Social comparisons and changes in expected liv- ing standard strongly influence individual well- being . . . . Overall, Easterlin's research shows that people in wealthy nations show no higher life satisfaction than people in poorer nations once the level of income is high enough to provide for food, shelter and other fundamental needs. This apparently contradictory finding became known as the "Easterlin Paradox. " 15 Is there a way to adapt the traditional theory of consumer choice from microeconomics, so that its implications are consistent with the empirical find- ings from the literature on psychological well-being? Bridging psychology and economic theory is the cen- tral purpose of an important area within economics known as behavioral economics. Research in behav- ioral economics seeks to strengthen the psychologi- cal foundations of economic models so that they can make better predictions about individual decision making. Behavioral economists Botond Koszegi and Matthew Rabin have proposed a theory of reference- based preferences that yields implications consistent with psychological research on happiness. 16 Koszegi and Rabin posit that an individual's utility depends not llWe wo uld like to tha nk Eric Schultz for hi s commen ts and su ggestions on this app li ca ti on. 14 We ar e, of course, ta l ki ng abo ut "goo ds " ra th er than "bads," which wo ul d include phenomena su ch as po ll ution or tra ffic congestion. 15 IZA pr ess release, May 4, 2009. 16 B. Koszegi and M. Rabin, "A Model of Reference-Dependent Pr e fer ences," Quarterly J ourna l of Econo m ics 12, no. 4 (2 006): 113 3 -1165.
98 CHAPTER 3 CONSUMER PREFERENCES AND THE CONCEPT OF UT ILITY on the individual's absolute consumption of goods and services but on the consumption of goods and services relative to some sort of reference level. In Koszegi and Rabin's theory, reference levels represent a consumer's expectation (prior to making consumption decisions) about how much of each good the consumer is likely to end up consuming. If the consumer ends up consuming less than the expected amount, the consumer experi- ences a loss; if the consumer ends up consuming more than the expected amount, the consumer experiences a gain (which typically would be expected to be smaller than the loss). These assumptions imply that it could easily be the case that an increase in consumption could leave a consumer no happier than he or she was before. This would be the case if the consumer ends up consuming exactly what he or she expected to consume. Utility functions that include reference levels of consumption are a special case of a broader phenom- enon in which individuals tend to adapt to the situa- tions in which they find themselves. Psychologists define hedonic adaptation as the tendency of our moods to settle back to some set range after a tempo - rary burst of emotion in response to certain events.
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