Why Does (or Should) an Economist Care about "Happiness"?

When I told my friend that one of the things that I study is the economics of happiness, he was quite confused about what it was. This reaction was not very much unexpected. In many people's head, economics is about things like inflation and GDP. What they think economics is is actually closer to macroeconomics. So for them, why would "happiness" have anything to do with economics?

First of all, just for those who are not familiar with the field of economics, economics is not the study of the economy. It does, of course, study the whole economy so it does study inflation, unemployment, GDP, etc. But it actually studies a very wide range of things, such as how a business can maximize its profit, what the government can do when markets fail to deliver certain services that are desired by the society (e.g. firefighting, road-building, etc.), etc. It cannot easily be explained briefly but keywords about economics are: scarcity, decision-making, allocation of resources, etc. And no, you do not become a professional investor after studying economics.

Secondly, economics has long been a field that attempts to study "happiness" already. The concept of utility has been used in economics to theoretically measure an individual or even the society's satisfaction or pleasure from consuming a good or service.(1) Economics students are taught that consumers are well-aware of their preference and how much utility they can gain from a good or service. That is why they consume what they consume. Their consumption reveals their preference.

But if you have ever been a human being, or at least encountered a human being, then you should know that humans' choice of consumption often contradicts with their real preference (i.e. the order of things based on utility). Even when there is enough information, we may still pick the wrong restaurant, buy the shirt that is too tight and later regret buying it, etc. We mispredict and misunderstand utility. Our consumption can reveal our preference, but not necessarily.

Happiness economics and behavioral economics attempt to challenge the simple and inaccurate assumptions about utility in economics, and use empirical evidence to study utility. Some economists in these fields and psychologists argue that we tend to over-consume certain goods and services (or activities) that bring us low utility, and we under-consume certain goods and services that bring us high utility. (2) Naturally, the supply side responds to this and we over-produce things that bring us low utility, and vice-versa.

If happiness (or "well-being") is our ultimate goal of life (or at least a very top goal), then economists should care about what makes us happy, because that should determine how we allocate our resources. Why would we allocate resources to things that do not matter? Then we collectively have the incentive to request laws, policies and programs that contribute to our happiness from the government.

Here is a very simple conceptual scenario: Let's say we have services A, B and C in the economy and the types and quantity of resources required are the same. We have been producing 1 million units for each. If, as a society, the consumption of A can bring the population 1000 utils in total, B 500 utils, C 0 utils, then we are probably spending too much resources for producing C and allocating too little resources for A. Of course, there are complications. One of them is: Although B can generate less utility than A, if B is desired and consumed by those who are less fortunate in the society (e.g. the low-income), should the government, under a fixed amount of budget, choose to purchase more of B? Value judgement is unavoidable here.

If I ask 1,000 people "if you can only choose one, which one do you want for the country, an increase in GDP or an increase in happiness?" I suppose the majority would choose the latter, because why would we blindly pursue an increase in GDP? What is the intrinsic value of it? GDP and a country's life satisfaction have a strong correlation, but a strong causal effect is not proven. Even if we can prove it (I am quite certain that GDP must at least have indirect positive effect on happiness), there are many other determinants too. We should not ignore those determinants.

Because some economists and people outside the discipline recognize the importance of happiness (or "well-being") over productivity, they propose measuring the aggregate happiness of the society and having such an indicator that illustrates the development of a country (or region), instead of stressing on GDP (or GNP).

One of the widely known index is the Gross National Happiness ("GNH"). Bhutan is a strong proponent of it and has been using it since 2008. But there are definitely many challenges for measuring GNH. One of them is to decide how to measure it. GDP (or GNP) is very costly to measure, in terms of money and human resources, but it is rather straightforward. How do we measure the "happiness" of the people? Is reported subjective well-being reliable? What are the determinants of happiness that we can observe objectively? What weights do we give to different determinants? In Bhutan's GNH, how much a citizen knows the traditional folktales and songs and recites prayers are also taken into account. Are they really necessary to achieve happiness? Will they be applicable to other countries? (Of course not.) There are many things that we would have to deal with using lots of empirical evidence and perhaps societal values, and it would not be easy to come up with a measurement that is commonly agreed upon.

In today's world, we are so deluded by materialism and falsely believe that consumption and the pursuit of luxury goods is a main source of happiness. And there are so many things that distract and keep us from doing what can really bring us joy and long-term happiness. What I hope to see is that more economists will come to study happiness and suggest what we can do to achieve a better life on the level of individuals, firms, organizations and governments.


1. No matter what you think "happiness" is, this must be part of it.
2. Frey, B.S. (2008). Happiness: A Revolution in Economics. The MIT Press. p.127

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Sunk Cost Fallacy: How You Can Possibly Make Lots of Mistakes in a Day

After you wake up in the morning, you are looking through your closet and thinking what you should wear today for work. You notice a shirt that does not look too bad but the texture makes you uncomfortable. Thinking that you have paid $30 for it, you do not want to simply let it stay in the closet. Not wearing it anymore after wearing it only once would mean the money has simply gone down to the drain, right? You decide to put up with the discomfort and wear it.

After you leave the house, as you are walking to the parking lot, the sky looks very gloomy and is drizzling a little. There is a chance of raining today. But because you feel that you have already walked so much, you do not want to go back to grab your umbrella.

At work, you have been working on a project that has already cost the company a few thousand dollars but there is very little return. Your colleague asks you, "should we consider dropping this project and put our money, time and effort on the other project that is going well?" Then you get a little upset and said, "there is no way we are going to give up. We have already invested so much in this."

It is lunch break now and you go to a Korean restaurant that you like. The line is not long but not short neither. You still decide to write your name on the wait list and wait, hoping that it is actually not going to take too long. After 10 minutes, you are still waiting in the line and there are still quite a few people in front of you. Then you take a look at another restaurant nearby, which you think is also good and does not need to wait for. But thinking how much time you have waited already, you immediately squash your thought of changing to another restaurant and end up waiting for 20 minutes in total.

At night, you are watching a Netflix movie at home. After watching 20 minutes of it, you do not really enjoy that movie and you just do not think it is going to end well neither. But you feel like, "I have watched it for 20 minutes already. I feel like I should watch until the end." So you keep watching for another 50 minutes.

It definitely does not feel good when we see the money, effort, time we have spent become costs that do not come with a return. But when a cost is sunk, it has already incurred and there is nothing you can do about it. Your cost-benefit analysis should look at what has happened as something completely irrelevant and focus on the future. Look forward. Do not cry over spilt milk.


Also read: Why Do You Finish Your Plate: Waste Aversion and Sunk Cost Fallacy

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Why Do You Finish Your Plate: Waste Aversion and Sunk Cost Fallacy

Imagine the following scenario:

You are having lunch at a restaurant. After eating 2/3 of your plate, you feel quite full already. If you keep on eating, you will very possibly feel too full. No one is willing to eat the leftover and you cannot take it home. Will you finish the 1/3 that is left? 

For most economists, they would say no and suggest you not doing so too. The price that you have to pay or have paid is already a sunk cost, which means that you cannot recover the cost. Eating more or less would not make you pay more or less. After you order that dish, all you should do is to maximize your net utility (the happiness/satisfaction from the consumption of the plate). You should look at the future, enjoy the dish as much as possible and avoid the other way. Therefore, in this scenario, you should stop eating because you would feel too full and your utility would decrease otherwise. This concept can be illustrated using hypothetical and conceptual units, utils, as follows:

The utility of having the first 1/3 is higher than the utility of having the second 1/3 because of diminishing marginal utility. If the dish is tasty, then you should enjoy the first few bites a lot but the extra satisfaction from every bite should decrease over time.

But quite many people would keep on eating because:

1) they have already paid for the meal and they think they can cover the cost (the price) by eating the whole thing, and/or 

2) they would hate to see the food on their plate ending up in the dumpster. It would make them feel guilty. This is more common in some cultures. The Japanese culture would be one of them. 

The first one is called "sunk cost fallacy", and the second one is what I call "waste aversion" (very straight-forward). The truth is that resources for that dish has already been used. Finishing the steak would not reincarnate the cow; nor would finishing the broccoli bring it back to the farm. Whether it ends up in your stomach or dumpster, the resources have already been used. The food ending up in the dumpster does not incur a new cost to the world but if it ends up in your stomach, it would cost you utility (lower satisfaction). If you want to avoid waste, just be careful of what you order next time. If you feel sorry for wasting food while people in poor countries are in famine, donate money to a charity that uses your donation well.

Whether it is rational or not, it is good for us to be able to describe the psychology of waste aversion. This table illustrates the concept. Blue is where economist think we can maximize our utility and yellow is where someone with moderate or strong waste aversion think they can maximize their utility.



For an economist, they only look at the consumption utility and say that you should stop when it is maximized. But in the perspective of many homo sapiens, waste utility is also taken into the account. If they order a dish and not eat it at all, then they will leave with negative utility because of the sunk cost fallacy and waste aversion. If they eat only 2/3 of the plate, they will get 10 utils from the consumption but the waste aversion would cost them -5 utils so in total, they will only have earn 5 utils from the whole experience.

As the person eats more and more, the cost of utility of waste aversion decreases by a bigger margin. This is clearer in the graph. 

Maybe it is our nature to tend to hate wasting food. It was part of our ancestors' survival to avoid any waste and eat every bit of the food they gathered or hunted. But waste aversion can still be reduced by altering your perspective. Educate yourself and tell yourself to not feel guilty about it.

Note:

- Leaving food on your plate probably involves loss aversion too. It may make you feel like you lose you money to the restaurant because you eat less than what you pay for. 

- I admit that even when I fully understand what sunk cost fallacy and waste aversion are, I still can't help but naturally feel a little guilty for not finishing a plate or a drink.

- The concept of waste aversion is my original hypothesis based on my observation. I would love to do research on this topic in the future. If you know there are already scholars who have studied this, please let me know.