Happiness researchers challenge revealed preference theory

Neoclassical economic theory relies on consumer's revealed behavior to evaluate the utility of their choices. It assumes perfect information and consistent preferences, and implies that people do not make systematic errors. Alois Stutzer and Bruno S. Frey take issue with revealed preference theory in a new working paper What Happiness Research can tell us about Self-Control Problems and Utility Misprediction (Institute for Empirical Research in Economics, Zurich).

This paper takes a step beyond standard neoclassical economics: (i) systematic errors in consumption are taken seriously, and (ii) a strategy is proposed to test the assumption that individuals do not commit any systematic mistakes when consuming, and that they therefore reach the highest possible utility level achievable, given the constraints they face.

A recent revolution in economics - happiness research - has made it possible to approximate individuals’ utility in a satisfactory way for many questions (see Kahneman et al. 1999; Frey and Stutzer 2002a,b; Layard 2005). The consumption decision can therefore be separated from the utility thereby produced. The research results discussed in this paper suggest that specific consumption decisions taken by particular individuals are not utility maximizing, according to the individuals’ own evaluation.

Unlike Lord Layard's work, the authors argue their initial findings of sub-optimal choices by consumers on smoking, eating, TV viewing and commuting do not necessarily require government action:

It should be noted that this analysis is not a normative evaluation from the point of view of a benevolent social planner. Rather, the focus is on the mistakes in consumption that individuals commit according to their own perception, placing people in a less favorable position in terms of their own utility evaluation. The systematic errors in consumption identified and discussed for four specific areas are no cause for immediate government intervention.

It is very likely that individuals are quite capable of making satisfactory consumption decisions for most of the goods most of the time. Moreover, it is doubtful whether “the government” is able to make better decisions in the interests of the persons concerned (see Frey and Stutzer 2006).

They outline some potential implications for public policy, but largely favour education and information over 'social engineering':

Nevertheless, our results raise the question of whether activities, typically subject to excess consumption, should be subsidized by the public, and whether taxes in fact produce the extent of dead weight losses claimed in standard public economics.

With regard to subsidies, this applies, in particular, to public TV and commuting, which in many countries are highly subsidized by the government. With regard to taxes, tobacco taxes are a case in point as they may not only serve as a means to generate revenue to finance health care, but may also help to overcome problems of self control.

We think, however, that a more effective way to deal with individual errors in consumption is to help individuals to make more reasoned decisions, enabling them to get a clearer picture of the future utility of particular consumption goods and services. In some cases, a “cooling down period” may be beneficial. In other cases, people could be informed about self-control mechanisms.

Comments

[AJE]

It's a shame that - generally speaking - when people see evidence that undermines the legitimacy of neoclassical economics they automatically question whether economics itself is under attack. It'd be like rejecting Jackson Pollock and automatically dispensing with Picasso, Boccioni and Klee.

I think that it's possible to accept some of the findings of happiness research, and conclude that neoclassical economics has been weakened. But that should generate a demand for alternative branches of economic theory - all the more so those that are at the very roots of neoclassical economics but failed to follow the formalist path that is no being undermined.

In short, scholars such as Mises and Hayek should see their stock rise as a consequence of this research!

[Arthur Eckart]

I don't know how it's possible to conclude that people make consumption or utility mistakes. If someone prefers to watch TV or smoke a cigar than do something else, how can that be a mistake? It's a tradeoff. The person making the choice knows the opportunity costs, and is aware that "good" choices can replace "bad" choices. The utility function is not a one-size fits all model. Rather, it's about individual preferences and tastes. The article is really about social engineering.

[Lord]

specific consumption decisions taken by particular individuals are not utility maximizing, according to the individuals’ own evaluation

That would be rather conclusive to me. Predicting the results of our actions is difficult in the best of circumstances. Impulsivity, and buyer's remorse, are real problems. If only we all knew then what we know now.

[Arthur Eckart]

If an individual does something that's perceived by society as a "bad," although that's what the individual chooses to maximize utility, then of course the individual will not give a positive evaluation of that choice (to conform with the dominant group). What can be concluded is the "bad" choice of an individual doesn't conform with the "good" choices (or value judgments) inherent in the study. The study is biased and flawed.

[cartucho r4]

However, if tastes are socially constructed, then it seems to me that social context is at least as likely to affect survey research as it is to affect behavior. For example, Layard reports that marriage increases happiness, based on survey research...it could easily be that the difference in reported happiness reflects respondents' views of how they are expected to feel about being single or married.

[contemporary art]

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