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Relative Income, Happiness, and Utility: An Explanation for the Easterlin Paradox and Other Puzzles

  • Andrew E. Clark
  • Paul Frijters
  • Michael A. Shields

The well-known Easterlin paradox points out that average happiness has remained constant over time despite sharp rises in GNP per head. At the same time, a micro literature has typically found positive correlations between individual income and individual measures of subjective well-being. This paper suggests that these two findings are consistent with the presence of relative income terms in the utility function. Income may be evaluated relative to others (social comparison) or to oneself in the past (habituation). We review the evidence on relative income from the subjective well-being literature. We also discuss the relation (or not) between happiness and utility, and discuss some nonhappiness research (behavioral, experimental, neurological) related to income comparisons. We last consider how relative income in the utility function can affect economic models of behavior in the domains of consumption, investment, economic growth, savings, taxation, labor supply, wages, and migration.

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/jel.46.1.95
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Article provided by American Economic Association in its journal Journal of Economic Literature.

Volume (Year): 46 (2008)
Issue (Month): 1 (March)
Pages: 95-144

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Handle: RePEc:aea:jeclit:v:46:y:2008:i:1:p:95-144
Note: DOI: 10.1257/jel.46.1.95
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  1. Stark, Oded, 2005. "Inequality and Migration: A Behavioral Link," Economics Series 178, Institute for Advanced Studies.
  2. Vernon L. Smith, 1994. "Economics in the Laboratory," Journal of Economic Perspectives, American Economic Association, vol. 8(1), pages 113-131, Winter.
  3. Oded Stark, 2006. "Status Aspirations, Wealth Inequality, and Economic Growth," Review of Development Economics, Wiley Blackwell, vol. 10(1), pages 171-176, 02.
  4. Vendrik, Maarten C. M., 1998. "Unstable bandwagon and habit effects on labor supply," Journal of Economic Behavior & Organization, Elsevier, vol. 36(2), pages 235-255, August.
  5. P. J. Sloane & H. Williams, 2000. "Job Satisfaction, Comparison Earnings, and Gender," LABOUR, CEIS, vol. 14(3), pages 473-502, 09.
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