How to get the most from your money? This is the question posed by the linked article below. It’s a topic we’ve looked at in previous posts, such as Studies show that money can buy happiness (but only if you spend on experiences), Happiness economics and Peak stuff. This article takes the arguments further.
It suggests that, up to a certain level of income, there is a roughly linear relationship between money and life satisfaction. As poor people have more to spend, so they can begin to escape poverty and the negative features of financial insecurity and a lack of basic necessities, such as food and shelter. They also gain a greater freedom to choose what and when to buy. Beyond a certain level, however, the rate of increase in life satisfaction tends to decline, as does the specific pleasure from additional individual purchases. In economists’ language, the marginal utility of income diminishes.
But the article goes further than this. It suggests that satisfaction or happiness is of two broad types. The first is the general sense of well-being that people get from their life. This tends to be relatively stable for any given person, but will tend to increase as people have more money to spend or have more fulfilling jobs. Of course, there may well be a trade-off between income and job satisfaction. Some people may prefer to take a cut in pay for a more fulfilling job.
The second is the satisfaction or happiness you get from specific experiences. This tends to fluctuate on a day-to-day basis, depending on what you are doing. Here, what you purchase and the use you make of the purchases is a key component.
So what lessons are there for earning and spending money wisely? To start with, it is important to get a good work-life balance. It may be worth trading income for job satisfaction. Here the focus should be on long-term fulfilment, rather than on the short-term happiness from more ‘stuff’. Then it is important to spend money wisely. Here the author identifies three lessons:
The first is to consider buying time. Time-saving purchases, such as dishwashers can help. So too can ‘outsourcing’ activities, such as cleaning, laundry, cooking, DIY or child care, if they give you more time to do other more fulfilling things (but not if you love doing them!).
The second is to spend more money on experiences (as we saw in the post Studies show that money can buy happiness (but only if you spend on experiences). A better TV or car may seem like a wiser investment than more dinners out, holidays or going to concerts. But we quickly adapt to new upgraded ‘stuff’, thereby eliminating any additional satisfaction. Experiences, however, tend to linger in the memory. As Tom Gilovich, a psychology professor at Cornell University, is quoted by the article as saying:
Even though, in a material sense, they [experiences] come and go, they live on in the stories we tell, the relationships we cement, and ultimately in the sense of who we are.
Choosing a more fulfilling but less well-paid job is a form of spending money on experiences.
The third is to give some of your money away, whether to charity or to helping friends or relatives. As Gilovich says:
It’s hard to find a more charming finding than that by giving away money, you not only make someone else happier, you make yourself happier.
Article
Questions
- What is meant by ‘diminishing marginal utility of income’? Is the concept consistent with the arguments in the article?
- In what sense may it be rational to choose a lower-paid job?
- Is ‘happiness’ the same as ‘utility’ as the concept is used by economists?
- Does the concept of ‘peak stuff’ apply to all physical products? Explain your answer.
- If giving money away makes a person happy, is it truly altruistic for that person to do so? Explain.
Australia is a rich country. It is one of the few to have avoided a recession. This has been the result partly of successful macroeconomic policies, but largely of the huge mining boom, with Australia exporting minerals to China and other fast growing Asian economies.
But has this growth brought happiness? Are Australians having to work harder and harder to pay for their high standard of living? Indeed, do higher incomes generally result in greater happiness? The following articles explore this issue, both in an Australian context and more broadly. They look at some recent evidence.
For example, in one study, Canadian, Chinese, Indian, and Japanese university students were asked what they held to be most important for assessing the worth of their lives. The crucial finding was that although higher incomes may be a contributing factor to increased happiness and well-being, especially for poorer people, other factors are more important. These include developing fulfilling personal relationships, whether with partners, family members or friends; gaining knowledge and wisdom; having enjoyable hobbies; having financial security (as opposed to higher incomes); having a worthwhile career; living a moral life; helping other people.
The question then arises whether our economic systems and incentives are geared towards achieving these outcomes. Or are we encouraged to consume more and more and to seek higher and higher incomes to feed our addiction to consumption?
Is there an information problem here? Do many individuals perceive that money will buy them happiness, whereas, in reality, money can’t buy them love?
Articles
Australia: Where the good life comes at a price BBC News Magazine, Madeleine Morris (24/2/13)
Australia has the know-how to boost wellbeing Sydney Morning Herald, Matt Wade (8/9/12)
Money can’t buy you the good life Independent, Roger Dobson (24/2/13)
The 10 Things Economics Can Tell Us About Happiness The Atlantic, Derek Thompson (31/5/12)
Yes, Money Does Buy Happiness: 6 Lessons from the Newest Research on Income and Well-Being The Atlantic, Derek Thompson (10/1/13)
The fact is, the richer you are, the happier you are The Telegraph, Allister Heath (5/2/13)
Money buys happiness? I wouldn’t bank on it The Telegraph, Christopher Howse (6/2/13)
Who Says Wealth Doesn’t Buy Happiness? The Wealthy Do CNBC, Robert Frank (4/2/13)
More Proof That Money Can’t Buy Happiness Business Insider, Aimee Groth (28/1/13)
Money Changes Everything The New York Times, Adam Davidson (5/2/13)
Why are the Chinese so sad? Maclean’s (Canada), Mitch Moxley (4/2/13)
Reports
First World Happiness Report Launched at the United Nations The Earth Institute, Columbia University (2/4/12)
World Happiness Report The Earth Institute, Columbia University, John Helliwell, Richard Layard and Jeffrey Sachs (eds.) (2/4/12)
Well-being evidence for policy: A review New Economics Foundation, Laura Stoll, Juliet Michaelson and Charles Seaford (3/4/12)
Questions
- Distinguish between necessary and sufficient conditions. Is higher income a necessary or sufficient condition (or both or neither) for an increase in happiness? Does a person’s circumstances affect the answer to this question?
- Explain what is meant by ‘rational behaviour’ at the margin in the traditional economic sense?
- If a person always behaved rationally, would they be happier than if they did not? Explain.
- Explain how information asymmetry between the two or more parties involved in a transaction may make people worse off, rather than better off, even though they were behaving rationally.
- Explain what is meant by diminishing returns to income.Do richer countries get happier as they get richer?
- How would you set about measuring happiness?
- What do you understand by the term ‘hedonic elevation and decline’? Does this provide an accurate description of you own purchasing behaviour? If so, explain whether or not you would like to change this behaviour.
- When people make economic decisions, these are normally made with bounded rationality. How may this affect the desirability of the outcomes of the decisions?
- In explaining bankers’ behaviour, Christopher Howse (author of the second Telegraph article above) states: ‘It’s the power game that keeps them happy, not the money itself. When I say “keeps them happy” I mean “feeds their addiction”. It is a negative kind of satisfaction. A morning spent without the distraction of making big bucks is a morning left exposed to the empty horror of being a little rational animal on the bare surface of the Earth lost in space.’ Do you agree? Explain why or why not.
- When people are addicted to something, would doing more of it be classed as irrational? Explain.
- Why are the Chinese so sad?
Are consumers ‘rational’ is the sense of trying to maximise consumer surplus? In some circumstances the answer is yes. When we go shopping we do generally try to get best value for money, where value is defined in terms of utility. With limited incomes, we don’t want to waste money. If we were offered two baskets of goods costing the same amount, we would generally choose basket A if its contents gave us more utility than basket B.
So why do we frequently buy things that are bad for us? Take the case of food. Why do we consume junk food if we know fresh produce is better for us? To answer this we need to look a little closer at the concept of utility and what motivates us when we consumer things. The following article does just that. It reports on writings of Michael Pollan. Pollan looks at our motivation when choosing what and how much to eat. For much of the time our choices are governed by our subconscious and by habit.
“Millions of humans, while believing they govern their actions with conscious intelligence, clean every morsel from their dinner plates, mainly because their parents told them to. And we do this even if we don’t particularly like the food on the plate and even if we know we should be eating less of it. Unthinkingly, we follow a habit we would condemn if we looked at it clearly.”
You mar what you eat and the politics of Michael Pollan National Post (Canada), Robert Fulford (18/1/10)
Questions
- What is meant by ‘rational behaviour’? Is it reasonable to assume that people are rational in most circumstances?
- Is eating junk food consistent with the attempt to maximise consumer surplus?
- How relevant is the principle of diminishing marginal utility in explaining the amount of junk food we eat?
- To what extent are the problems that Pollan identifies examples of (a) imperfect information; (b) irrationality?
- What does people’s eating behaviour reveal about their preferences for the present over the future and hence their personal discount rate?
- What are the policy implications of Pollan’s analysis for governments trying to get people to eat more healthily?
Researchers at the California Institute of Technology have shown that a person’s enjoyment of wine is heightened if they are told that the wine is an expensive one. So what are the main factors determining the demand for wine? Is it really the taste or is it simply the expectation resulting from the price?
Raising a glass to pricey wine BBC News Online (14/1/08)
High price makes wine taste better Times Online (13/2/08)
Why expensive wine tastes the best Metro (13/2/08)
Questions
| 1. |
What are the main factors determining the demand for wine? Assess the relative importance of each of these factors in the overall level of demand. |
| 2. |
Analyse how utility theory can help to explain the level of demand for more expensive wine.
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| 3. |
How would marginal utility and market demand be affected by the knowledge that bottle of wine is a relatively expensive one? |