Increasing Income Inequality, External Habits, and Self-Reported Happiness

Citation:

Karen E. Dynan and Enrichetta Ravina. 5/2007. “Increasing Income Inequality, External Habits, and Self-Reported Happiness.” American Economic Review, 97, 2, Pp. 226-31. Publisher's Version

Abstract:

A large literature has documented an increase in income equality in the United States over the past several decades (see, for example, David H. Autor, Lawrence F. Katz, and Melissa S. Kearney 2006). At the same time, real aggregate income has risen markedly, and most socioeconomic groups have experienced at least some rise in real purchasing power. Standard models of consumption, which typically assume that an individual’s utility is based only on her own consumption, would predict that these gains have led to higher levels of happiness for all groups, albeit with greater increases for some more than others. Economists have long recognized, however, that an individual’s utility may depend not only on the level of her own consumption but also on how that level compares with the consumption of others. If preferences are characterized by such “external habits,” then the observed widening of the income distribution may have implications for the happiness of different groups that go beyond those associated with the changes in their respective incomes.

This study combines data from two sources to document the evolution of reported levels of happiness for different socioeconomic groups over the past 25 years and to explore whether those levels have been affected by the changing relative position of these groups within the income distribution. We find that people’s happiness appears to depend positively on how well their group is doing relative to the average in their geographic area, even after controlling for the level of their own income. This result is consistent with evidence in earlier work by Erzo F. P. Luttmer (2005) and Ravina (2005). In addition, we find some evidence that the relationship is much stronger for people whose group has above-average income than for people whose group has below-average income. It would thus appear that relative concerns do not become an issue until a person has attained a certain place within the income distribution.

Last updated on 06/19/2018