Happiness and unhappiness are central to economists’ analysis of consumer behaviour. If we define ‘utility’ as perceived happiness, standard consumer theory assumes that rational people will seek to maximise the excess of happiness over the costs of achieving it: i.e. will seek to maximise consumer surplus. In fact, this analysis can be traced back to the work of the utilitarians, Jeremy Bentham and John Stuart Mill. Bentham reffered to it as hedonic or felicific calculus (see also and also).
Now, of course, whether people actually behave in this way is an empirical question: one that behavioural and experimental economists have been investigating over a number of years. Nevertheless, it remains central to neoclassical analysis of ‘rational behaviour’.
But if happiness is central to a large part of economic analysis, how is happiness to be measured? At a micro level, this has proved problematic as it is virtually impossible to have inter-personal comparisons of utility. As a result, consumer theory uses indifference analysis, characteristics analysis, revealed preference and other approaches to analyse consumer demand.
But what about at the macro level? How is a nation’s happiness or well-being to be measured? There is general acceptance that GDP is a relatively poor proxy for national well-being and is more a measure of production. There have been various indices developed over the years (see, for example, Box 14.7 on ISEW in Economics, 7th edition) as alternatives to GDP. None has been adopted by governments, however, with the exception of a Gross National Happiness index in Bhutan.
Recently, however, there has been renewed interest in developing an index of well-being. In France, President Sarkozy commissioned two Nobel economists, Joseph Stiglitz and Amartya Sen, to examine the issues in developing such a measure. In the light of the Stiglitz/Sen report, David Cameron has asked the Office of National Statistics to measure the UK’s general well-being. The articles below look at the difficulties that could arise in producing an index of well-being, of meauring the elements and in using it for policy.
Articles
UK Prime Minister Cameron Moves on UK Happiness Index Triple Pundit, Kristina Robinson (17/11/10)
David Cameron’s happiness index finds support despite impending decade of austerity Daily Record, Magnus Gardham (16/11/10)
How can we measure happiness? Telegraph, Philip Johnston (16/11/10)
David Cameron aims to make happiness the new GDP Guardian, Allegra Stratton (14/11/10)
An unhappiness index is more David Cameron’s style Guardian, Polly Toynbee (16/11/10)
Happiness is a warm baguette? The Economist (13/1/08)
‘Stiglitz-Sen Moving in the Right Direction, but Slowly’ IPS, Hazel Henderson (18/9/09)
The Rise and Fall of the G.D.P. New York Times Magazine (13/5/10)
Happiness doesn’t increase with growing wealth of nations, finds study Guardian, Alok Jha (13/12/10)
Should governments pursue happiness rather than economic growth? The Economist (25/11/10)
M&S’s Sir Stuart Rose among UK’s expert happiness panel BBC News (27/1/11)
The Stiglitz/Sen/Fitoussi report
Report by the Commission on the Measurement of Economic Performance and Social Progress, Joseph Stiglitz, Amartya Sen, Jean-Paul Fitoussi (September 2009)
Questions
- What are the shortcomings of using GDP as a measure of a nation’s well-being?
- Summarise the main findings of the Stiglitz/Sen/Fetoussi report.
- What items would be included in a happiness or well-being index that (a) are not included in GDP; (b) not included in Stiglitz and Sen’s proposed net national product measure? How would such an index be compiled?
- Would it be satisfactory to compile such an index purely on the basis of survey evidence? Why might such evidence prove unreliable?
- What are the political advantages and disadvantages of using such an index?
- Is utilitarianism the best basis for judging the progress of society?
If ever there was something to make you clean out your house and sort out your ‘rubbish’, this has got to be it!! A Chinese vase found gathering dust in an attic has just sold for £43 million at auction. The buyer will pay around £53 million after paying the buyer’s 20% commission to the auction house and VAT. The seller will get around £40.75 million, after deduction of the seller’s commission by the auction house. The auction house itself will make over £10 million – not a bad day to be an auctioneer!
With the price starting at £500,000, onlookers could hardly believe it as the price began to increase by £1 million at a time. The buyer is thought to be a Chinese person or a state-backed company. And, just in case you didn’t realise, the FT article does make special mention that the person is likely to be ‘wealthy’!
The Chinese vase sold for over 40 times its estimate, with speculation that the price was forced up by a Chinese cultural agency owned by the state. As China aims to regain many of its lost artefacts, prices for objects such as this have been pushed up: although perhaps £53 million is a little expensive for the everyday consumer! However, unstable financial markets and rising inflation may also be partly to blame for the surge in prices for objects such as this. We’ve seen how gold and other commodities have increased in value throughout the recession, as investors look for more stable investments – and the same appears to be happening in the world of art. I’ll certainly be keeping a look out for any dusty artefacts!
House clearance vase fetches £53 million Financial Times, Jan Dalley, Peter Aspden and Justine Lau (12/11/10)
Chinese vase: the suburban auction house that made £12m Telegraph, Andy Bloxham and Martin Evans (12/11/10)
Qianlong Chinese porcelain vase sold for £43m BBC News (12/11/10)
Chinese vase fetches record $69 million in UK auction Reuters (12/11/10)
Questions
- Why are auctions a good way of selling and buying a product?
- The auction house has made over £10 million from this sale, despite only employing 8 people. Does this income guarantee the success of this business?
- Using a demand and supply diagram, explain the factors that have fuelled the price increase in artefacts, such as this Qianlong porcelain vase.
- Why are people investing in assets, such as art and commodities, rather than in more traditional financial assets?
- Could an auction be an example of price discrimination?
The latest mortgage approval numbers from the Bank of England continue to demonstrate the fragility of the UK housing market and, in particular, waning levels of activity. The 47,474 approvals in September was the lowest number since February. The downward momentum in approvals has gained pace in recent months. The number of approvals in Q3 was 2.9% lower than in Q2 and was 11.5% lower than in Q3 of last year. All of this provides evidence that housing demand is weakening.
Tight credit conditions have affected the supply of mortgages for some time and, as a consequence, negatively impacted on the number of house buyers. This is likely to be especially true for potential first-time buyers who have no housing equity with which to help purchase property. But, the marked downward momentum in mortgage approvals is reflecting a weakening in housing demand.
So what explains this weakening of housing demand? In part, it is likely to be current economic conditions. But, expectations of future economic conditions are crucially important in determining activity levels in the housing market. With concerns about future economic growth it would be no surprise if households are feeling more than a little cautious about their spending plans and about their household finances. Economic uncertainty amongst households does not bode well for activity levels in the housing market. If this line of thinking is right we can expect mortgage approvals numbers to remain subdued for some time to come.
Articles
Drop in mortgages sparks concerns over house price falls The Herald, Ian McConnell (30/10/10)
Housing dip feared as mortgage approvals stall Guardian, Mark King (29/10/10)
UK mortgage approvals decline Irish Times (29/10/10)
Net mortgage lending slumps to just £112 million Independent, James Moore (30/10/10)
Mortgage approvals lowest since Feb Reuters (29/10/10)
Data
Mortgage approval numbers and other lending data are available from the Bank of England’s statistics publication, Monetary and Financial Statistics (Bankstats) (See Table A5.4.)
Questions
- What variables do you think will affect the demand for mortgages?
- What variables do you think will affect the supply of mortgages by lenders?
- What do you understand by housing and mortgages being complementary products? Why might the complementary relationship between housing and mortgages be stronger for first-time buyers?
- If housing demand weakens, would we expect house prices to fall? Are there circumstances when a weakening of demand might not translate into lower house prices? Illustrate your answer using demand and supply diagrams.
The governor of the Bank of England, Mervyn King, made an important speech in New York on 25th October. The Governor’s speech was a wide-ranging discussion of the banking system. At the heart of it was a fundamental economic concept: market failure. The market failure that King was referring to stems from the maturity transformation which occurs when banks borrow short, say through our savings or wholesale funds from other financial institutions, and then lend long as is the case with mortgages. Of course, the positive outcome of this maturity transformation is that it does allow for funds to be pooled and this, in turn, enables long-term finance, something which is incredibly important for business and households. However, King believes that banks have become too heavily reliant on short-term debt to finance lending. Indeed he went so far as to describe their levels of leverage as ‘extraordinary’ and ‘absurd’. He argued that such a system can only work with the ‘implicit support of the taxpayer’.
In elaborating on the market failure arising from maturity transformation in today’s financial system, King notes
…the scale of maturity transformation undertaken today produces private benefits and social costs. We have seen from the experience of first Iceland, and now Ireland, the results that can follow from allowing a banking system to become too large relative to national output without having first solved the “too important to fail” problem.
In the speech, King considers a range of remedies to reduce the risks to the financial system. These include: (i) imposing a tax on banks’ short-term borrowing which could, to use the economic terminology, help internalise the external cost arising from maturity transformation; (ii) placing limits on banks’ leverage and setting capital requirements as outlined in the recent Basel III framework (for a discussion on Basel III see Basel III – tough new regulations or letting the banks off lightly?; (iii) functional separation of bank activities to safeguard those activities critical to the economy. King argues that whatever remedies we choose they should be guided by one fundamental principle: “ensure that the costs of maturity transformation – the costs of periodic financial crises – fall on those who enjoy the benefits of maturity transformation – the reduced cost of financial intermediation”.
Mervyn King’s speech makes considerable reference to our banks’ balance sheets. So to conclude this piece we consider the latest numbers on the liabilities of British banks. At the end of each month, in its publication Monetary and Financial Statistics, the Bank of England publishes figures on the assets and liabilities of Britain’s banking institutions or ‘MFIs’ (monetary and financial institutions). The latest release showed that British banks had total liabilities of some £8.15 trillion at the end of September 2010. To put it into perspective that’s equivalent to around 5½ times the country’s annual Gross Domestic Product. Of this sum, £3.75 trillion was classified as Sterling-denominated liabilities, so largely reflecting operations here in the UK, while £4.39 trillion was foreign currency liabilities reflecting the extent of over-seas operations.
The Sterling liabilities of our financial institutions are dominated by two principal deposit types: sight deposits and time deposits. The former are deposits that can be withdrawn on demand without penalty whereas time deposits require notice of withdrawals. Sterling sight deposits at the end of September totalled £1.16 trillion (31% of Sterling liabilities and 80% of annual GDP) while time deposits totalled £1.52 trillion (40% of Sterling liabilities and 105% of annual GDP). The next largest group of deposits are known repos or, to give them their full title, sales and repurchase agreements. Repos are essentially loans, usually fairly short-term, where banks can sell some of their financial assets, such as government debt, to other banks and this can help to ease any shortages in funds. Sterling-denominated repos totalled £197.8 billion at the end of September (8% of Sterling liabilities and 21% of annual GDP).
To conclude, the growth in our banking system’s liabilities has been pretty staggering. Compared with today’s liabilities of nearly £8.15 trillion, liabilities 13 years ago totalled £2.35 trillion. So over this period the banks’ liabilities have risen from a little below 3 times Gross Domestic Product to over 5½ times GDP. That is certainly worthy of analysis.
Mervyn King’s speech
Banking: from Bagehot to Basel, and back again The second Bagehot lecture, New York City (25/10/10)
Articles
Mervyn King mobilises his tanks Independent, Ben Chu (26/10/10)
Get tougher on banks, says banking governor Mervyn King’ Daily Mail, Hugo Duncan (26/10/10)
Mervyn King attacks ‘absurd’ bank risk BBC News (26/10/10)
Mervyn King says banking must be reinvented BBC News blogs: Peston’s Picks, Robert Peston (26/10/10)
Data
Data on banks’ liabilities and assets are available from the Bank of England’s statistics publication, Monetary and Financial Statistics (Bankstats) (See Table B1.4.)
Questions
- What do you understand by the terms: (i) market failure; and (ii) maturity transformation?
- What is the external cost identified by Mervyn King arising out of maturity transformation?
- What does it mean to internalise an external cost? Can you think of examples from everyday life where attempts are made to do this?
- Consider the various ‘remedies’ identified by Mervyn King to reduce the riskiness of our financial system. (You may wish to download the speech using the web link above).
- Distinguish between the following deposits: (i) time deposit; (ii) sight deposit; and (iii) repos.
GDP (or Gross Domestic Product) measures the value of output produced within a country over a 12-month period. It is this figure which we use to see how much the economy is growing (or shrinking). We can also look at how much different sectors contribute towards this figure. Over the past few decades, there has been a significant change in the output of different sectors, as a percentage of GDP, within the UK economy. In particular, the contribution of manufacturing has diminished, while services have grown rapidly.
However, there is one specific area that is making a growing contribution towards UK GDP and is expected to see acceleration in its growth rate by some 10% annually over the next few years: the internet. Although the internet is not an economic sector, the Boston Consulting Group (BCG) said that if it was, it would be the UK’s fifth largest sector and according to a report by Google, it is worth approximately £100 billion per year to the UK economy. Furthermore, it is an area in which the UK is one of the leading exporters. The emergence of the internet has transformed industries and individual businesses and the trend looks set to continue. The report by Google found that some 31 million adults bought goods and services online over the past year, spending some £50 billion.
What are the benefits for businesses of internet shopping and does it have an impact on the retail outlets on Britain’s highstreets? The answer is undoubtedly yes, but is it good or bad? What does the emergence of this new ‘sector’ mean for the UK economy?
Articles
UK net economy ‘worth billions’ BBC News (28/10/10)
UK’s internet industry worth £100 billion report Guardian, James Robinson (28/10/10)
’Nation of internet shopkeepers’ pumps £100 billion into economy Independent, Nick Clark (28/10/10)
UK internet is now worth £100bn to UK economy Telegraph, Rupert Neate (28/10/10)
Google at 10 BBC News, Success Story, Tim Weber (4/9/08)
Britain’s £100bn internet economy leads the world in online shopping Guardian, James Robinson (28/10/10)
Report
How the internet is transforming the UK economy The Boston Consulting Group October 2010
Government Statistics
United Kingdom: National Accounts, The Blue Book 2009 Office for National Statistics 2009 edition
Questions
- What is the UK’s GDP? How does it compare with other countries and how has it changed over the past 10 years?
- How does internet provision contribute towards growth? Think about the AD curve. Illustrate this on a diagram and explain the effect on the main macroeconomic objectives.
- Is there a problem with becoming too dependent on this emerging sector?
- How has the internet and online environment helped businesses? Think about the impact on costs and revenue and hence profits.
- What explanation is there for the change in the structure of the UK economy that we have seen over the past few decades.
- Will internet shopping ever replace the ‘normal’ method of shopping? Explain your answer.