Happiness, as a generally accepted goal, has been viewed as a 'social indicator'. Drawing on economics and psychology, relationship between income and happiness has been researched in the ways of data analysis and behaviour observer. It is evident that relative income is one of the important factors. This factor will affect happiness. Compared to actual income, relative income might affect happiness more. Based on these research findings, action can be recommended. That is, in individual consumption and investment activities, people should recognize the effects of relative income, especially, personal strive and relevant psychological adjustment are needed to improve individual happiness.
Over the past 50 years, in spite of the extraordinary success in producing material and accumulating wealth, happiness seems have not to be improved at the same level (Layard, 2011). The value of an extra dollar seems also become smaller and smaller as people become richer. In the process of accumulating wealth, increasing investment may not contribute more income. This may lead investor to feel frustration, affect their following investment performance, so that affect their happiness. In this situation, following investment performance means relative income, it is defined as the income compared to other similar social group or to oneself in the past (Ball & Chernova, 2008). Happiness refers to the human experience which is good (a psychological statement). This was first summarised by a leading economists Layard in 2005(Layard, 2011).
Based on these relevant researches, this essay aims to explain the reason of these phenomena. First, give evidence of relative income affects happiness. Second is the explanation why relative income affects happiness more than absolute income. Finally, try to recommend increasing relative income actions, so as to improve happiness effectively. In addition, the implications of individual financial decision and limitations of research methods will also be presented in the conclusion section.
First evidence, relative income affect happiness
There are many persuasive reasons for relative income affect happiness, which has been explained in both theoretical and empirical directions.
To begin with, theoretical economists Layard (2011) explained happiness is feeling good. He clearly pointed out the relationship between income and happiness. In his theoretical framework, he concluded 'the big seven' factors affect happiness. Those are: family relationships, financial situation, work, communication and friends, health, personal freedom, as well as personal value. In the seven factors, in the important order, financial situation and work are the first two factors directly correlated with income. So, undoubtedly, as the most important factor, income affects happiness directly. For example, developing country, like India, Mexico, Brazil and South Korea, their average happiness have risen because of economic growth and income increase.
Another empirical report was presented by Ball and Chernova in 2008. In order to identify the different impacts on happiness, Ball and Chernova (2008) stated that income can be separated into absolute income and relative income. They explained 'absolute income means actual income in a certain period, relative income may be evaluated relative to others or to oneself in the past'. Based on the analyses of 20,771 samples, the noticeable relationship between absolute income and happiness can be found, and perceptible correlated relationship between relative income and happiness can also be noticed.
For example, if student of Reading University plan to go to town center, one person's return ticket cost must be ?3.6 normally. However, if the student purchase group ticket with other three students together, one person's ticket cost will become ?1.2. The student may realize the plan to go to town center while saved money is ?2.4. Compared with other students who buy normal return ticket, the outcome of commuting is the same. As the student's former budget is ?3.6, saved money ?2.4 can be viewed as his relative income, this unexpected income must make the student feeling good, in other words, affects the happiness positively. The implication is, when compared with similar social group, generated relative income in rational consumption activities affect happiness effectively, even if the absolute income may not be changed.
Further evidence, relative income might affect happiness more
Relative income affects happiness more than absolute income. Further evidence has been showed in many researchers' report. These obvious effects can be found both in group comparison and individual level.
First, Mackerron (2012), an advocate of Layard, implied more argument between income and happiness. He argued that the terms 'happiness' and 'wellbeing' can be used interchangeably, so as to communicate effectively with individuals or policy maker. He described absolute income as 'individual income or household income', which discussion in the literature seems to be unnecessary. But, in his views, there is a visible trend that relative income's contribution on happiness has been neglected, because absolute income's effects on happiness has been emphasised more.
Moreover, in one country, strong evidence have also been found by Clark, Frijters and Shields in 2008. That is effects on happiness which caused by the changed individual income are far more than the one caused by the aggregate level. Figure 1 showed the relationship between income and happiness at the individual and the aggregate level. The hypothesis of their model is happiness equal to utility. In economic, the term 'utility' refers to maximize something, outcome or wealth. The collected data described the increasing happiness of the same group in three periods. The three short curves refer to group level in three periods. The dots stand for the individual level. It is clear that the level of most personal data is higher than the group level. This model powerfully demonstrated that changes in individual income have larger effects on happiness than the aggregate level. In other words, to increase relative income affects happiness more.
Figure1. The relationship between income and happiness at the individual and the aggregate level (Clark, Frijters & Shields, 2008)
Another interesting example comes from Layard's book (2011, p40). That is a scenario of office. One staff is talking with the leader. Another staff sits there. The picture was accompanied with text 'O.K., if you can't see your way to giving me a pay raise, how about giving Parkerson a pay cut?' (2011, p40). This example revealed the difference of relative income will bring more happiness to people, even though it is impossible to increase absolute income. Accordingly, it also revealed that the main reason of social comparison: The human jealousy and greed. The leading economist Layard (2011) presented a dialectical thinking to this example.
He thinks the struggle for relative income is self-defeating at the level of whole society. If one person's income rises, other person's income will fall accordingly, the amount must be the same ones. This feature will imply the policy-maker' devotion to increasing public relative income compared with the past, rather than to increase individual relative income simply. But, individual will remain benefit from the group increase of relative income, so that improve happiness as a member of the group.
These kind of social interaction behaviour connected with relative income bilaterally, it's analysis and measurement can be found by mental account measurement in behavioural finance.
Applying mental account measurement to increase relative income will be helpful to improve happiness
It is possible to use mental account measurement to improve happiness in consumption and investment activities. As a recommended action plan, it is beneficial for people to isolate risks, pursue potential relative income, so, it can improve happiness. In fact, the key aspects of this action must be personal strive and relevant psychological adjustment.
In recent 10 years, behavioural finance studies how people actually behave in financial decision (Nofsinger, 2014, p181). That is to say, how psychological affect investor's relative income and happiness. Just as mentioned group ticket, investor may feel good if they obtain unexpected investment performance in their investment activities. This means people may be used to separate their behavioural outcome into invisible different baskets in mind, and evaluated them separately. So, mental account can be described as different baskets in mind, classified different outcome of different activities, not only consumption activities but also investment activities. Thus, so called 'mental account' may be used to manage consumption and investment activities in an effective way.
Nofsinger (2014) explains the mental account as a process to store and keep track of important decisions and outcomes. Statman (2014) named the mental account as layers in a portfolio pyramid. It is commonly referred to mental accounting 'buckets.' This layer pyramid will help to isolate risk in different directions. He analyse that one mental account might be a 'downside protection' mental account, which is designed for protection from poverty. Another might be an 'upside potential' mental account, designed for a chance at riches. Investors might behave as if they are risk-averse in the downside protection mental account, when risk is measured at a certain level. Conversely, investors also might act as if they are risk-seeking in the upside potential mental account, when risk is measured by expected high returns. In short, lower risk, lower return, higher risk, higher returns.
In order to generate relative income, people should also understand and overcome psychological bias when managing mental account. According to Layard (2011), a famous statement about human nature in investment activities is loss-aversion and risk hating. As can be seen, people always hate a loss more than they value an equal gain. On average, if someone loses ?100, his mood worsens twice much as it would improve if he gained ?100. In other words, people tend to win double gains which could be supplemented their lost when people involved financial decisions.
There are two implications can be utilized in making satisfactory individual financial decisions. In one hand, when people make consumption decisions, if the utility is constant, which means the same outcome, the saved money will be the earning, that will be generated relative income in the consumption activities. When people involved investment decisions, if the utility is constant, it also means the money not losing in some certain period will be the earning, that will generate relative income from investment activities.
As a result, applying mental account measurement to manage consumption and investment expectancy might increase relative income effectively, so as to improve happiness accordingly.
However, increase relative income could not only be the method, although it might lead to marked improvement of happiness. To pursue long term happiness or wellbeing, a World Values Survey (WVS) indicates another option approach (Ball &Chernova, 2008). WVS researcher revealed, absolute income and relative income are apparently correlated with happiness, which questionnaire included 227 items, involved samples over 70 countries (Ball & Chernova, 2008). The effects of income on happiness have been measured linking with monetary factors. But income growth might eventually lead to improvements in some of the factors that have a big impact on happiness, such as health and employment. So to some extent, further social factors might lead to the growth of income, it may have a large effect on happiness.
As above discussed, this essay has shown reasonable research findings among absolute income, relative income, and happiness. In general, it is clear that income affects happiness obviously. In particular, compared with similar social group such as peer, friend, and colleague, to a more extent, it should be realized that relative income affects happiness strikingly because of jealousy. Compared with personal historical income or investment performance, relative income can also be seen apparent effects on happiness, since greed of normal people. Therefore, although other social factors may also affect happiness, personal strive and psychological adjustment must be born in mind. This could come in two different ways. By managing consumption and investment expectancy, to increase relative income might be helpful to improve happiness effectively. This mental account measurement has revealed that behavioural finance incorporates parts of finance, economics and psychology and includes bridges among theory, evidence, and practise.
Due to the complexity of social interaction, one limitation of this conclusion needs to be explained. Data analysis between different social group are just compared in one country. Lack of real data, this has to be interpreted among different country in the future. However, it is truly believed that, with the development and interaction of cross-subject, a better way could come into practise.
Ball, R., & Chernova, K. (2008). Absolute income, relative income, and happiness. Social Indicators Research, 88(3), 497-529.
Clark, A. E., Frijters, P., & Shields, M. A. (2008). Relative income, happiness, and utility: An explanation for the Easterlin paradox and other puzzles. Journal of Economic Literature, 95-144.
Layard, P. R. G., & Layard, R. (2011). Happiness: Lessons from a new science. Penguin UK.
MacKerron, G. (2012). Happiness economics from 35 000 feet. Journal of Economic Surveys, 26(4), 705-735.
Nofsinger, J. R. (2014). The psychology of investmenting. Person and China Machine Press.
Statman, M. (2014). Behavioral finance: Finance with normal people. Borsa Istanbul Review
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