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Diminishing Marginal Utility of Income? A Caveat

  • Richard Easterlin
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    Few 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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    File URL: http://law.bepress.com/cgi/viewcontent.cgi?article=1004&context=usclwps
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    Paper provided by University of Southern California Law School in its series University of Southern California Legal Working Paper Series with number usclwps-1004.

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    Handle: RePEc:bep:usclwp:usclwps-1004
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    1. Easterlin, Richard A, 2001. "Income and Happiness: Towards an Unified Theory," Economic Journal, Royal Economic Society, vol. 111(473), pages 465-84, July.
    2. Easterlin, Richard A., 1995. "Will raising the incomes of all increase the happiness of all?," Journal of Economic Behavior & Organization, Elsevier, vol. 27(1), pages 35-47, June.
    3. Bruno S. Frey & Alois Stutzer, . "What can Economists Learn from Happiness Research?," IEW - Working Papers 080, Institute for Empirical Research in Economics - University of Zurich.
    4. Frank, Robert H, 1997. "The Frame of Reference as a Public Good," Economic Journal, Royal Economic Society, vol. 107(445), pages 1832-47, November.
    5. Ruut Veenhoven, 1991. "Is happiness relative?," Social Indicators Research, Springer, vol. 24(1), pages 1-34, February.
    6. Robert Lane, 2000. "Diminishing Returns to Income, Companionship – and Happiness," Journal of Happiness Studies, Springer, vol. 1(1), pages 103-119, March.
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