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Sociologist and psychologist would say based on the definition of marginal utility, when additional satisfaction obtained from consuming one additional unit of a good, the one¡¯s happiness will increase as their income rises. And because of consumption effect, people are happier when they consume more goods and services. Studies by psychologists and socialists show that, both within a country and across nations, the happiness level of people increases with the income level, but only slightly. For example, using regional and cultural classifications, the Northern European countries with high incomes score top on happiness, followed by the group of English- speaking US, UK, Australia, and Ireland. Central and South American countries including Brazil come next, followed by the Middle East, the Central European, Southern and Eastern European, the Indian Sub-continent, and Africa which does not, however, come last. Southern and Western Europeans score significantly lower than Africa. And the last group is East Asia, including the country that leads in income, Japan. Singapore has an income level 82.4 times that of India. Even in terms of purchasing power parity instead of using exchange rate, Singapore is still 16.4 times higher than India in income. However, the happiness scores of both countries are exactly the same, both significantly higher than that of Japan. This is due mainly to the inter group difference between the high-income and high-happiness within either of these two groups.
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As illustrate above, when one's customary consumption level is indicated by the point A, the welfare curve is X. When one's customary level increases to B, the curve moves to Y. Thus, the welfare level does not increase BB¡¯¡¯ but only marginally to BB¡¯. However, the marginal welfare of consumption may increase. This makes the individual feel that having more money to spend becomes more important. However, the long-run welfare curve is the curve that passes through A¡¯B¡¯C¡¯ which has a much lower marginal welfare of consumption. ( Ng 315). This tells us that higher income and consumption may increase the preference for even higher levels but they may in fact decrease the happiness level if the consumption level remains unchanged. Higher consumption makes us adapted to the higher level and makes us needing even higher consumption to remain at the same welfare level. To maximize happiness in the long run, one should start with not too high a consumption level so as to be able to gradually increase the level over time. In this perspective children of the rich may really suffer a disadvantage. They start off being accustomed to very high levels of consumption which they may find difficult to surpass, hence suffering in happiness terms.
Individual irrational choice, including the rat race for making more money. At the individual level, higher incomes increase not only the absolute but also the relative income and consumption levels and hence are perceived to be very important. However, at least certain minimum level, higher incomes do not really make the individual significantly happier. Although there is evidence that the more materialistically inclined are less happy. People, whose goals are oriented toward self-acceptance, affiliation, and community participation, are happier than those whose goals are oriented towards some external rewards such as financial success, popularity, and attractiveness. Most people are sacrifice things more important for happiness in order to make more money. This irrational materialistic bias influenced by both nature and nurture. A more rational people are those behavior is controlled relatively more by the reward penalty system than by automatic, inflexible, and hard-wired responses. In other words, our behavior is affected by genetically. And also an individual may prefer something without liking it and wanting it.
We are also brought up in a consumption oriented society with incessant and omnipresent advertisements encouraging us to consume more good and services. This advertising and facilitators favor of consuming goods and services is because people can only profit by selling good and services, not by selling leisure or happiness as such. The animal spirit and the influence of a materialistic society interacted to cause a vicious cycle towards insatiable demand for higher incomes. For example, it seems that no income group is contented with their income level, as judged from the answers to the following question by Americans in 1980 ¡°What would be the smallest income¡¦your family would need to make ends meet?¡± (US Bureau of Labor Statistics 1986). As Lebergott comments, ¡®the more one has, the more one wants. Families with incomes below $5000 felt that $7883 would be sufficed. Families with incomes from 5000 to $10000 felt $10139 was needed. Those who averaged $44837 knew that almost three times that sum was absolutely necessary¡¯. There are also psychological studies showing that most people are not perfectly rational. Psychological studies show that most people ignore or underestimate the negative effects of current consumption on future happiness and the positive effects of current suffering on future happiness. Most people believe that, rather than becoming disabled, it is better to be killed in an accident. Studies show that physically challenged people are only slightly less happy that healthy people. After a period of adjustment, the happiness levels of seriously disabled accident victims are restored to levels close to the pre-accident levels. They are then glad that they were not killed in the accidents.
Another evidence of money does not buy happiness is buying lottery tickets. Many people spend a lot of money and time buying lottery tickets. However, there is evidence that lottery winners are no happier than non-winners. The winner¡¯s happiness falls back to the original levels within weeks. Their original expectation of having a much happier life after winning is no fulfilled. It is thus not really worthwhile to spend say $10 per week plus the time and trouble when the expected return is only $6. Obviously, we are subject to big adaptation affect, making our welfare depending much on our reference position, not just on the actual position. On the other hand, people fail to purchase flood insurance even when offered at less than its actual value. The failure to take adequake account of the adaptation effect and the influence of market culture are explain why people think that money is more important than it really is. Kahneman concluded the evidence available suggests that people may not have the ability to predict their future tastes and hedonic experiences with the accuracy that the economic model requires. There are many studies showing that decisions made by individuals are much affected by the current emotional states. Our choice is framework by allowing emotions or utility at the beginning of a period to influence preferences. While this is a useful way of looking at certain aspects of the problem, it hides the point of imperfect information. One may explain the effect of mood on the willingness to help others by the fact that an increase in mood either increases an individual¡¯s pleasure from helping or lowers the psychic cost of helping. There is a particular source of potential incorrect choices due to imperfect memory. Its due to the difficulty of estimating such an integral, human subjects appear to extract only two key values from the temporal profile. Just as perfect intelligence is impossible to program, perfect rationality is also too costly. It is thus not surprising that some degrees of ignorance and imperfect rationality apply to most individuals. Denying the existence of irrationality is not only inconsistent with common sense and psychological studies, it also violates the basic principles of evolutionary biology (Ng 1999). Moreover, since mad people must have some irrational preferences, it is incongruous to assume that people are either perfectly rational or mad; it is more realistic to accept that more people fall between perfectly rational or mad; it is more realistic to accept that most people fall between the extremes of perfect rationality and complete madness.
As a result, we defined economics, opportunity costs, and the economic way of thinking. The economic way of thinking to recognize that people are self interested. As a result, people will do those things that they believe or expect will make them happiest. We say people compare the costs and benefits of some activity. But it is the marginal costs and benefits that are important. Thus, people compare marginal benefits and marginal cost. If marginal benefits are greater than marginal cost, then people do that thing. If marginal benefits are less then marginal costs, people do not do that thing. One of the things people do is trade or exchange. But they trade only if they believe it will make them better off. We capture the interaction of traders with demand and supply. We describe demand and supply as a market. And we also say that demand and supply determines the market price. Understanding demand and supply and thus how market work is economics. At the end, we want to know how people respond to price changes, income changes, changes in prices of related goods and services. This is what the elasticity measure; consumer responsiveness. Emphasize consumer behavior by figuring out utility level.
Diminishing marginal utility tells us that the more of something a consumer gets, the less additional benefits from another unit of that something. If the marginal cost of something increases, then less of that something will be purchased. Suppose you could measure happiness. Then suppose that following situation exists: unit 1 is equal to 6 units of happiness, unit 2 is equal to 8 units of happiness, unit 3 is equal to 4 units of happiness, and unit 4 is equal to 2 units of happiness. The total amount of happiness depends on how much of the good we have. Unit 1 is equal to 6 units of total happiness, unit 2 is equal to 14 units of total happiness, unit 3 is equal to 18 units of total happiness, and unit 4 is equal to 20 units of total happiness. As units increase, our total happiness diminishes. The total amount of happiness depends on how much of the good we have. The marginal utility of unit 1 is equal to 6 marginal, unit 2 is equal to 8 marginal, unit 3 is equal to 4 marginal, and unit 4 is equal to 2 marginal. The first unit gives us 6 units of happiness, the second unit gives us 8 units of happiness; the first two units then are providing a total of 14 units of happiness. Even though marginal utility is falling, total utility continues to rise in the middle until marginal utility reaches zero. Zero marginal utility means maximum total utility. Any more consumption and marginal utility is negative so total utility declines. When there is no scarcity you consume a good or carry out an activity until marginal utility is zero. When you much choose among different goods or activities because of your scarcity of income or time individuals will maximize utility by allocating their income among their purchases so that each additional dollar of spending on any good or activity yields the same additional utility.
In conclusion, evidences suggest that an increase in income and consumption does not appreciably increase happiness. However, due to relative income effect, people still engage in the rat race for making more money. But as a person's income increases over time, a person increases a person's expectation; in other words, they aspire to having higher incomes. To the extent that satisfaction is tied to whether those aspirations are met, satisfaction may not increase as income grows over time. It is possible that the relationship between income and satisfaction goes two ways: although higher income generates more satisfaction, greater satisfaction offers greater motivation for individuals to work hard and generate higher incomes.
Ng Y-K (1999) Utility, informed preference, or happiness? Soc Choice Welfare 16(2):197–216