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The Economics of Happiness

Happy New Year!  It’s the time of year where this greeting is shared between family, friends, and strangers alike.  It is the perfect time to celebrate another year that was and at the same time wishing everyone “happiness” for the coming new year.

But what does happiness really mean?  Is there a way to measure it? From a macro level does it mean more output by the economy as measured by a country’s gross domestic product (GDP)?  Does more income lead to more happiness? Or is it the opposite? Do social connections make us happier?

Happiness economics is a field (yes, it is an actual field of study), that endeavors to find the relationship between individual satisfaction with the macroeconomic measures such as employment and wealth.  Moreover, it recognizes that individual wellbeing and happiness are important as well as other macroeconomic measures like GDP, employment etc.

But what really makes us happy?  Richard Easterlin was the first economist to study happiness data and one of the early proponents of happiness economics.  He came up with the concept called the Easterlin paradox, which states that happiness varies directly with income to a certain extent, that is, when income rises, happiness rises.  Over time however, happiness does not trend upward as income continues to grow. Mo Money, Mo Problems?  Maybe.

The key to understanding the paradox comes from distinguishing absolute income versus relative income, that is my happiness depends on the comparison between my income and perceptions of the standard of living for others.  In the short run, if everyone’s income increases, my increased income will increase my happiness,  But once I realize that everyone’s income increased as well, the happiness boost is gone.  For example, my income rises such that I can finally afford to have a pool built and all the neighborhood kids come over and swim and play.  That makes me so happy since everyone wants to hang out at Average Joe’s cool crib with the swanky pool.  But months afterward, many or most of my neighbors also start building pools, probably bigger than mine and with slides! My happiness diminishes because Average Joe is once again…average.

This is related to the ranked income hypothesis, which states that increasing a person’s income will increase his happiness only if an increase in ranked position or income will reduce the happiness of those who lose rank.  

Another explanation comes from adaptation.  Humans tend to adapt quickly to changes in income by increasing spending, which may increase income in the short-run but becomes less sustainable in the long-run.

Lastly the Hedonic Treadmill concept suggests that human desires tend to shift to a higher standard as income increases, thereby making sustained happiness less achievable.  The idea is similar to a treadmill, where happiness stays the same after sometime even with increased output due higher income.

There are limitations to the Easterlin Paradox however.  In low income countries, increased income can lead to increased happiness, while in high income countries that relationship isn’t that clear.  There are other factors at play such as social well-being, health and even sense of purpose.

In fact the small country of Bhutan uses an index that aims to look beyond the Gross Domestic Product (an economic measure of a country’s overall output), to include other factors that are important as well.  Enter, the Gross National Happiness (GNH) Index.  It aims to measure development in the context of several factors like environmental degradation, good governance, diversity, etc.

Bhutan may just be on the right track too.  The UN in recent years, advocates using the GNH as another measure to gauge economic development.  While there are criticisms to the Happiness Economics due to measurement bias and a certain level of subjectivity, one must appreciate its value of taking into account what we are truly in pursuit of…happiness.

So, to summarize some key takeaways: Happiness (in the world of economics) is pretty much based on comparisons with others, adaptations towards increased spending, and our desired standard of living. So how can we be happy? Well, my personal advice is to be a little more frugal, be happy with what you have instead of always wanting more, and, most importantly, stop comparing yourself to others. I know it’s a little cliché, but hey, sometimes the most clichéd answers are the ones that are most true.

Happy New Year and looking forward to an amazing 2024!

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