Diminishing Marginal Utility of Income? A Caveat
AbstractFew generalizations in the social sciences enjoy such wide-ranging support as that of diminishing marginal utility of income. Put simply, this proposition states that the effect on subjective well-being of a $1,000 increase in income becomes progressively smaller the higher the initial level of income. Distinguished scholars in economics, political science, psychology, and sociology who have made major contributions to the study of subjective well-being concur on this assertion. Its policy appeal is great because it implies that raising the income of poor people or poor countries will raise their well-being considerably, while an increase of equal amount for the rich will have comparatively little effect. The diminishing returns generalization is based on point-of-time bivariate comparisons of happiness with real income, either among or within countries. If, as these cross sectional studies suggest, there is diminishing marginal utility of income, then this point-of-time pattern should be replicated over time as income traverses the range of values covered in the cross sectional analysis. I propose to test whether historical experience reproduces the point-of-time relationship, first, using an international cross section of happiness and income, and then, a within-country one for the United States. As in the studies cited, I use a simple bivariate comparison. It turns out that income change over time does not generate the change in happiness implied by the cross sectional pattern. The present analysis is not exhaustive, but it does suggest the need for caution in assuming that cross sectional generalizations about diminishing marginal utility of income can be safely used to anticipate change over time.
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-07-26 (All new papers)
- NEP-LAW-2004-07-26 (Law & Economics)
- NEP-LTV-2004-07-26 (Unemployment, Inequality & Poverty)
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