotherassumptions. Layard,

Mayraz

and

Nickell notethatthey

make

theassumptionthatreported happiness

depends

on

other variables only viathe

dependence

oftrueutility

on

thosevariables.

While

some

assumptionisneeded, it isnotapparent thatthis isthe only assumption

worth

considering.

As shown

in

some

experiments, answers are influenced

by

recent events

and

currentcircumstancesthatarenotparticularlyrelevantfor alifesatisfaction

measure.

One

could explore empirically the influenceofrecentevents (e. g.,

income

growth,promotion, sunshine

on

the

day

interviewed)

on

reported happiness

and

consider thedifferenceinimplications as fractionsofthat effectare attributed to adifference

between

reported

and

trueutility. Layard,

Mayraz

and

Nickell also note the tensions acrossdifferent elicitationmethods, a tensionthatneeds resolution for

more

confidence

inusing

any one

of them.

Loewenstein and

Ubel

(thisissue) question theidentificationof happiness with thebase

fornormativeevaluation, a questioningwith

which

I fullyagree:

The main

problem

with experienceutilityis itsfailuretoincorporatenon-hedonic aspectsofexperience,such as

meaning and

capabilities (evenifsuch capabilities arenotused) that are importanttopeople but

have

little impact

on

theirhappiness.

Behavioralresearch is

showing

us veryinterestingthings about

human

behavior. In additiontocontinuing to look forinteresting insights,

we

need

to learn

more

about

how

to

use

what

we

are learning. I concludeas I

began

-

what

has

been happening

inbehavioral

economics

is veryexciting

and

thepapers in this special issueareverywell

worth

Page

10of 10

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