Happiness, Income And Heterogeneity

This paper investigates the relationship between happiness, income, and relative income, with an emphasis on heterogeneity between individuals. We develop a random coefficient model in which people are allowed to differ in baseline happiness, and the way they transform income and leisure into utility. We hypothesize that additional dollars of income and leisure (work) hours do not necessarily increase (decrease) the utility of all individuals in the same way, and relative income positions and heterogeneity around relative income positions are important explanations for happiness. Using eight waves Australian household panel data (HILDA), we find strong evidence of heterogeneity in the income-happiness relationship, and differences in baseline happiness were partially explained by personality traits. In addition, we also find relative income positions to play an important role in explaining happiness. In some instances the marginal utility estimates of relative income positions were larger in magnitude than the marginal utility estimate of absolute income, affirming EJ Mishan's view that relative income is an important determinant of happiness.