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The Marginal Utility of Income

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Author Info
Richard Layard
Guy Mayraz
Stephen Nickell

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Abstract

In normative public economics it is crucial to know how fast the marginal utility of income declinesas income increases. One needs this parameter for cost-benefit analysis, for optimal taxation and forthe (Atkinson) measurement of inequality. We estimate this parameter using four large cross-sectionalsurveys of subjective happiness and two panel surveys. Altogether, the data cover over 50 countriesand time periods between 1972 and 2005. In each of the six very different surveys, using a number ofassumptions, we are able to estimate the elasticity of marginal utility with respect to income. Weobtain very similar results from each survey. The highest (absolute) value is 1.34 and the lowest is1.19, with a combined estimate of 1.26. The results are also very similar for subgroups in thepopulation. We also examine whether these estimates (which are based directly on the scale ofreported happiness) could be biased upwards if true utility is convex with respect to reportedhappiness. We find some evidence of such bias, but it is small—yielding a new estimated elasticity of1.24 for the combined sample.

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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp0784.

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Date of creation: Mar 2007
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Handle: RePEc:cep:cepdps:dp0784

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Related research
Keywords: Marginal utility; income; life satisfaction; happiness; public economic; welfare; inequality; optimal taxation; reference-dependent preferences;

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Find related papers by JEL classification:
I31 - Health, Education, and Welfare - - Welfare and Poverty - - - General Welfare
H00 - Public Economics - - General - - - General
D1 - Microeconomics - - Household Behavior
D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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References listed on IDEAS
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  6. Thomas Dohmen & Armin Falk & David Huffman & Uwe Sunde & Jürgen Schupp & Gert G. Wagner, 2005. "Individual Risk Attitudes: New Evidence from a Large, Representative, Experimentally-Validated Survey," IZA Discussion Papers 1730, Institute for the Study of Labor (IZA). [Downloadable!]
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  8. Matthew Rabin., 2000. "Risk Aversion and Expected-Utility Theory: A Calibration Theorem," Economics Working Papers E00-279, University of California at Berkeley. [Downloadable!]
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  10. Andrew E. Clark & Paul Frijters & Michael A. Shields, 2008. "Relative Income, Happiness, and Utility: An Explanation for the Easterlin Paradox and Other Puzzles," Journal of Economic Literature, American Economic Association, vol. 46(1), pages 95-144, March.
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  11. Clark, Andrew E., 1999. "Are wages habit-forming? evidence from micro data," Journal of Economic Behavior & Organization, Elsevier, vol. 39(2), pages 179-200, June. [Downloadable!] (restricted)
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  22. Matthew Rabin, 2000. "Risk Aversion and Expected-Utility Theory: A Calibration Theorem," Econometrica, Econometric Society, vol. 68(5), pages 1281-1292, September.
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Oswald, Andrew J., 2008. "On the Curvature of the Reporting Function from Objective Reality to Subjective Feelings," IZA Discussion Papers 3344, Institute for the Study of Labor (IZA). [Downloadable!]
    Other versions:
  2. Steven Carter & Michael McBride, 2009. "Experienced Utility versus Decision Utility: Putting the 'S' in Satisfaction," Working Papers 080925, University of California-Irvine, Department of Economics. [Downloadable!]
  3. Richard Layard & Guy Mayraz & Stephen Nickell, 2009. "Does Relative Income Matter?: Are the Critics Right?," SOEPpapers 210, DIW Berlin, The German Socio-Economic Panel (SOEP). [Downloadable!]
    Other versions:
  4. Michael Ehrmann & Panagiota Tzamourani, 2009. "Memories of high inflation," Working Paper Series 1095, European Central Bank. [Downloadable!]
  5. Guy Mayraz & Jürgen Schupp & Gert G. Wagner, 2009. "Life Satisfaction and Relative Income: Perceptions and Evidence," CEP Discussion Papers dp0938, Centre for Economic Performance, LSE. [Downloadable!]
    Other versions:
  6. Richard Layard, 2007. "Well-Being Measurement and Public Policy," NBER Chapters, in: Measuring the Subjective Well-Being of Nations: National Accounts of Time Use and Well-Being, pages 145-154 National Bureau of Economic Research, Inc. [Downloadable!]
  7. Nattavudh Powdthavee, 2009. "Estimating the Causal Effects of Income on Happiness," Discussion Papers 09/02, Department of Economics, University of York. [Downloadable!]
  8. Arik Levinson, 2009. "Valuing Public Goods Using Happiness Data: The Case of Air Quality," Working Papers gueconwpa~09-09-03, Georgetown University, Department of Economics. [Downloadable!]
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