Andrew E Clark

Paul Frijters

Michael A Shields

Colin Camerer

Richie Davidson

Ed Diener

Dick Easterlin

Ada Ferrer-I-Carbonell

Felicia Huppert

Danny Kahneman

Brian Knutson

George Loewenstein

Dan Mroczek

Yew-Kwang Ng

Matthew Rablen

David Schkade

Wolfram Schultz

Arthur Stone

Stephen Wheatley Price

Peter Ubel

Dan Andrew Wilson

Bernard Oswald

Van Praag

Income and happiness: Evidence, explanations and economic implications

Keywords: Income, happiness, social comparisons, habituation, economic policy

Every pitifulest whipster that walks within a skin has had his head filled with the notion that he is, shall be, or by all human and divine laws ought to be, 'happy'" (Thomas Carlyle).

Issues

). 2 To illustrate, a search of ECONLIT for journal articles with either 'Happiness', 'Life Satisfaction' or 'Well-being' in the title, identifies 465 published articles between 1960 and 2006. Of these 363 (78%) have been published since 1995, 285 (61%) have been published since 2000, and one-third of the literature (37%, or 173 articles) has appeared in print in just the last three years. 3 Focusing only on the period 2000-2006, this measure of economists' interest in the 'economics' or 'science' of happiness places that interest at roughly half the level of interest in 'Wages' and just below that in 'Discrimination'. However, happiness is quickly catching up: it is in its 'industrial revolution' stage.

the theoretical foundations of the economics of happiness are also being expanded (see, for example, [START_REF] Rayo | Evolutionary efficiency and happiness[END_REF][START_REF] Rayo | Evolutionary efficiency and happiness[END_REF]Graham andOswald, 2006).

The empirical cornerstone of this literature is the analysis of answers to current happiness or life satisfaction questions in cross-section and panel survey data. The responses to such questions are mostly on an ordinal scale (for example, ranging from 0 (Very Unhappy) to 10 (Very Happy)). These responses are then taken as proxies for what economists call utility. If this is reasonable, the analysis of subjective well-being may be able to provide powerful additional insights into the factors motivating individual behaviour, and therefore the assumptions that underpin economic theory and policy design. The potential for new knowledge from this approach, especially in parallel with more traditional analysis, seems substantial. This potential has already been demonstrated in a number of domains. In the realm of macroeconomics, Di [START_REF] Di Tella | Preferences over inflation and unemployment: Evidence from surveys of happiness[END_REF][START_REF] Di Tella | The macroeconomics of happiness[END_REF] use cross-country happiness data from European countries to calculate the trade-off between inflation and unemployment; Di Tella and MacCulloch (2005), in the same vein, conclude that there is no difference in this inflationunemployment trade-off between the rich and poor. Frijters et al. (2004a) show large life satisfaction gains in East Germany from increased real incomes in the decade following Reunification, while [START_REF] Frijters | Can the large swings in Russian life satisfaction be explained by ups and downs in real incomes[END_REF] calculate that the large swings in life satisfaction observed in post-transition Russia can be partially explained by variations in real incomes. [START_REF] Alesina | Inequality and happiness: Are Europeans and Americans different[END_REF] consider the demand for redistribution between the US and Europe via the effect of income inequality on individual well-being. Lastly, [START_REF] Kahneman | Developments in the measurement of subjective wellbeing[END_REF] discuss the validity of subjective well-being questions and the use of real time measures of wellbeing (experience sampling), and also promote the concept of national well-being indices to complement traditional National Income and Product Accounts.

In microeconomic analysis, happiness data has been used to better establish the current psychological cost and longer-run scarring effects of unemployment (e.g. [START_REF] Clark | Unhappiness and unemployment[END_REF][START_REF] Clark | Scarring: The psychological impact of past unemployment[END_REF][START_REF] Winkelmann | Why are the unemployed so unhappy? Evidence from panel data[END_REF]. The normative use of subjective well-being is discussed in Di [START_REF] Di Tella | Some uses of happiness data in economics[END_REF], with particular reference to their work on political economy, and [START_REF] Van Praag | Happiness Quantified: A Satisfaction. Calculus Approach[END_REF] provide a detailed account of how happiness data can be used to calculate the monetary equivalents of, amongst other things, climate change, chronic disease and noise pollution (also see [START_REF] Van Praag | Using happiness surveys to value intangibles: The case of airport noise[END_REF]. [START_REF] Frey | The life satisfaction approach to the value of public goods: The case of terrorism[END_REF] take the same approach with respect to terrorism. [START_REF] Schwarze | What can happiness research tell us about altruism? Evidence from the German Socio-Economic Panel[END_REF] show that happiness data can be fruitfully applied to the study of interdependent utility, such as the extent of altruism between parents and children; see also [START_REF] Kalugina | Within-Household Comparisons Using Subjective Data in a Collective Model[END_REF]. [START_REF] Gruber | Do cigarette taxes make smokers happier[END_REF] relate the well-being of smokers to cigarette taxes to conclude that smoking is at least partly a bad choice, from which smokers would prefer to be rescued (via higher tobacco taxes).

The range of issues that have been addressed using subjective information is now wide. In terms of the causes of happiness, two topics have arguably attracted more interest than most: (1) the relationship between income and happiness; and (2) the relationship between labour market status (and especially unemployment) and happiness. While it is now widely accepted that unemployment reduces well-being, even after controlling for the associated fall in income, the relationship between income and happiness remains more contentious. It is this latter relationship which is the focus of this paper.

One of the catalysts in the literature on income and happiness was Easterlin's seminal article (1974, updated in 1995), setting out the 'paradox' of substantial real income growth in Western countries over the last fifty years, but without any corresponding rise in reported happiness levels. Similar studies have also since been conducted by psychologists [START_REF] Diener | Factors predicting the subjective well-being of nations[END_REF] and political scientists [START_REF] Inglehart | Cultural Shift in Advanced Industrial Society[END_REF]. Figure 1 shows an Easterlin graph for the US over the period . While real income per capita almost doubles, happiness (from the General Social Survey) shows essentially no trend. From this figure, to borrow a term from health economics, it looks as if individuals in rich countries are 'flat of the curve', with additional income buying little if any extra happiness. It has been argued that once an individual rises above a poverty line or 'subsistence level', the main source of increased well-being is not income but rather friends and a good family life (see, for example, [START_REF] Lane | The Loss of Happiness in Market Economies[END_REF]. This 'subsistence level' could be as low as US$10,000 per annum (as reported in Frey and Stutzer, 2002a;[START_REF] Mcmahon | Happiness: A History[END_REF]. Following on with this argument, the radical implication for developed countries at least is that economic growth per se is of little importance, and should therefore not be the primary goal of economic policy [START_REF] Oswald | Happiness and economic performance[END_REF]. [START_REF] Layard | Happiness. Lessons from a New Science[END_REF] goes as far as arguing that we need a 'revolution' in academia, where every social scientist should be attempting to understand the determinants of happiness, and it should be happiness which is the explicit aim of government intervention. 1973 1977 1980 1983 1986 1988 1990 1993 1996 2000 2004 Year Average Life Satisfactio UK France Germany Italy Netherlands

This 'paradox' is not specifically a US phenomenon. The same picture can be drawn for Japan [START_REF] Easterlin | Will raising the incomes of all increase the happiness of all[END_REF], which has seen one of the largest increases in real per capita income of any country since World War II, and also for Europe. Figure 2 shows trends in average life satisfaction for five European countries since 1973. As in the US, there has been no obvious increase in life satisfaction over a thirty-year period, even though real incomes per capita have increased sharply in all five countries. The only trend is found in Italy, the poorest country of the five, where average life satisfaction increased from 2.67 in 1973 to 2.88 in 2004, a rise of 9.3%. Easterlin (2005a) provides a useful summary of this macro empirical literature.

The same time-series data in transitional countries, however, suggest a larger role for income. Consider Figure 3, which shows average life satisfaction and real income in East Germany during the decade following reunification. East Germans experienced a substantial increase in real income between 1991 and 2002, and reported a considerable rise in their life satisfaction over the same period. 1991 1992 1993 1994 1995 1996 1997 1998 1999 However, we should be cautious in concluding from these graphs, which illustrate bivariate correlations, that income does not buy happiness in the developed world. A parallel body of work has produced what is now a large body of evidence suggesting that money does matter.

There are three stylised facts in this second literature.

1) A regression of happiness on income in cross-section survey data from one country (with or without standard demographic controls) generally produces a significant positive estimated coefficient on income. This holds for both developed (see, for example, [START_REF] Blanchflower | Well-being over time in Britain and the USA[END_REF][START_REF] Shields | Exploring the economic and social determinants of psychological well-being and perceived social support in England[END_REF] and developing [START_REF] Graham | Happiness and Hardship: Opportunity and Insecurity in New Market Economies[END_REF][START_REF] Lelkes | Tasting freedom: Happiness, religion and economic transition[END_REF] countries. However, the income-happiness slope is larger in developing or transition than in developed economies.

2) Recent work has used panel data to control for unobserved individual fixed effects, such as personality traits, and concludes that changes in real incomes are correlated with changes in happiness (see, for example, [START_REF] Winkelmann | Why are the unemployed so unhappy? Evidence from panel data[END_REF]Ravallion and Lokshin, 2001;[START_REF] Ferrer-I-Carbonell | How important is methodology for the estimates of the determinants of happiness[END_REF][START_REF] Senik | When information dominates comparison: A panel data analysis using Russian subjective data[END_REF][START_REF] Ferrer-I-Carbonell | Income and well-being: An empirical analysis of the comparison income effect[END_REF]Clark et al., 2005).

Further, a number of these studies have been able to utilise exogenous variations in income to more firmly establish the causal effect of income on happiness (e.g. [START_REF] Gardner | Money and Mental Wellbeing: A Longitudinal Study of Medium-Sized Lottery Wins[END_REF]Frijters et al., 2004aFrijters et al., , 2004b[START_REF] Frijters | Can the large swings in Russian life satisfaction be explained by ups and downs in real incomes[END_REF]. It is again the case that income has a larger effect in transition than in developed countries. In addition, the slope of the income-happiness relationship is not necessarily the same between groups (Clark et al., 2005;Frijters et al., 2004a;[START_REF] Lelkes | Tasting freedom: Happiness, religion and economic transition[END_REF].

3) Recent detailed studies of the 'macroeconomics of happiness' using very large samples and cross-time cross-country models that control for country fixed-effects, have shown that happiness co-moves with macroeconomic variables including GDP, GDP growth and inflation (see, for example, Di [START_REF] Di Tella | The macroeconomics of happiness[END_REF][START_REF] Helliwell | How's life? Combining individual and national variables to explain subjective well-being[END_REF][START_REF] Alesina | Inequality and happiness: Are Europeans and Americans different[END_REF]. A useful set of recent figures is to be found in [START_REF] Leigh | Happiness and the Human Development Index: Australia Is Not a Paradox[END_REF].

The bulk of the evidence in 1) -3) thus suggests that income does raise happiness. This is likely one reason why economists' interest in happiness has been growing: happiness functions look like utility functions.

One of the main challenges for the economics of happiness is therefore to render the significant income coefficient found in much of empirical literature consistent with the time profiles shown in Figures 1, 2 and 3, and to identify the ensuing implications of the fundamental income-happiness relationship for both economic theory and policy design.

This paper attempts to respond to that challenge. Our answer is based on the concept of income comparisons -both to others in the relevant reference group (social comparisons) and to oneself in the past (adaptation or habituation). We provide a unified account of the observed income-happiness gradients in both the micro and macro literature by presenting them as straightforward extensions of the textbook utility function.

The recent growth of the empirical literature on income and happiness has produced much information with respect to income comparisons. We summarise these new findings, especially focusing on studies that have used panel data from surveys such as the British Household Panel Survey (BHPS), the German Socio-Economic Panel Study (GSOEP) and the Russian Longitudinal Monitoring Survey (RLMS). These panel studies allow researchers to track individuals' income and happiness over long periods (now over 20 years in the case of the GSOEP) and to control for individual fixed traits, the latter having been shown to be crucial components in the modelling of subjective well-being [START_REF] Ferrer-I-Carbonell | How important is methodology for the estimates of the determinants of happiness[END_REF].

We then highlight some of the main implications of income comparisons for a range of issues relating to economic theory and policy design. The economic issues we focus on include many of the central concerns of economics: consumption, investment, economic growth, savings, taxation, labour supply, wages and migration.

This recent growth of interest by economists in happiness might to some extent obscure the fact that psychologists have been putting serious effort into the analysis of various well-being measures for at least the past forty years. Recent reviews of this literature include [START_REF] Diener | Will money increase subjective well-being?[END_REF], Diener et al. (1999), [START_REF] Elster | Interpersonal Comparisons of Well-Being[END_REF], [START_REF] Huppert | The Science of Well-Being[END_REF] and [START_REF] Kahneman | Foundations of Hedonic Psychology: Scientific Perspectives on Enjoyment and Suffering[END_REF]. It is clear from this body of work that economists can learn a great deal from psychologists about the factors that make people happy. Perhaps the most salient lessons from this psychological literature are that: (i) individuals appear to adapt to a considerable extent to changes in their circumstances, although the evidence on income adaptation is very limited;

(ii) people are concerned about their relative standing (e.g. income, status) 8 and not just about their absolute position in society; (iii) individuals have aspirations about their future, and subjective well-being is substantially lower if these expectations are not met; and (iv) a large amount (somewhere between 50% and 80%; see [START_REF] Lykken | Happiness is a stochastic phenomenon[END_REF] of the variation in individuals' reported well-being might be explained by genetics or personality traits. Currently manipulating such genetic traits is well outside the current remit of public policy, so that only up to one-half of human happiness can potentially be changed. However, to the extent that personality traits are developed in early childhood, and reflect 'nurture' rather than 'nature', this malleable percentage is potentially far higher.

This leads to the following question: 'Given that psychologists have been working on this most important of human issues 9 , why has it taken economists so much longer to enter the field?' One commonly-cited reason is that happiness is hard to measure directly, and economists have expressed doubts about attempts to do so (see, for example, [START_REF] Bertrand | Do people mean what they say? Implications for subjective survey data[END_REF]. This view concords with the traditional 'indirect' economic method of measuring happiness via revealed preferences, where individuals are assumed to make utility-maximising decisions given their constraints. In this case, the observation of individual behaviour allows preferences to be identified, obviating the need for direct measurement of utility. Our position is that the analysis of subjective measures provides a useful complement to the traditional analysis of objective behaviours.

The potential criticisms raised against the use of subjective happiness data include the following. First, does a question asking about current happiness on some ordinal scale really provide a good assessment of current circumstances (relating to, for example, family life, job and income), or will the response also pick up ephemeral factors like having a cold or toothache, the weather, their sports team's recent results, or having recently watched a hard-hitting documentary about Third-World famine? Second, can we compare the responses of different people to questions like 'All things considered, how happy are you with your life?', to conclude that individual A is happier than individual B? Or even that individual A is happier today than she was a month ago? That is, can we carry out interpersonal or intertemporal comparisons in happiness scores?

Fortunately, psychologists and other scientists have been examining these issues for many years, and the broad consensus is that subjective well-being data contains a great deal of 'valid variability' [START_REF] Diener | Subjective wellbeing[END_REF]; also see the discussion in [START_REF] Kahneman | Developments in the measurement of subjective wellbeing[END_REF]. This is the subject of the next section.

Validity: How Well do Happiness Scores Measure Utility?

There is now a wide body of evidence supporting the hypothesis that subjective well-being measures contain valid information on what economists call utility. Some of the main validation approaches are presented below.

9 It is often argued that happiness is the ultimate goal of life. Such a goal, for example, is explicit in the United States Declaration of Independence. This Declaration "takes is as a self-evident truth that the pursuit of happiness is an unalienable right, comparable to life and liberty". However, such a goal has not always been evident (see [START_REF] Mcmahon | Happiness: A History[END_REF]. Along the same lines, Health is defined in the World Health Organisation's Constitution as a "state of complete physical, mental and social well-being and not merely the absence of disease or infirmity".

Cross-Rater Validity

It is presumed that asking A how happy she is will provide information about her unobserved real level of happiness. A simple validity check is then to ask B whether he thinks A is happy.

Many studies have shown that individuals are able to a large extent to recognise and predict the satisfaction level of others. In interviews in which respondents are shown pictures or videos of others, they accurately identify whether the individual shown to them was happy, sad, jealous, and so on (see [START_REF] Sandvik | Subjective well-being: the convergence and stability of self and non self report measures[END_REF]and Diener and Lucas, 1999). This is also the case when respondents were shown individuals from other cultures. 10 It might then be argued that there is a common human language of satisfaction or happiness, so that subjective well-being is at least to an extent observable and comparable between individuals. It has also been found that individuals in the same language community have a common understanding of how to translate internal feelings into a number scale, simply in order to be able to communicate with each other.

Respondents translate verbal labels, such as 'very good' and 'very bad', into roughly the same numerical values (see [START_REF] Van Praag | Ordinal and cardinal utility: An integration of the two dimensions of the welfare concept[END_REF]. 11 A tempting conclusion is that an evolutionary advantage accrues to the accurate evaluation of how well others are doing. 12 The general idea of having a third party evaluate respondents' happiness has been used to validate the replies that individuals themselves provide (see [START_REF] Sandvik | Subjective well-being: the convergence and stability of self and non self report measures[END_REF]Diener and Lucas, 1999). When friends and family are asked about how happy they believe the respondent is, the scores they provide tend to correlate with the respondent's own report. 13 Another obvious choice is the interviewer: again, the answer the interviewer gives tallies with that of the respondent. Lastly, respondents are sometimes given open-ended interviews in conjunction with standard questions about their well-being. When third parties, who do not know the respondent,

are played these open-ended interviews their evaluation of the respondent's well-being matches well with the respondent's own reply.

10 This is reminiscent of work in the area of 'emotion' undertaken in the 1960s (see the description in Chapter 1 of [START_REF] Nettle | Happiness: The Science Behind Your Smile[END_REF]. American respondents were very good at identifying the emotions depicted by American actors in a series of photographs; but importantly so were the Dani tribespeople of Papua New Guinea.

11 More precisely, it looks as if individuals convert the verbal labels into cardinal numbers that equally divide up the response space. Practically, this is one reason why ordinal and cardinal estimation techniques applied to subjective measures of well-being or health most often produce similar results [START_REF] Ferrer-I-Carbonell | How important is methodology for the estimates of the determinants of happiness[END_REF]. 12 Seabright (2004, Chapter 3) invokes the possibility that smiling and laughter may have evolved as (accurate) signals of trustworthiness. It is not easy to fake smiles, and extremely difficult to fake laughter. 13 This test is not as clean as it might appear at first sight, for the reasons underlined in [START_REF] Manski | Identification of endogenous social effects: The reflection problem[END_REF]. Third parties and respondents may share unobserved characteristics which lead them to supply similar answers, even though the correlation between the two underlying constructs (how happy the individual thinks she is, and how happy her friend thinks she is) may be only small. This applies particularly to third-party reports from both friends and family who likely share with the respondent idiosyncratic uses of language. This is less of a problem with third-party raters who are unknown to the respondent. The correlation is not affected if both A and B use the same linear transformation of their real evaluation into a report, but it will be exaggerated if part of both A's and B's answer reflects a norm belief that people "should" score 8 out of 10 on subjective well-being scales.

Physiological and Neurological Evidence

Instead of relying on others' judgements, individuals' well-being scores can be examined in relation to various physiological and neurological phenomena. It is known (see [START_REF] Shizgal | On the Neural Computation of Utility: Implications from Studies of Brain Stimulation Reward[END_REF][START_REF] Fernández-Dols | Expression of emotion versus expressions of emotions: Everyday conceptions about spontaneous facial behavior[END_REF][START_REF] Sandvik | Subjective well-being: the convergence and stability of self and non self report measures[END_REF] that there is a strong positive correlation between emotional expressions like smiling, and frowning, and answers to wellbeing questions. [START_REF] Ito | The psychophysiology of utility appraisals[END_REF] showed that positive and negative emotions are associated with the extent of the startle response, and various measures of facial expressions (facial electromyography).

A recent literature has looked at the relationships between positive and negative states, on the one hand, and neurological measures, on the other. Obtaining physical measures of brain activity is an important step in showing that individuals' self-reports reflect real phenomena. 14Particular interest has been shown in prefrontal brain asymmetry. 15 In right-handed people, positive feelings are generally associated with more alpha power in the left prefrontal cortex (the dominant brain wave activity of awake adults are called alpha waves), and negative feelings with more alpha power in the right prefrontal cortex. 16 This relationship was initially suggested by the observations of patients with unilateral cortical damage (see [START_REF] Davidson | Well-being and affective style: neural substrates and biobehavioural correlates[END_REF]), but more recently has been explored using techniques to measure localised brain activity, such as electrodes on the scalp in Electro-encephalography (EEG) or scanners in Magnetic Resonance

Imaging (MRI).

A recent example is [START_REF] Urry | Making a life worth living: Neural correlates of well-being[END_REF]. In this study 84 right-handed individuals (drawn from the Wisconsin Longitudinal Study) provide answers to questions on positive and negative affect, measures of hedonic well-being using global life satisfaction scores, and measures of eudaimonic well-being, which are designed to capture elements such as mastery, relations with others, self-acceptance and purpose. Brain activity is measured via EEG. Left-right brain asymmetry is shown to be associated with higher levels of positive affect, and with both hedonic and eudaimonic well-being. Interestingly, the correlation between brain asymmetry and positive affect explains all of the correlation with hedonic well-being, but only some of the correlation with eudaimonic well-being; in other words, left-right asymmetry is not just about pleasurable feelings. [START_REF] Davidson | Well-being and affective style: neural substrates and biobehavioural correlates[END_REF] describes further work in which left-right asymmetry is associated with quicker recovery from negative affect challenge (i.e. "shocks" to happiness), over and above its effect on baseline well-being.

Brain asymmetry is also associated with physiological measures, such as cortisol and corticotropin releasing hormone (CRH), which are involved in response to stress, and with antibody production in response to influenza vaccine [START_REF] Davidson | Well-being and affective style: neural substrates and biobehavioural correlates[END_REF]. In general, it seems that brain asymmetry is not only associated with measures of subjective well-being, but general measures of wellness of the organism's functioning.17

Given the general positive outcomes associated with brain asymmetry, it is important to know how the latter comes about. It seems likely that there is a role for genetics, with recent work showing that the form of a certain gene involved in regulating the serotonin system (5HTT) is a predictor of neuroticism, which is related to left-right asymmetry (see [START_REF] Nettle | Happiness: The Science Behind Your Smile[END_REF].

However, the degree of asymmetry is far from being a fatality. [START_REF] Huppert | Positive emotions and cognition: developmental, neuroscience and health perspectives[END_REF] underlines the plasticity of the brain in the young, and [START_REF] Davidson | Well-being and affective style: neural substrates and biobehavioural correlates[END_REF] describes the role of early social experiences in determining some aspects of brain circuitry. In adults, it is possible to manipulate this left-right balance by showing respondents pleasant or unpleasant pictures or films, and also by using magnetic fields to stimulate activity in the left frontal portion of the brain. [START_REF] Davidson | Well-being and affective style: neural substrates and biobehavioural correlates[END_REF]Davidson ( , p.1407) also mentions some intriguing results from a controlled experiment in which those randomly assigned to a meditation group (compared to a neutral control) showed an increase in left-right brain activation; remarkably the meditation group also showed an increase in antibody production in response to influenza vaccine relative to the control group. Although the long-run duration of these effects is not known, it is clear that "the wiring in our brains is not static, nor irrevocably fixed" [START_REF] Davidson | Well-being and affective style: neural substrates and biobehavioural correlates[END_REF].

Test-Retest Correlation

Whereas the other approaches mentioned here concern validity (i.e. is the measure correlated with the underlying construct of interest?), test-retest correlations are used to evaluate instrument reliability (i.e. do you obtain the same outcome when you repeatedly apply the measure?). The reliability of a measure is defined by [START_REF] Larsen | Measurement issues in emotion research[END_REF] as the degree to which measures reflect the 'true' amount of the construct. As this latter aspect is unobservable in many domains, they note that "For certain psychological constructs, a test-retest correlation is a good estimate of reliability" (p.42). This does suppose, however, that the underlying construct is stable over time (so that any differences found will be between individuals), and it is arguable to what extent well-being measures fall into this category. Testretest correlations of happiness are high when the measures are taken fairly close together, partly because the personality element (the fixed effect) does not change but also because many individuals' lives change little from one month to the next. It is worth noting that when changes do occur (such as marriage, divorce, unemployment, birth of first child and so on), there are sizeable movements, in the expected direction, in subjective well-being.

Predicting Outcomes

Perhaps the evidence that is most persuasive to economists is that respondents seem to act on what they say i.e. they behave as if they were maximising their subjective well-being. Many panel data studies have found that subjective well-being at time t predicts future behaviour, in that individuals clearly choose to discontinue activities associated with low levels of well-being (see [START_REF] Kahneman | When more pain is preferred to less: Adding a better end[END_REF][START_REF] Frijters | Do individuals try to maximize general satisfaction[END_REF][START_REF] Shiv | The impact of anticipating satisfaction on consumer choice[END_REF]. A number of labour market studies have shown that job satisfaction is a strong predictor of job quits, even when controlling for wages, hours of work and other standard individual and job variables (see, for example, [START_REF] Freeman | Job satisfaction as an economic variable[END_REF][START_REF] Clark | Job satisfaction, wage changes and quits: Evidence from Germany[END_REF][START_REF] Clark | What really matters in a Job? Hedonic measurement using quit data[END_REF][START_REF] Kristensen | Job Satisfaction and Quits --Which Job Characteristics Matters Most?[END_REF]. A recent example using data on the self-employed is found in [START_REF] Georgellis | Pecuniary and non-pecuniary aspects of self-employment survival[END_REF].

Clark (2003) shows that mental stress scores on entering unemployment predict unemployment duration: those who suffered the sharpest drop in well-being upon entering unemployment were the quickest to leave it.

The medical literature has also found high correlations in the expected sense between low well-being scores and coronary heart disease [START_REF] Sales | Job dissatisfaction as a possible risk factor in Coronary Heart Disease[END_REF], strokes [START_REF] Huppert | Positive emotions and cognition: developmental, neuroscience and health perspectives[END_REF], suicide [START_REF] Koivumaa-Honkanen | Life satisfaction and suicide: A 20 year follow-up study[END_REF] and length of life [START_REF] Palmore | Predicting longevity: A follow-up controlling for age[END_REF][START_REF] Mroczek | Personality Change Influences Mortality in Older Men[END_REF]. Individuals with higher life satisfaction scores were less likely to catch a cold when exposed to a cold virus, and recovered faster if they did [START_REF] Cohen | Emotional style and susceptibility to the common cold[END_REF]. Lastly, measures of life satisfaction have also recently been shown to predict future marital break-up (Gardner and Oswald, 2006a). 18Overall, the growing economics of happiness literature is testament to the fact that a growing number of economists believe that self-reported well-being data contain valuable information that can complement our understanding of individual behaviour. In terms of the specific subject of this review, happiness data are the cornerstone of the Easterlin paradox; the following section asks whether the same data can be used to resolve this paradox, by demonstrating the importance of social comparisons and adaptation.

Income and Happiness: Evidence and Explanations

Here we focus on the main explanations that have been proposed to reconcile the Easterlin Paradox, as illustrated in Figures 123, and the stylised facts that have emerged from the empirical literature showing a significant positive relationship between income (changes) and happiness (changes) at both the microeconomic and macroeconomic levels. These explanations mainly appeal to the existence of relative terms in the individual utility function. These comparisons may concern others, or oneself in the past, evoking the possibility that individuals adapt or 'get used to' their changing income [START_REF] Easterlin | Income and happiness: Towards a unified theory[END_REF]. After showing how both types of comparison can be presented as simple extensions to the standard economics textbook utility function, we discuss recent work that has shed new light on the degree to which individuals do compare themselves to others (or to themselves in the past or the future). We conclude by highlighting a number of other candidate explanations for the Paradox, which emphasise some of the empirical difficulties facing researchers in this field of study.

Consider a utility function of the form:

(1)

* 1 2 3 1 ( ( ), ( | ), u ( , )) t t t t t U U u Y u Y Y T l Z = t - t
where is a common function over all individuals indicating how the subutilities are combined into final utility ; the subscript t refers to time. Here is (a monotonic transformation of) utility for which reported happiness or life satisfaction is taken to be a useful empirical proxy. We will most often interpret as individual happiness or life satisfaction, both in terms of experienced and decision utility [START_REF] Kahneman | Back to Bentham: Explorations of experienced utility[END_REF], but in some specific instances we will use it to measure the aggregate happiness of all individuals in a given geographical area. In this specification, is the vector of incomes from t=0 to t and can be thought of as the classic function showing utility from consumption, which is increasing at a decreasing rate in its argument. As we are thinking of a vector of incomes in general, past incomes may affect current consumption, for example via wealth. In a one-period model, or in a model without savings, income will equal consumption , so that .

(.)

U 1 2 3
, , and u u u (.)

U t U t U t Y t y 1 (.) u t c 1 1 1 ( ) ( ) ( ) t t u Y u y u c = =
The subutility function picks up the influence of leisure, , with denoting hours at work, and a vector of other socio-economic and demographic variables, 3 ( ,

t t u T l Z - 1 ) ( ) t T l - t l 1t Z .
While the first and third parts of the utility function in (1) are standard, the second is less so, and shows the influence of status or habituation. The economic analysis of such relative income effects (or more generally, interdependent preferences) can be dated back to at least Veblen (1899), and then [START_REF] Duesenberry | Income, Saving and the Theory of Consumer Behavior[END_REF]. More recent contributions include [START_REF] Pollak | Interdependent preferences[END_REF][START_REF] Frank | Choosing the Right Pond[END_REF] and Elster and Roemer (1991) The variable is often called 'reference group' or 'comparison' income, and the ratio of [START_REF] Blanchflower | Well-being over time in Britain and the USA[END_REF][START_REF] Frijters | Can the large swings in Russian life satisfaction be explained by ups and downs in real incomes[END_REF][START_REF] Luttmer | Neighbors as negatives: Relative earnings and well-being[END_REF]. Another method is to use regression analysis to predict the income of 'someone like me', where the regression controls for individual characteristics such as age, sex, education and region (examples include [START_REF] Clark | Satisfaction and comparison income[END_REF][START_REF] Mcbride | Relative-income effects on subjective well-being in the cross-section[END_REF][START_REF] Senik | When information dominates comparison: A panel data analysis using Russian subjective data[END_REF]. Alternatively, the income of family members, friends or colleagues can be used to measure .

y t /

* t y

The above reference groups can be thought of as external. A parallel literature has examined internal reference points, specifically the individual's own past income or income aspirations for the future (see, for example, [START_REF] Mcbride | Relative-income effects on subjective well-being in the cross-section[END_REF][START_REF] Knight | Subjective well-being and its determinants in rural China[END_REF][START_REF] Stutzer | The role of income aspirations in individual happiness[END_REF]. [START_REF] Kimball | Utility and happiness[END_REF] provide a fuller review of work on the psychology of adaptation and reference points. In the next two sub-sections, we consider external reference groups, before turning to adaptation and aspirations.

Social Comparisons

To illustrate the main forces at work when individuals compare to others, consider the following stylised implication of the relationship between income and happiness across countries when: i) income is the only systematic difference between countries (so that we can relegate u 3 in equation ( 1) to a constant and ignore it); and ii) reference income is average income within the country. This case is depicted in Figure 4, for the function: The functional form here is deliberately chosen to ensure that the benefit of an across-the-board proportional rise in income tends to zero as income goes to infinity: a general rise in income leaves the second term unchanged, and produces a change in the first term which tends to zero as income increases. Note that this is not true of the formulation in (2) where a growth in logincome by x will increase utility by x 1 β for any level of income.

The main prediction of this model is that the gradient between income and happiness is steeper within a country at a point in time, than over time by country. This is because of the status benefit of high income within a country. Crucially, however, this status benefit has no aggregate impact on country-level happiness (in this model, the more status one person has, the less others have: status is a zero-sum game). Over time in a given country, the only effect of income on aggregate happiness will be via the consumption component of the utility function (u 1 ). the thick line). In the last period, where individuals are relatively rich, there is almost no aggregate benefit at the country level to higher income, but there is still a substantial individual status return to earning more.

This stylised illustration sums up a pervasive opinion over the last few decades about the relationship between income and happiness at the individual country level. The marginal utility from extra consumption approaches zero as countries become richer (in equation ( 2), this marginal utility equals β 1 /y; in the specification we use for Figure 4, it is β 1 A/(y i +A) 2 ). On the contrary, the marginal utility of extra status never approaches zero, because in general y* (reference group income) rises in line with own income, y. This model thus explains the [START_REF] Easterlin | Does economic growth improve the human lot? Some empirical evidence[END_REF] paradox and concurs with much of the psychological and some of the economic literature. At a point in time, those with higher incomes enjoy higher consumption and higher status (and are thus happier); over time, as everyone becomes richer, as the amount of status is fixed the only benefit to the country is from higher consumption, the value of which drops towards zero.

This simple model can be embellished by considering the relationship between income and happiness across several countries simultaneously, as in Di [START_REF] Di Tella | The macroeconomics of happiness[END_REF]. Here the authors estimate individual happiness equations over 12 countries and 18 years, controlling for not only individual demographic variables, but also country fixed effects, time dummies, and macroeconomic variables such as lagged GDP. They find, as [START_REF] Kapteyn | Individual welfare functions and social reference spaces[END_REF] had previously argued, that `social reference spaces' (reference groups) can include whole countries, and that happiness within a country is strongly positively correlated with GDP growth over the last year. This can be squared with the general observation that, over long periods of time, GDP and happiness are uncorrelated in richer countries by an expanded happiness function with two different kinds of comparison:

* * * 1 2 3 ln( ) ln( / ) ln( / ) ijt ijt ijt jt jt t ijt U y y y y y ' Z β β β = + + + γ * * (3)
Here is the happiness of an individual i in country j at time t, is average income in country j at time t; and is average income over the whole set of countries (say Europe) at time t. This happiness function is of the same nature as that appealed to in (2) to describe happiness within a country, but with an added component reflecting the income of one country relative to that in a set of other countries. This added component shows individuals' utility gain from living in a relatively successful country. If income in all countries grows at the same pace, then will remain unchanged. In this case, the discussion applied to Figure 4 is valid for each country, although individual countries at a point in time may be on different portions of the unbroken line, depending on their income level. However, if one country's GDP grows relative to that of its neighbours, then will change, and the high-growth country will enjoy greater happiness. The best outcome for each country is to have high income while its neighbours have low incomes. However, unless one country can increasingly outstrip its neighbours, the additional benefit of more

β β γ = + + - (4
| t i t t i t y y y y it it it t U U y y = ∂ ∂ + ∂ ∂ | =
, which is the effect of additional income in the country when everyone's income increases at the same time (i.e. when all individuals make the same choice). This effectively removes the status benefit of higher income. The second curve lies below the first due to the negative externality of in the term

t y 2 ln( / ) it t y y β . Individuals choose income of Y2,
where their marginal utility of income is zero, whereas the societal optimum, taking externalities into account, is at the lower income of Y1. It is tempting to relate Figure 5 to the literature on excessive work hours (see [START_REF] Schor | The Overworked American: The Unexpected Decline of Leisure[END_REF].

The above illustrations considered, for simplicity, reference groups defined at the country or supra-country level, but the same argument holds when reference groups are defined at a finer level. The empirical literature has typically appealed to more disaggregated reference groups.

This is partly for intuitive reasons of social distance (people living in London are more likely to compare themselves to other Londoners than to people living in Glasgow or Cardiff; people compare more within their age cohort than outside of it), and partly to obtain sufficient variation in comparison income, , to allow for a tight estimate of its coefficient.

* t y

Evidence of Social Comparisons

A rapidly growing number of econometric studies use survey data on happiness or life satisfaction to evaluate the importance of 'absolute' versus 'relative' income. This corresponds to estimating the relative size of the coefficients β 1 and β 2 in (2). Here we first concentrate on the contributions from the econometric estimation of subjective well-being including reference group income as an explanatory variable, before turning to a variety of other approaches that have revealed evidence consistent with a concern for status in the utility function.

Empirical tests of social comparisons over income require candidate measures of . One such candidate is the income of "people like me" (i.e. those with the same age, education etc., who are doing the same kind of job). This reference group income can be calculated in two different ways. We can either estimate wage equations and then calculate the predicted income for each individual, as in [START_REF] Clark | Satisfaction and comparison income[END_REF], or, perhaps more simply, we can compute * t y cell averages (for example, average wage by region, sex and education). This latter calculation can either be carried out within the dataset, or matched in from an external source.

A crucial issue in the econometric literature is that of identification: is typically estimated as a linear function of some explanatory variables X 1 in the wage equation approach. To then identify the effect of on happiness, we need either exclusion restrictions (some variables which appear in X 1 but which do not enter the happiness equation), or identification directly from the functional form (such as when the prediction of enters in a different functional form in the happiness regression to the variables in X 1 ). The cell average approach relies on more hidden exclusion restrictions in that it relies on the assumption that individuals compare themselves only to average incomes in the same cell and that other incomes do not enter at all. Probably the first economist to estimate subjective well-being equations using both y and was Dan [START_REF] Hamermesh | Economic Aspects of Job Satisfaction[END_REF]. Although Hamermesh's focus is upon occupational choice and the effects of training in American data, and he does not discuss relative income in detail, his job satisfaction regressions include the residual from a wage equation as an explanatory variable.

This residual, yin our terminology, has a positive and significant effect on job satisfaction.

* t y * t y

The regression approach of calculating the income of "people like me" was also used by [START_REF] Clark | Satisfaction and comparison income[END_REF] on the first wave of British Household Panel Study (BHPS) data. The estimated coefficients on income and comparison income in a job satisfaction equation are statistically equal and opposite, which is consistent with a fully relative utility function: to paraphrase [START_REF] Easterlin | Will raising the incomes of all increase the happiness of all[END_REF], in these results increasing the income of all increases the happiness of no-one. Lévy-Garboua and Montmarquette ( 2004), and [START_REF] Sloane | Job Satisfaction, Comparison Earnings, and Gender[END_REF], using

Canadian and British data respectively, have also found evidence that econometrically-predicted comparison income is negatively correlated with job satisfaction.

Articles which calculate comparison income as a cell average, rather than an econometric prediction from individual data, include [START_REF] Cappelli | Satisfaction, Market Wages and Labour Relations: An Airline Study[END_REF] who find that pay satisfaction is negatively correlated with an outside "market wage", calculated by averaging pay for specific occupations in other firms (airlines, in this case). [START_REF] Clark | Satisfaction and comparison income[END_REF] [START_REF] Knight | Subjective well-being and its determinants in rural China[END_REF]. This paper appeals to cross-sectional information on 9,200 households in China, and thus refers to an economy which is very different from the Europe-North America nexus which has so far dominated the literature. The authors are not only able to identify the villages their respondents came from, but also confirm that 70% of individuals indeed see their village as their reference group (by simply asking them to whom they compare themselves), making their rural sample well-suited to the question of how important reference groups really are. Controlling for own income, and for village income, those respondents who say that their income was much above the village average report far higher happiness than those who say that their income was much below the village average. The difference between the two estimated coefficients implies a happiness boost of one point, on a zero to four scale, making relative income the most important right-hand side variable.

The above work considers as the income of "people like me" or those living in the same neighbourhood. Another potential peer group is those with whom the individual comes into close daily contact: her family, friends and work colleagues. With respect to the latter, and despite the current abundance of microeconomic data, very few papers have related individual well-being to co-workers' wages. Indirect evidence has shown that observable behaviour (quits) * t y depends on own wage relative to colleagues' wages [START_REF] Galizzi | Relative wages, wage growth and quit behavior[END_REF]. One direct test is [START_REF] Brown | Does Wage Rank Affect Employees' Wellbeing? University of Warwick[END_REF], who use matched employer-employee data from the British Workplace Employee Relations Survey (WERS). Individuals were asked to report their satisfaction with the amount of influence they have, their pay, their achievement, and the respect they receive.

Controlling for own wage, the (normalised) rank of the individual in the firm wage distribution is correlated positively and significantly with all four measures of satisfaction (see their Table 6b).

The situation is equally sparse with respect to family and friends. [START_REF] Clark | L'utilité est-elle relative? Analyse à l'aide de données sur les ménages[END_REF] (1971). This project involved asking individuals to assign income levels (per period) to six different verbal labels (such as "excellent", "good", "sufficient" and "bad") and then, based on the values given, estimating for each individual a lognormal "Welfare Function of Income". The resulting estimated mean (µ) and variance (σ)

were then used as dependent variables in regressions which sought to explain which types of individuals require a higher level of income to be satisfied, and which individuals have valuations that are more sensitive to changes in income.

The results using cross-country data produced a number of important findings. In terms of this paper's subject, we would like to know who has a higher value of µ (i.e. who needs more money to be satisfied?). Comparisons to others were analysed via the inclusion in the regressions of reference group income (usually cell average income over age, education and certain other individual or job characteristics) as a right-hand side variable. The empirical results

(for example, [START_REF] Hagenaars | The Perception of Poverty[END_REF][START_REF] Van De Stadt | The relativity of utility: Evidence from panel data[END_REF] show that, ceteris paribus, the higher is the reference group's income, the higher are the levels of income assigned by individuals to the six verbal labels, as social comparisons over income would imply.

One of the very few papers ever to appeal to respondent-defined (rather than researcherdefined) reference groups is [START_REF] Melenberg | Micro-Economic Models of Consumer Behaviour and Welfare[END_REF] (respondent-defined) reference group is positively and significantly correlated with the estimate of µ from the WFI: those who associate with higher-earners need more money in order to describe their income as good or adequate.

A further source of evidence on the importance of comparisons to others comes from the burgeoning experimental economics literature on fairness. Survey evidence such as [START_REF] Kahneman | Fairness as a constraint on profit seeking: Entitlements in the market[END_REF] shows that people have strong views about fairness in economic exchange.

Laboratory evidence on ultimatum games [START_REF] Guth | An experimental analysis of ultimatum bargaining[END_REF][START_REF] Smith | Economics in the laboratory[END_REF] suggests that individuals will throw away real income to obtain a fairer division of a smaller pie. Perhaps even more explicitly, [START_REF] Zizzo | Are people willing to pay to reduce others' incomes?[END_REF] report the results of an experiment whereby subjects in an experiment can pay to burn each other's money. A majority of subjects chose to do so, even though it costs them real earnings. The average subject had half of her earnings burnt, and richer subjects were burnt more often. It is tempting to view these experimental outcomes in the light of some sort of comparative process. 20Social comparisons can also be demonstrated by asking individuals to express preferences over hypothetical outcomes. A: Your current yearly income is $50,000; others earn $25,000.

B:

Your current yearly income is $100,000; others earn $200,000.

It is specified that "others" refers to the average of other people in the society, and emphasised that "prices are what they are currently and prices (the purchasing power of money) are the same in States A and B".

All three papers find evidence of strong positional concerns over income, in that individuals say they are willing to give up absolute income in order to gain status (choosing A over B above). Further, two of the papers ask analogous questions with respect to other life domains, and compare the resulting taste for status. Finally, it would be useful to appeal to physiological and neurological evidence regarding status and relative income. A series of well-known studies 22 relates the level of serotonin in monkeys to status within the primate group, and show experimentally that it is status that produces serotonin, rather than the inverse. We are not aware of experiments that have shown that relative income is associated with physiological outcomes. Animal studies have examined neuronal activity when faced with pairs of rewards (here different flavours of fruit juice).

Previous testing allows a preference ranking over fruit juices to be established for each monkey.

The experimental results show that "striatal neurons do not process reward information in a fixed manner but relative to other available rewards" (Cromwell et al, 2005, p.522; see also [START_REF] Tremblay | Relative reward preference in primate orbitofrontal cortex[END_REF]. Equally, while there is some evidence that neuron firing is determined by the amount of relative reward within a gamble (i.e. relative to the amount that could have been won), income comparisons to other individuals have not to our knowledge figured in neurological research.

Adaptation

The second main explanation of the flat relationship between income and happiness over time is adaptation to the arguments of the utility function. Here we are principally concerned with adaptation to income, although recent work by economists and psychologists has covered other 21 The current survey concentrates on the relationship between income and utility, and the moderating role of comparisons. An active research area in social science concerns the extent of comparisons to others and habituation in non-income life domains, such as employment, marriage, and social activities: see [START_REF] Clark | Unemployment as a social norm: Psychological evidence from panel data[END_REF][START_REF] Clark | Happiness, habits and high rank: Comparisons in economic and social life[END_REF], and [START_REF] Clark | Let us pray: Religious interactions in life satisfaction[END_REF]. 22 Nicely summarised in [START_REF] Frank | Luxury Fever[END_REF], pp.140-142. There is an entire separate literature on health outcomes and status: see [START_REF] Marmot | Status Syndrome[END_REF] and [START_REF] Cherkas | The effects of social status on biological aging as measured by whiteblood-cell telomere length[END_REF] for example. Research has also shown that suicide is a function of relative income [START_REF] Daly | Keeping up with the Joneses and Staying Ahead of the Smiths. Evidence from Suicide Data[END_REF], and that suicide and para-suicide by the unemployed is actually higher in low unemployment regions [START_REF] Platt | Suicide and Unemployment in Italy: Description, Analysis and Interpretation of Recent Trends[END_REF].

life domains, such as unemployment, marriage, divorce and health. With income adaptation, individuals get used to their circumstances, so that changes in income have only transient effects. [START_REF] Frederick | Hedonic adaptation[END_REF] define adaptation as 'a reduction in the affective intensity of favourable and unfavourable circumstances', and the concept of reversion back to some baseline hedonic level following temporary highs and lows in happiness has been termed the 'hedonic treadmill' [START_REF] Brickman | Hedonic relativism and planning the good society[END_REF].

From an economist's point of view, a simple way of thinking of adaptation to income is in terms of an internal backward-looking reference point. We thus remain in the general framework of equation ( 2), but now consider that is formed from own past incomes. If the individual compares her own income at time t to (a geometric average of) that earned over the past three years, we would have:

* t y (5) * 1 2 * 1 1 2 3 1 2 1 2 ln( ) ln( / ) ( ) ( ) ( ) ln( ) [ln( ) ln( ) ln( ) (
β β β β α γ α γ -- - - - - - = + = = + - - --- 3 -
The final happiness equation to be estimated (the third line) consists of the logs of current income and income over the last three periods. This equation can in principle be extended to include further lags of current income; if aspirations are important (another internal reference point, but this time forward-looking) it may also include expected future incomes. One of the main implications of this specification is that the short-run effect of an increase in log income equals 1 β + 2 β whilst the long-run effect is only 1 β . This is obviously analogous to the social comparison case, where the marginal utility of higher income was greater when others' income remained constant than when others' income also changed. In terms of Figure 4, the short-run benefit of higher income is illustrated by the dotted lines, whereas the (flatter) thick line shows the long-run benefit.

Figure 6 illustrates a simple case where 1 β =0 (so that there is no consumption benefit from income), and α =γ =1/3, which corresponds to the situation where the short-run benefit of higher income dissipates linearly over the following three years. The top line denotes happiness and the lower line income. This latter is constant for the first two years, jumps at the beginning of year two, and remains constant thereafter. At the time of the income shock, happiness also jumps, but due to the gradual adaptation of reference income, happiness returns to its initial level by the beginning of period five. In this set-up, the only way to achieve permanently higher happiness is to have continually rising income. 23 We can turn to adaptation to explain the Easterlin paradox. Within a country, the richer are more likely to have received a positive income shock than are the poorer; they thus report greater happiness (quite apart from any consumption benefit of greater income). However, for average happiness to grow with GDP per head, we would require that greater GDP levels be positively correlated with GDP growth rates. Over the past forty years, this has not been the case within the OECD.

Evidence of Adaptation

There is a large literature in psychology that deals with the general issue of adaptation in many life domains (see [START_REF] Frederick | Hedonic adaptation[END_REF], but only a very few studies have focused on income adaptation (see the studies reviewed on their page 313). Perhaps the most famous example is that of [START_REF] Brickman | Lottery winners and accident victims: Is happiness relative[END_REF], who show using a very small sample of lottery winners (n=22) that such a positive income shock does not lead to a significant long-term difference in life satisfaction compared to a control group. 24 They propose an explanation based on the twin concepts of contrast (i.e. winning money opens up new pleasures but also makes existing pleasures less enjoyable) and habituation (winners get used to a new standard of living).

More recent examples of adaptation in non-monetary spheres are [START_REF] Lucas | Re-examining adaptation and the setpoint model of happiness: Reaction to changes in marital status[END_REF] and [START_REF] Lucas | Time does not heal all wounds -A longitudinal study of reaction and adaptation to divorce[END_REF] with respect to marriage and divorce, [START_REF] Wu | Adapting to heart conditions: A test of the hedonic treadmill[END_REF] and [START_REF] Oswald | Does happiness adapt? A longitudinal study of disability with implications for economists and judges[END_REF] for adaptation to illness or disability, and [START_REF] Lucas | Unemployment alters the set-point for life satisfaction[END_REF] regarding unemployment.

Here we are especially interested in adaptation to income changes. One early article is [START_REF] Inglehart | Aspirations adapt to situations -But why are the Belgians so much happier than the French? A cross-cultural analysis of the subjective quality of life[END_REF], who use pooled Eurobarometer data from ten Western European countries between 1973 and 1983 to show that life satisfaction and happiness scores are essentially unrelated to the level of current income, but are positively correlated with a measure of change in financial position over the past twelve months. Their conclusion is that aspirations adapt to circumstances, such that, in the long run, stable characteristics do not affect well-being.

In the same tradition, [START_REF] Clark | Are Wages Habit-Forming? Evidence from Micro Data[END_REF] European countries, and argue that some of their results on current and lagged GDP per capita show that "bursts of GDP produce temporarily higher happiness" (p.817).

The Leyden Group (e.g. [START_REF] Hagenaars | The Perception of Poverty[END_REF][START_REF] Van De Stadt | The relativity of utility: Evidence from panel data[END_REF][START_REF] Plug | Leyden Welfare and Beyond[END_REF][START_REF] Van Praag | The Welfare Function of Income in Belgium: An Empirical Investigation[END_REF]) explicitly attempt to measure the degree of adaptation to income. The cornerstone of this empirical work is the Welfare Function of Income, as described in Section 3.2 above.

Questions permitting a direct estimate of the income needed to achieve a fixed level of welfare were posed in the GSOEP, in the EUROSTAT surveys of the 1980s, in Russian panels, in the Dutch Socio-Economic Panel, and in various other surveys. The relationship between this required income level and the individual's past income can then be seen as a direct measure of adaptation, or as Van Praag (1971) calls it, "preference drift". The stylised finding for about 20

European countries is that a $1 increase in the income of a household leads to a 60 cents increase (within about 2 years) in what people consider to be a 'excellent', 'good', 'sufficient' and 'bad' income. Income adaptation is therefore high, but not complete in this methodology.

This individual-level result matches up with what is found at the aggregate level concerning subjective poverty (having an income lower than that was deemed minimal). European countries which are on average poorer (such as Greece and Portugal) are found to have many more respondents whose own income was below an insufficient level than richer European countries such as Germany or Switzerland. For instance, subjective poverty was about 3% in West Germany in the 1990s, but up to 90% in Russia in 1993 [START_REF] Van Praag | The measurement of welfare and well-being; The Leyden approach[END_REF]. [START_REF] Kahneman | Prospect theory: An analysis of decision under risk[END_REF] summarise a number of their results on preferences from small-scale surveys as being consistent with a model where "the carriers of value or utility are changes in wealth, rather than final asset positions that include current wealth" (p. 273). The empirical results from what remains a relatively small and new literature are consistent with individuals having a concern for rising income, independent of its current level. At the extreme, utility is only dependent on these changes and independent of the level of income.

A second individual-level reference point is aspirations. The concept is the same as that of adaptation: if aspirations rise with own actual income, then the effect of income on happiness will be muted.

As might be imagined, there is only relatively little work here, as it is difficult to know how to accurately measure income aspirations. 25 Easterlin (2005b) uses direct measures of aspirations to show that material aspirations (the big-ticket consumer items that make up the good life) seem to increase in line with ownership of such consumer items. However, this is not true with respect to marriage, where over forty percent of those who have been single their entire lives, and are aged 45 and over, cite a happy marriage as part of the good life. Two recent papers have taken different approaches to measuring income aspirations, and relating them to subjective wellbeing. [START_REF] Stutzer | The role of income aspirations in individual happiness[END_REF] combines the analysis of subjective data with the income evaluation work of the Leyden school, by using the answer to the Minimum Income Question26 as a measure of individual income aspirations (and thus one measure of y*) in a life satisfaction equation.

McBride ( 2006) introduces a novel way of calculating aspirations directly in a matching pennies game, where individuals play against computers. The computer chooses heads or tails according to (known) probability distributions (for example 80% heads, 20% tails). After each round of playing, individuals report their satisfaction with the outcome. McBride's first contribution is to introduce social comparisons in some of the treatments (by telling the individual the outcomes of the other players). Second, he is able to identify an aspiration effect by varying the heads and tails probabilities played by the computer. Each subject has five pennies to play. When paired with a 80% heads, 20% tails computer, the best strategy is to always play heads, which gives an expected payoff of four pennies. When paired with a 65% heads, 35% tails computer, the best strategy is still to always play heads, but now the expected payoff is only 3.25 pennies. By manipulating the probabilities, McBride creates variations in aspirations. The empirical analysis shows that satisfaction is a) higher the more one wins, b) lower the more others win, and c) lower the higher was the aspiration level.

Some neurological evidence is presented in [START_REF] Tobler | Adaptive Coding of Reward Value by Dopamine Neurons[END_REF], using animal studies.

Monkeys were conditioned to expect different small volumes of juice as rewards for successful task completion. The authors were then able to measure neuronal activity subsequent to a certain reward volume as a function of the conditioned expectation; they conclude that dopamine neurons encode value as "the difference between the reward value…and its expected value" (pp.1642-1643).

Do Social Comparison and Adaptation Explain the Easterlin 'Paradox'?

Some of the research that we have cited allows us to undertake tentative back-of-the-envelope calculations of the relationship between income and happiness. For example, we can take the key finding in the Leyden literature that adaptation over time accounts for around 60% of the effect of income (i.e. income's effect in the long run is only 40% of its effect in the short run), which corresponds closely to the results in Di Tella et al. (2005). We can further appeal to one of the best sources of information on the extent of social comparisons, [START_REF] Knight | Subjective well-being and its determinants in rural China[END_REF] finding that relative income is at least twice as important for individual happiness as actual income, even in poor regions (in their case rural China). Together, this suggests a utility function in which 2/3 of aggregate income has no effect because it is status-related, and thus disappears in a zero-sum game, and where 60% of the effect at the individual level evaporates within 2 years due to adaptation. Hence only around 13% of the initial individual effect will survive in the long run at the aggregate level. 27 Precisely such a happiness function is shown in Figure 4, which represents the basic aspects of the Easterlin 'Paradox' shown in Figures 1 and2. It is possible that even this small positive long-run effect may be an overestimate, as new generations or cohorts may start with higher aspiration levels than older generations. Any such intergenerational adaptation of aspirations would further diminish the long-run aggregate effect of higher income, but is at present still ill-accounted for in the literature.

Key Challenges in Empirical Work

Akin to many areas of applied economics, establishing the nature of the empirical relationship between income and happiness faces a number of challenges, even if we presume happiness is perfectly measured and conforms to experienced utility. Here we highlight a number of the key difficulties.

Firstly, economic theory often dictates that the relevant measure of welfare is consumption, not income, and that income in happiness regressions is only a noisy proxy for consumption [START_REF] Weinzierl | Estimating a Relative Utility Function[END_REF]. As such researchers will tend to underestimate the importance of material circumstances on happiness. [START_REF] Headey | The effects of wealth and income on subjective well-being and ill-being[END_REF] go some way toward addressing this issue. They use Australian panel data (HILDA) and find that 'net worth', which is arguably a better proxy for current consumption than a transitory measure of income, matters broadly at least as much as does income in determining happiness. As they conclude: 'the unimportance of material circumstances has been exaggerated'. The main reasons why consumption and income may differ are the consumption that individuals obtain directly from others, and deferred consumption via savings. Regarding the first of these, individuals in developed economies are provided with a great deal of consumption goods via the State, such as education, health care, and transfers-in-kind, which are only rarely taken into account in empirical estimations. If public goods consumption is not directly measured, then proxy variables, such as local area or country income, which are related to public goods via taxation, will pick up positive coefficients. This will pollute the status effect of aggregate incomes on happiness, suggesting that the coefficients on aggregate incomes in happiness regressions suffer from upward bias if public good consumption is not taken into account.

Even measuring personal consumption is difficult. Not only will individuals likely have difficulty in remembering how much of their income they have saved in financial assets, but more fundamentally it is difficult to establish empirically a clean borderline between purchases that have only current consumption benefits and purchases with some future consumption benefit. How much of a car or a house purchased today should be counted as current consumption and how much as future consumption? How much is education current status consumption, and how much is it an investment? Issues such as these, which relate to the majority of major purchase decisions, are very tricky and create a significant rift between theoretical models and empirical estimates of consumption. If we do use individual income instead of consumption in happiness regressions, we should remember that income is an overestimate of what is consumed when young (when we save) and an underestimate when old (when we dis-save). Forcing income to have a single coefficient over all ages then implies an upward bias in the effect of age on happiness.

The second major empirical difficulty, as already briefly mentioned above, is to correctly identify reference groups, especially when individuals move a great deal in their lifetimes and reside in high population-density areas. Only very few studies ask individuals about their reference groups, rather than simply imposing one. As noted in Section 3.2, [START_REF] Melenberg | Micro-Economic Models of Consumer Behaviour and Welfare[END_REF] asks respondents directly about the income of the people with whom they interact often. We are only aware of one study where respondents were given a list of options and asked to explicitly state to whom who they compare themselves. We have already noted that in [START_REF] Knight | Subjective well-being and its determinants in rural China[END_REF], 68% of survey respondents in China reported that their main comparison group consisted of individuals in their own village, whereas only 11% stated that their main comparison group consisted of individuals from outside of the village. 28 Nearly all of the rest of the literature has had to assume a particular reference income, and therefore inserts variables into the empirical model such as the individual's predicted income according to her characteristics or the income in some geographical area, which is less convincing. The generic problem with using constructed reference groups is that they might pick 28 Wave 3 (2006) of the European Social Survey will go some way to filling this lacuna. Individuals are first asked "How important is it to you to compare your income with other people's incomes?" They are then asked "Whose income would you be most likely to compare your own with?", with responses on a showcard of Work colleagues, Family members, Friends, and Others.

up effects other than social comparison: average income by geographical area will likely also measure local public good consumption; co-workers' income may pick up measurement error in own reported income; and income predicted from a regression may reflect own expected future income. Therefore, in the absence of clean measurement of reference groups, we have to be cautious when claiming to know the full importance of social comparisons over income.

A third point is that the group of individuals (or countries), to whom individuals compare is assumed to be exogenous, and not a matter of choice. [START_REF] Falk | Choosing the Joneses: Endogenous goals and reference standards[END_REF] ask what happens if individuals can partly choose their reference group. 29 To obtain interior solutions for this choice, the psychological literature has distinguished between 'self-enhancement' and 'self improvement' motives. A concern for status implies that individuals will choose low-income reference groups: this is 'self-enhancement'. In the extreme, everyone would compare themselves to the poorest individual(s), which clearly does not fit reality. The 'self improvement' motive then posits some indirect benefit to having a higher-income reference group. One such benefit works through the cost of effort: "people perform better and are more successful if they set themselves high goals or compare with high reference standards" (p. 421).

The main result of Falk and Knell's model is that the endogenously-chosen reference level increases with individual ability (as measured by the rate of transformation of effort into output), so that higher-ability individuals will choose higher-income reference groups. The choice of reference group will then be based on the trade-off between status and the higher output that comes from lower effort cost. [START_REF] Rablen | Endogenous Reference Level Formation as a Solution to a Problem of Self-Control[END_REF] considers an explicit dynamic model where agents face self-control problems (there are future benefits from current effort). He shows that the "planner", who maximises the individual's intertemporal utility, may find it optimal to introduce a reference level into the utility function. The optimum reference level comes from the trade-off between the direct utility cost of evaluating outcomes relatively and the future benefits from higher current effort levels. Stark (2004a[START_REF] Stark | Rethinking the Brain Drain[END_REF][START_REF] Stark | Status aspirations, wealth inequality and economic growth[END_REF] has written a number of papers which appeal to reference group choice to better explain migration decisions of heterogenous individuals. We will return the possibility of endogenous reference group formation in Section 4, but note here that the empirical happiness literature is still in its infancy on this issue.

A fourth challenge concerns the timing of income changes: the empirical prediction from the loss-aversion hypothesis of [START_REF] Tversky | Loss aversion in riskless choice: A reference-dependent model[END_REF] is that the absolute effect of a loss of one dollar, from an initial reference position, on individual happiness is greater than the effect of a gain of one dollar. Any test of this prediction, which is highly relevant for many economic phenomena (see Section 4), will require precise observation of both the timing of income movements and the timing of reference income movements. Panel data, in which individuals are typically interviewed only once per year, is consequently severely limited in its ability to distinguish asymmetric happiness responses to incomes that are above and below the reference position. At present, only experiments can address this asymmetry, but even these face wellknown limitations: experimental subjects are very often non-representative; the laboratory situation itself may lack realism; and laboratory experiments on social phenomena are inherently unsuitable for the measure of meaningful adaptation (such as the adaptation of reference groups) as subjects cannot be kept in the laboratory for sufficiently long periods of time. Until we can better track movements in both income and reference income, the loss-aversion hypothesis will remain difficult to verify in this literature.

A fifth challenge is to deal with the issue of missing variables. No data set has all the variables one might wish and their absence leads to problems. Missing variables lead onto the issue of the endogeneity of key variables, the issue of spurious relations between income and happiness, and the problem of slope heterogeneity.

The first effect of missing variables is to lead to potential endogeneity of income, as noted in Section 1. It is not unlikely that happy people, or, equivalently, individuals with 'happy' personality traits, are more likely to obtain better jobs (see [START_REF] Lyubomirsky | The benefits of frequent positive affect: Does happiness lead to success[END_REF]; [START_REF] Barker | The developmental origins of well-being[END_REF] similarly concludes that many later life outcomes depend on adverse influences during early development, and specifically links both income and depression to birth size. Lacking personality traits and early life influences as variables in the data implies that income becomes endogenous. Drawing on these arguments, Ferrer-i-Carbonell and Frijters (2004) find in GSOEP data that the partial correlation coefficient between changes in income and changes in happiness is smaller than that between levels of income and levels of happiness. They advocate panel data techniques to account for unobserved fixed individual traits that produce endogeneity problems.

However, even fixed-effect estimation will not identify time-varying factors that lead to both greater happiness and higher income, producing spurious correlation. Good health, which allows individuals to obtain better jobs and increases well-being, is a good candidate for a missing factor that may lead to a spurious correlation; marital stability and good relations with coworkers are other possibilities. While the omission of these types of variable in happiness regressions leads to an upward bias on the income coefficient, the reverse holds with variables that are themselves influenced by income and which are included as separate regressors in a happiness regression. Health again fits the bill, as does housing and even marital status: these outcomes are improved by higher incomes but are included in the regression as exogenous factors, so that the income coefficient is biased downwards. The balance of such conflicting effects is hard to predict.

Recent years have seen a number of papers appealing to natural experiments to skirt the issue of endogeneity by providing some exogenous variation in income. 30 Frijters et al. (2004a, 2004b, 2006) consider the large changes in real incomes observed in East Germany (following reunification) and Russia (following transition) as exogenous, and find a greater effect of income on happiness than in much of the existing literature. [START_REF] Gardner | Money and Mental Wellbeing: A Longitudinal Study of Medium-Sized Lottery Wins[END_REF] use information on lottery winnings in the BHPS as exogenous income movements. In both level and panel equations, lottery winnings are found to significantly reduce mental stress scores. It is worth underlining that natural data will only very rarely produce truly exogenous income movements, although this is an issue for all the work in applied microeconomics for which income is important.

Missing variables at the aggregate level are an important worry since any variable that correlates positively with income and negatively with happiness may, if excluded from the data,

give the false impression that income does not lead to greater happiness and would thus be able to explain the Easterlin Paradox. Some candidates which might spring to mind in this context are pollution, social capital, and hours of work. Can any of these indeed explain why growth is not making us happier? Probably the most detailed attempt at tackling this research question is Di Tella and MacCulloch (2005) using 23 years of Eurobarometer data and 28 years of American GSS data. They examine a series of potential omitted variables which could explain why increasing income has not led to more happiness. These are life expectancy, pollution (measured as kilograms of Sulphur Oxide emissions per capita), unemployment and inflation, hours worked, the divorce rate, crime and income inequality. Their empirical results show that most of these are correlated with life satisfaction in the expected manner. However, their inclusion as right-hand side variables does not explain why rising income has not produced rising well-being because, like income, these additional variables also improve over time without increasing happiness: in their own words "introducing omitted variables worsens the income-withouthappiness paradox".

Missing variables may also lead to different individuals having a different marginal benefit from income i.e. 'slope heterogeneity'. Presuming the same coefficient on income over the whole sample may not be appropriate if there are important interacting variables omitted from the data. Has the literature found any such interacting variables? The answer appears to be yes: a recent example is [START_REF] Lelkes | Tasting freedom: Happiness, religion and economic transition[END_REF], who shows that the religious were less affected, in life satisfaction terms, by income movements during economic transition in Hungary. If religiosity were a missing variable in this example, there would have been slope heterogeneity on unobservables in Hungary. Clark et al. (2005) argue that such slope heterogeneity is likely to be present in many more settings and propose to identify it on functional form assumptions on the error term and the allowed types of slope heterogeneity. They use latent class techniques applied to three waves of European Community Household Panel data to identify four different classes, in terms of both intercept and the estimated coefficient on income in financial satisfaction equations.

A sixth and final challenge is the issue of the estimation method. Frey and Stutzer's (2002a) plea for greater use of panel techniques to overcome some of the missing variables problems signalled above has largely been heeded. However, little attention has been paid to the exact specification of the independent variables and one can think of many non-linearities that may be important in actual work but that are usually ignored. In particular, the consensus use of log income in well-being equations may hide important deviations for log-linearity. What it may miss is the presence of kinks, not only over time (as in loss-aversion), but also regarding comparisons to others: is the return to having one dollar more than the neighbour the exact opposite as having one dollar less? Better data and more flexible estimation techniques are needed to address this challenge.

Some Implications for Economic Theory and Policy Design

We now turn to a discussion of the implications for economic theory and policy design of social comparisons and adaptation. Some of these implications have been presented in general terms (e.g. Frey and Stutzer, 2002a;[START_REF] Layard | Happiness. Lessons from a New Science[END_REF][START_REF] Di Tella | Some uses of happiness data in economics[END_REF]), but we here provide a more formal and wide-ranging discussion of these economic issues. In particular we focus on the core issues of economic growth, labour supply, wage profiles, optimal taxation and consumption, savings and investment, and migration.

Economic Growth

We start with the ongoing debate about whether economic growth leads to greater happiness. [START_REF] Easterlin | Does economic growth improve the human lot? Some empirical evidence[END_REF][START_REF] Easterlin | Will raising the incomes of all increase the happiness of all[END_REF] and others since (e.g. [START_REF] Lane | The Loss of Happiness in Market Economies[END_REF] have argued that economic growth in Western countries does not lead to greater happiness, backed up by the fact that happiness levels are essentially flat in Western countries over time (Figures 1 and2). Yet, in countries that started out from much lower levels, income growth has been associated with modest increases in happiness (Frijters et al., 2004a(Frijters et al., , 2004b[START_REF] Frijters | Can the large swings in Russian life satisfaction be explained by ups and downs in real incomes[END_REF]. In terms of the models described in Section 3, it can be argued that most developed countries appear to be at a point of personal consumption c t where the marginal utility from is minimal, while for poorer countries there are still gains to be had in from higher personal consumption. Further economic growth in developed countries then has little aggregate effect because reference incomes increase in line with income, producing no change in with higher income. This explanation for the Easterlin Paradox has been widely adopted (see, for example, [START_REF] Easterlin | Will raising the incomes of all increase the happiness of all[END_REF][START_REF] Easterlin | Income and happiness: Towards a unified theory[END_REF][START_REF] Veenhoven | Quality-of-life in individualistic society: A comparison of 43 nations in the early 1990's[END_REF][START_REF] Mcbride | Relative-income effects on subjective well-being in the cross-section[END_REF][START_REF] Layard | Happiness. Lessons from a New Science[END_REF]. Equivalent formulations are the assertion that at certain levels of development only conspicuous consumption is important, or that 'keeping up with the Jones's' is the main economic motive in rich countries.

1 ( )

t U c 1 ( ) t U c * 2 ( | ) t t

U y y

However, one possible weak point in this explanation is that it presumes that economic growth only affects consumption levels and has no effect on the distribution of income. If we relax this assumption, the effect of inequality on aggregate happiness also becomes relevant. For example, if we think of the second sub-utility function as concave, with everyone in the country sharing the same reference income (some national 'norm'), then it is immediate that at a given level of aggregate income, personal consumption and work choices, a country with a more unequal income distribution will be less happy on average: the additional status benefit of the individual with one dollar more than the norm does not compensate the additional status loss of the person with one dollar less than the norm. This is an additional rationale for pursuing income equality as a policy goal over and above the usual argument that consumption equality has welfare benefits due to concavity in the subutility . The effect of economic growth on happiness then hinges on the relationship between growth and inequality.

* 2 ( | )

t t U y y 1 ( ) t U c
There is also a flip side to the argument that greater economic prosperity at some point ceases to buy more happiness. It can be argued that it is actually the concern for relative income embodied in the second sub-utility function that keeps economic growth going beyond some wealth level. The argument here is that relative concerns are more important in rich countries, as personal consumption plays an increasingly marginal role: status is a luxury good. The driving force behind hard work in rich countries, despite high aggregate consumption levels, is the concern for status. This is indeed one possible evolutionary reason for having a term in the utility function in the first place [START_REF] Rayo | Evolutionary efficiency and happiness[END_REF]. This argument has a long ancestry in economic debates. ). Mandeville postulates that the first beehive would be happy but not very rich, and is ultimately doomed to be taken over by the second beehive where the bees are mainly motivated by status (by ). In that second beehive, the bees would keep working and looking for opportunities both within and outside their beehive to further their relative standing, leading to continual expansion and growth of the second beehive.

3 ( , Mandeville and Smith and many other early economists is made in theoretical models by [START_REF] Glomm | Growth-inequality tradeoffs in a model with public sector R-D[END_REF], [START_REF] Corneo | Status, the distribution of wealth, and growth[END_REF][START_REF] Corneo | Status, the distribution of wealth, and growth[END_REF][START_REF] Pham | Economic growth and status-seeking through personal wealth[END_REF]. The key aspect of these models is that they specify as , and as , where denotes wealth instead of income. These models abstract from the possibility of leisure, but it is the part of the utility function in these models that drives continued economic growth. A related argument in [START_REF] Fershtman | Social status, education, and growth[END_REF] is that social status is determined in part by relative education, therefore linking economic growth via education to status considerations.

t t U T l Z - 1 ) t k * 2 ( | )
1 ( )

t U c ln( ) t c * 2 ( | ) t t U y y * ln( ) ln( ) t k θ - t k * 2 ( | ) t t

U y y

Normatively speaking, the dominance of the status motive in the income/happiness relationship means the benefits of economic growth are not to be found in greater happiness.

There are other reasons indirectly related to utility that would still provide a rationale for economic growth, much in the vein of Mandeville's arguments: the link between the length of life and (aggregate) income; the link between the ability to withstand foreign aggression and economic activity; the ability to attract migrants when income levels are relatively high; and some status utility benefit to a country as a whole from having high income compared to other countries. Each of these elements relates to other literatures which we will only touch upon in the remainder of the paper.

Labour Supply

Mandeville and his successors predicted that labour supply would remain high during economic expansions, as a result of status motives. Along the same lines, [START_REF] Neumark | Relative income concerns and the rise in married women's employment[END_REF] note that in models where only personal consumption matters, with decreasing marginal utility of consumption, we should see falling aggregate labour supply as aggregate consumption rises, just as the bees in Mandeville's first beehive cease to work hard. In the utility function (1) above, however, there is a limit to the long-run reduction in labour supply with increasing consumption, because the relative term is independent of consumption. Neumark and Postlewaite argue that status concerns in the income/happiness link are the main reason why labour supply has not declined dramatically in the 20 th century, despite the very significant rise in consumption levels. The same conclusions arise if we consider the job, rather than the income associated with it, as the carrier of status: here too, labour supply will be relatively unresponsive to overall consumption levels. [START_REF] Woittiez | Social interactions and habit formation in a model of female labour supply[END_REF] and [START_REF] Vendrik | Unstable bandwagon and habit effects on labor supply[END_REF] point out that there may be intermediate factors between relative income concerns and labour supply decisions, such as social norms with respect to appropriate labour supply decisions that themselves in the long-run are determined by the payoffs to a more basic utility function. They also argue that female labour supply has increased in many countries as a result of changing wages, but more slowly than expected because the associated social norms took time to adjust.

Both [START_REF] Neumark | Relative income concerns and the rise in married women's employment[END_REF] and [START_REF] Park | The Second Paycheck to Keep Up With the Joneses: Relative Income Concerns and Labor Market Decisions of Married Women[END_REF] [START_REF] Layard | Happiness. Lessons from a New Science[END_REF] explicitly argues that labour supply implications of income comparisons provide a rationale for growth-reducing taxation designed to bring about greater leisure. In this context, note that the model in (1) can be extended by supposing that status games may involve not only income, but also time-investments. Veblen (1899) recognised this by talking about conspicuous consumption and 'conspicuous leisure'. This latter consists of all time investments whose main payoff is demonstrating to other people that one can afford to spend time on leisure:

examples might be showing off (productively) useless skills (such as speaking Latin, or playing a musical instrument), which signal an abundance of time not used to increase . The tax implication is now far less clear, as we would ideally want to tax all investments into status races equally, so as to promote non-conspicuous consumption and leisure. [START_REF] Layard | Human satisfactions and public policy[END_REF] even went so far as to recognise that one may want to sustain several status races rather than fewer, because more races have more winners. The question then arises how multiple status races can be sustained, all the while countering crowding-out effects on non-conspicuous consumption and leisure. [START_REF] Frijters | Materialism on the march: from conspicuous leisure to conspicuous consumption[END_REF] hypothesise that conspicuous leisure is lower in mobile environments because mobility reduces the visibility of leisure more than that of consumption.

Empirically, they find that US states with higher mobility rates also have higher aggregate levels of investment in conspicuous consumption (i.e. higher labour supply), both at any moment in time and through time.

> - = = - - - = ∑ (6)
where the second term reflects the lower marginal utility of income higher than relative to income lower than , so that there is a kink at . This reference income itself can be considered as some weighted average of previous incomes. Figure 7 illustrates this kind of utility function in the context of increasing or decreasing income profiles. For ease of illustration, reference income is set to equal income in the previous period. This figure is read as follows. In the top panel, where income rises over time, income at t exceeds reference income, , so that the individual is on the relatively flat part of the utility function. At time t+1, the reference income is now equal to y t , so that the whole utility function shifts to the right. As income at t+1 is higher than income at t, the individual is again on the flat part of the curve. As time goes on, the utility function shifts further and further to the right.

* t y

The opposite occurs in the lower panel, where the income profile is decreasing. To make the point that the same number of dollars are being disbursed in the two profiles, the income figures exactly match vertically. With the decreasing profile, the individual always receives less than her reference income, which is heavily penalised by this utility function. Consequently, utility is far lower under the decreasing income profile than under the increasing income profile, despite the actuarial value of the decreasing income profile being higher: any positive discount rate will produce higher present-discounted value from the profile with the higher income first. Note that we do not actually require loss-aversion for this conclusion, which is driven by the evolution of reference income over time, but that the kinked utility function reinforces the preference for growth. In fact, individuals will show similar preferences over two positively-sloped income profiles, where loss-aversion plays no role. The steeper profile will be preferred, ceteris paribus, as income at each period will be evaluated relative to a lower reference point (a lower past income), producing higher utility.

minimum consumption basket defining the poverty line in the US, or the 1$ a day poverty line used by the World Bank. However, [START_REF] Sen | Poor, relatively speaking[END_REF] and many others in the poverty literature have explicitly argued that relative concerns also matter for individuals, and that we should base the poverty line on relative rather than absolute consumption. In this vein, the OECD publishes statistics on the number of individuals whose income is below half of median income in member countries, and the European Union currently employs a poverty line set at 60% of median income. In terms of equation ( 1), these relative representations of poverty assume that the component of utility is the most important for individuals. The measurement of poverty via U 2 does however pose problems once we realise that the norm level of income, y t *, is liable to evolve over time. For instance, if depends on own past income, then, at a given level of own current income y t , an individual whose income just increased has a higher utility than someone whose income just decreased, so that poverty depends on both income levels and income profiles. In practise, taking income adaptation into account for relative poverty measures would be very difficult. No known definition of poverty considers it to be relevant whether a materially poor person enjoys more hours of sunshine than a rich person who suffers in a cold climate, even if the materially poorer person is happier. Implicitly, sunshine and all of the other non-income factors influencing happiness are considered as orthogonal to poverty, even though they are highly relevant for both happiness and individual decision-making. Poverty as currently operationalised concerns the sub-utilities and , instead of happiness proper (U). A more happiness-based poverty measure would take into account non-material elements to provide a broader picture of well-being (the lives that individuals live), and would also jar less with the commonplace observation that individuals freely make a number of choices that leave them materially worse off (such as having children).

1 ( )

t U c * 2 ( | ) t t
U y y

Optimal Taxation and Consumption

A burgeoning literature in recent years has addressed the optimal tax implications of utility functions which depend on relative income; this literature both relies on and produces predictions about the precise empirical properties of the income/happiness relationship. To our knowledge, this theoretical literature has not in the past been explicitly connected to the empirical happiness literature, despite there being clear potential gains from such integration [START_REF] Weinzierl | Estimating a Relative Utility Function[END_REF].

One of the most influential papers on optimal taxation is [START_REF] Frank | Choosing the Right Pond[END_REF], who adopts the following utility function:

0 0 1 ( , ( ), ) U U c R c c = (7)
where is the consumption of some positional good, potentially including both positional material goods (conspicuous consumption) and positional immaterial goods (conspicuous leisure). This first term of ( 7 is a pure externality: changes in rank have no social benefit even though they yield private benefits. This additional benefit of positional goods to an individual leads to societal over-consumption of positional goods, to the detriment of non-positional goods. Frank then points out that this externality produces a rationale for the taxation of the positional good, in order to promote the non-positional good. If we equate the positional good to relative income and the non-positional good to leisure, we obtain a rationale for income taxation in order to promote leisure. [START_REF] Layard | Happiness. Lessons from a New Science[END_REF] adopts this argument. 32 A number of other authors have adopted different specifications of the utility function, and of the reference position in particular, which affect the tax implications. For example, if we take the utility function in [START_REF] Ireland | On limiting the market for status signals[END_REF]:

0 1 0 ( ( , ), ( )) U U f c c s c = (9)
where is a good whose consumption is unobservable, and is status, specified as the belief spectators have about is too high, very much in the same mould as [START_REF] Boskin | Optimal redistributive taxation when individual welfare depends upon relative income[END_REF] and [START_REF] Frank | Choosing the Right Pond[END_REF].

Ljungqvist and Uhlig show that this externality can be perfectly countered by a constant marginal tax on , independent of the business cycle. The analysis is then extended by considering the reference position not as t c t c , but as 1 t c -i.e. average consumption last period. In the presence of aggregate productivity shocks, they find that optimal tax rates co-move with 32 There's an old literature arguing that 'social preferences' (including also altruism) can only be identified from observed transfers under restrictive assumptions (though direct utility measures do not suffer from this): see [START_REF] Oswald | Altruism, Jealousy and the Theory of Optimal Non-Linear Taxation[END_REF] on the difficulties for the case of taxation and [START_REF] Ng | Relative Income Effects and the Appropriate Level of Public Expenditure[END_REF] for the related problem of public good provision.

current productivity shocks, creating counter-cyclical effects of taxation on the economy. This is exactly in line with the usual Keynesian optimal tax policy which is also counter-cyclical.

Savings and Investment

A related recent theoretical literature has emerged on the dynamic effects of relative consumption concerns (status concerns). The papers we mention here abstract from the possibility of a term like and focus in the main on the timing of consumption. The key question addressed is the optimality of savings.

3 ( ,

t t U T l Z - 1 )
We might naïvely think that status does not affect savings, because the trade-off between current and future status would seem to be identical to the trade-off between current and future consumption. However, this line of thinking breaks down when we consider that individuals accumulate wealth over their lifetime, and that productivity generally increases, implying that in a stylised sense the reference income when 'old' is always higher than when 'young'. In this case, relative concerns will change the marginal utility of consumption over the lifecycle and therefore affect saving and investment decisions. Most of the generic arguments that arise can be illustrated via the utility function introduced by [START_REF] Abel | Asset prices under habit formation and catching up with the Joneses[END_REF], and subsequently adopted by a number of other authors:

(1 )(1 ) (1 ) ( ) * ( ) 1

t t t t c c U c η α η α α - - - = - % (11)
Here is own consumption and is the geometric mean of the consumption of a reference group, which can be construed as the rest of the population or some slowly-adjusting social norm containing past generations' or the individual's previous consumption. The parameter As such, when 0<α <1, individuals will want higher consumption when reference consumption is lower: individuals will want to plan consumption in the periods when other individuals are not consuming. This creates a coordination problem, as reference consumption results from simultaneous choices by everyone in the economy (for example if the reference point refers to average consumption by others). The difficulty in solving such a coordination problem in endogenous growth models has to date appeared unsurpassable [START_REF] Ljungqvist | Tax policy and aggregate demand management under catching up with the Joneses[END_REF][START_REF] Ljungqvist | Tax policy and aggregate demand management under catching up with the Joneses[END_REF][START_REF] Abel | Optimal taxation when consumers have endogenous benchmark levels of consumption[END_REF], simply assume that α >1). Even so, it seems intuitively plausible to presume that the marginal (status) utility of consumption is higher when the consumption of others is lower. Intuitively also, we might think that when 0<α <1, savings will be too low: individuals will not postpone consumption to the future as future general consumption levels then will likely be higher due to productivity growth.

We obtain exactly the opposite results when α >1, corresponding to the lower panel of Figure 8, which is the dominant assumption made in the literature. Here again, individual utility falls as reference consumption rises, but now the marginal utility of consumption increases.

Individuals will want to consume more when others consume more, producing a kind of herding phenomenon: status is then a bandwagon good in the terminology of [START_REF] Duesenberry | Income, Saving and the Theory of Consumer Behavior[END_REF]. There is no difficult coordination issue to solve as all consumers will want to consume at the same time. The corollary is that individuals all save too much at the same time, because they all want to consume more towards the end of their lives, when the consumption of others will also be higher due to productivity increases.

In the terminology of [START_REF] Dupor | Jealousy and equilibrium overconsumption[END_REF], the case with α >1 can be called 'Keeping up with the Joneses' and that with α <1 'Running away from the Joneses'. Crucially, the issue of whether the parameter α is in fact greater than one or not can in principle be empirically evaluated using happiness data, although this test has not to our knowledge been carried out to date. A simple method of obtaining the sign of (α -1) is obtained from the cross-derivative of equation ( 11):

2 (1 ) 1 ( 1)( ) t t t t t d U c c dc dc α η α η α - --- = - % % (12)
It follows from ( 12) that the sign of the interaction between own consumption and reference group consumption in a reduced-form regression should be the same as the sign of (α -1). [START_REF] Abel | Optimal taxation when consumers have endogenous benchmark levels of consumption[END_REF] focuses on this issue in an overlapping two-generation model with a utility function for the new-born of the form:

(

1 )(1 ) (1 ) (1 )(1 ) (1 ) 1 1 1 ( ) * ( / ) ( ) * ( / ) 1 1 t t t t t t t c c c c c c U η α η α η α η β α α - - - - - - + + + = + - - % α % (13)
where is own current consumption and is the geometric mean of the current consumption of everyone else alive. The term

t c t c % (1 )(1 ) ( ) t c η α - -
refers to the part of own consumption that is independent of others' consumption, and the term following β refers to future consumption.

The main result emerges when we consider the marginal effect of an increase in future consumption:

(1 ) 1 1 1 ( )

t t t t dU c c dc α η α β - -- + + + = % (14)
When α <1 we obtain the intuitive result discussed above: the marginal return to status consumption in the future is lower when 1 t c + % is higher, and therefore when there are general productivity increases. The externality from higher future consumption reduces savings, which makes the case for subsidies on savings. Again though, the equilibrium under α <1 cannot be solved analytically because of the coordination issue mentioned above. Abel thus mainly concentrates on cases with α >1, under which general productivity increases, leading to higher future reference incomes , actually increase the future marginal return to status, yielding a case for taxes on savings. [START_REF] Carroll | Comparison utility in a growth model[END_REF][START_REF] Carroll | Saving and growth with habit formation[END_REF] make a different point by adopting a utility function where the reference position only depends on the consumption of the individual herself in the past:

1 t c + %
(1 )(1 )

(1 )

( ) ( ) * ( ) 1 t t t t t s t t s c c U c c e c ds η α η α ρ α - - - - - -∞ = - = ∫ % % (15)
This is the same utility function as [START_REF] Abel | Asset prices under habit formation and catching up with the Joneses[END_REF][START_REF] Abel | Optimal taxation when consumers have endogenous benchmark levels of consumption[END_REF] but with what we called an 'internal reference' point in Section 3. Carroll et al. also concentrate on cases with α >1 and generically argue that there will be upward pressure from technological growth on savings, as individuals anticipate that the marginal return to future status will be higher. However, in the specification of the reference position , there is another effect, related to the speed at which the reference point adjusts to current consumption. When the rate of adaptation to consumption changes, ρ, is high, individuals essentially only compare to their own recent consumption, and when ρ is small (although always positive), adjustment is slow and consumption in the distant past remains important. Again, the value of this critical variable, the speed of adjustment, can in principle be measured in happiness regressions by the coefficients of past consumption on current happiness. [START_REF] Carroll | Saving and growth with habit formation[END_REF] also show that when adaptation is slow, it makes sense for individuals to save more as economic growth increases, despite the fact that future reference consumption levels will be higher. The intuition is that under slow adjustment, individuals wish to 'smooth out income increases' more than under fast adjustment. On the contrary, if the reference position adjusts quickly, individuals essentially want to enjoy the status benefit of higher productivity immediately. This model is used to rationalise the empirical regularity that high-growth countries also have high savings rates. It is difficult to reconcile this empirical fact with a model without reference positions affecting utility: in the latter, the marginal utility of future consumption is always lower as economic growth increases because future consumption is higher, leading to lower savings rates. Why save now if we are all going to be rich tomorrow anyway? Carroll et al.'s answer is that individuals want to adjust slowly to ever higher consumption patterns, and it therefore makes sense to save more now, simply to avoid getting used to high consumption too soon. This provides the link between savings and the speed of adaptation of reference consumption in happiness regressions. [START_REF] Constantinides | Habit formation: A resolution of the equity premium puzzle[END_REF] and [START_REF] Gali | Keeping up with the Joneses: Consumption externalities, portfolio choice, and asset prices[END_REF] use a similar utility function to address the equity premium puzzle. Constantinides notes that the existence of internal reference points over consumption provides an additional reason for individuals to only slowly adjust their consumption over time. [START_REF] Deaton | Understanding Consumption[END_REF] confirms this prediction by showing in US data that individuals over-smooth consumption after permanent income shocks. Constantinides goes further by arguing that the presence of creates a bias in conventional estimates of riskaversion, which are based on the tradeoffs people make over time: without we imagine that the savings rates of the rich would be greater than those of the poor with high risk-aversion. The fact that savings rates vary only little across income groups may lead us to conclude that riskaversion is actually quite low. Constantinides shows that the presence of breaks this logic, in that even with high risk-aversion the presence of a moving reference point leads all individuals to smooth income over time in a similar manner. This provides a rationale for instances of high instantaneous risk-aversion, in particular the large premium that individuals are prepared to pay for risk-free assets versus risky higher-return assets i.e. the equity premium puzzle. [START_REF] Campbell | By force of habit: A consumption-based explanation of aggregate stock market behaviour[END_REF] extend this idea to further types of asset pricing puzzles and argue that models including a reference point exhibit superior predictive power over models without such a term.

t c % t c % t c % t c %
One particular strand of the empirical income-happiness literature fits in well with savings models, namely the so-called 'tunnel-effect'. The original idea is attributed to [START_REF] Hirschman | The changing tolerance for income inequality in the course of economic development[END_REF], who argued that individuals could actually derive utility from others' higher incomes if they consider them to be informative about their own future income. [START_REF] Senik | When information dominates comparison: A panel data analysis using Russian subjective data[END_REF] (and the United States). The potential importance of the information role is underscored by the finding that reference group income is more strongly positively correlated with life satisfaction for those in more uncertain situations (as measured by the volatility of their income and the probability of losing their job, for example). [START_REF] Brown | Does Wage Rank Affect Employees' Wellbeing? University of Warwick[END_REF] find some evidence that pay satisfaction is positively correlated with average wages within the firm.

The simplest model in which a tunnel effect can arise is a two-period model where individuals only derive utility from their own consumption, but face the problem of saving in period 1 in order to consume in period 2. For example, consider:

1 2 2 2 1 1 1 1 2 2 ( ) ( ) 1 1 '( ) (1 ) '( ) 0 U u c u c c y c y r r dc u c r u c dy = + + = + + + → = + → > (16)
where lifetime utility U is now simply the sum of happiness in period 1, which depends only on period 1 consumption, and happiness in period 2, which depends only on period 2 consumption.

The budget constraint (with an interest rate of r) links period 1 consumption to period 2 income: the higher is period 2 income, the higher is period 1 consumption because of a reduced need for savings. Now imagine that period 2 income is in fact unknown by the individual decision-maker, who estimates her next-period income from the incomes of 'reference' individuals around her who share the same observable characteristics (region, education, gender, age, etc.). This produces a reduced-form lifetime happiness function in the first period that depends positively on the observed incomes of reference individuals. Neither adaptation nor social comparisons are needed to produce a relationship between happiness and others' income; although equally, under certain parameterisations, tunnel effects can be observed even if relative income or consumption matters.

The tunnel-effect model provides several pointers as to what we should expect to observe empirically when we add more information: (i) we should see a positive relationship between reference group income and own current consumption, over and above the effect of own income (because the higher is others' income, the lower are one's own savings); and (ii) we should observe that happiness is positively correlated with reported expected future income, and that the positive effect of reference group income on one's own happiness transits via expected future income. These tunnel-effect predictions are yet to be empirically tested.

Migration

Consider the decision whether to migrate or not. Without a term in the utility function, then all those who find more attractive income and leisure combinations in another country will leave. This conclusion changes if we allow for comparisons, and consider that migration might lead to changes in . For instance, if equals average income in the local neighbourhood or the average income of people like yourself at your workplace, then someone who fears ending up with low relative income in another country would not migrate, even if both leisure and the absolute income she could earn there are higher. [START_REF] Stark | Migration incentives, migration types: The role of relative deprivation[END_REF] appeal to this idea to explain why the elites in poor countries do not emigrate: the elite are at the top of the income distribution in the country they currently live, but may well not be so if they emigrate. Stark and Taylor further introduce the notion of different economic migrant types. In terms of equation ( 1), they argue that we would expect those with relatively high earnings potential in another country to move abroad e.g. those whose skills are relatively undervalued in the country of origin. Furthermore, we expect those who can keep individuals in their home (poorer) country as their reference group to be more likely to emigrate than those whose reference income adapts to the new country. The former can become high-status in their home country by earning more in the host country, yet they remain in a status sense part of the home country. This line of thinking can help to explain why many migrants keep visiting their home country: this is when they can cash in as relatively high earners compared to those in the home country, making it irrelevant whether those same incomes are high in the host country.

This kind of analysis yields two distinct possible migration dynamics. In the first, those who migrate do so voluntarily in spite of adaptation in the element of their utility function. That is, they have exceptionally high skills and can become high-status even in the host country and want to compare themselves to persons in the host country anyway. The first group of voluntary migrants is therefore made up of high-status assimilators, who Stark (2004a[START_REF] Stark | Rethinking the Brain Drain[END_REF][START_REF] Stark | Status aspirations, wealth inequality and economic growth[END_REF] identifies with the brain-drain phenomenon. The networks of these early migrants may lead to more migration of the same variety, but the fast assimilation of early migrants implies that they are not preoccupied by this, as their networks will not primarily consist of other migrants from the same home country. The second migration pattern is very different, and may well result from exceptionally low consumption in the home country (i.e. by ). For example, we can think of the Irish in the US being driven by the potato famine back home, forced migration in general, or the 'guest worker phenomenon' of the European Union where whole villages were essentially transplanted to other countries in the 1960's. These individuals will by design be less likely to assimilate, and have strong incentives to carry on comparing themselves to individuals in the home country. This results from their high wages relative to those in the home country and low wages relative to the host country. These migrants may for the same reason try to attract more low-skill individuals from the home country, as these latter do not detract from their own status but rather increase it by reducing the reference income they face in the host country. The two types of immigration, associated with two different parts of the income/happiness gradient, will therefore have very different cultural and economic implications for the host country. Countries such as Canada and Australia, who operate a points system adaptation. However, the empirical literature is still only beginning to grapple with the questions of differential paces of adaptation to life events. While there is now growing evidence regarding the misprediction of adaptation (see [START_REF] Riis | Ignorance of hedonic adaptation to Hemodialysis: A study using ecological momentary assessment[END_REF], and the research reviewed in [START_REF] Loewenstein | Hedonic Adaptation and the Role of Decision and Experience Utility in Public Policy[END_REF], the information required to advocate paternalism is currently far from complete.

Conclusions

One of the exciting developments within economics over the last decade has been the booming 'economics of happiness' literature, which has expanded in both theoretical and empirical directions. The basis for the empirical work has been the increasing evidence from both psychologists and economists that measures of individual well-being collected in surveys contain 'valid variability', in the sense that current happiness or satisfaction is a strong predictor of future behaviour. The wider acceptance of subjective well-being measures as a direct proxy for utility has consequently opened up a wide-range of opportunities to further inform theory and policy design. The happiness literature has in the last few years began to make major inroads in this respect. The analysis of subjective well-being data provides a valuable alternative, but complementary, approach to the revealed-preference framework that dominates the discipline of economics.

The two specific issues that have generated the most interest in the literature are (i) the effect of labour market status, and especially unemployment, on happiness, and (ii) the relationship between income and happiness. This paper has focussed on the latter, motivated by its central importance to economists and policy-makers. Our contribution has been to provide a new overview of the theoretical and empirical literature on income and happiness, bringing together the most recent research, and showing how the traditional utility function framework can be readily generalised to incorporate a range of observed behaviours. In particular, our main challenge has been to align the widely cited Easterlin 'Paradox', that of increasing real incomes in developed countries but with no noticeable increase in average happiness, with the large empirical survey literature that has found that income and happiness are positively related. In particular, a growing number of studies have been able to use some exogenous variation in income, to show a significant causal effect of income on happiness.

The broad consensus in the literature is that the paradox points to the importance of relative considerations in the utility function, where higher income brings both consumption and status benefits to an individual. These individual benefits can explain the positive slope found in much of the empirical literature. However, since status is a zero-sum game, only the consumption benefit of income remains at the aggregate level. Since the consumption benefit approaches zero as income rises, happiness profiles over time in developed countries are flat.

Going beyond the paradox that initiated the literature, this paper has attempted to connect the literature on economics and happiness with theoretical economic models of taxation, labour supply, economic growth, savings, wage profiles, migration, and consumption. We have identified how the outcomes of mainstream theoretical models hinge on key behavioural parameters that could in principle be identified from the empirical analysis of happiness data.

Some examples of these parameters include:

i.

The degree of risk-aversion and the complementarity between own income and reference income, which are important for the savings literature;

ii.

The malleability of reference groups, which is key to migration decisions and education decisions;

iii.

The kink in utility functions around the reference position, which is important for wage policies and career decisions; and, iv.

The existence and extent of material and non-material status races, which are paramount for optimal taxation policy.

The interaction between economic theory and happiness is therefore the next milestone for the developing economics of happiness literature. However, it is clear that the empirical literature on happiness still faces several challenges, many of which are shared with other empirical literatures. Two of the key challenges are to deal with a general inability of survey data to precisely time changes in income with changes in happiness over long time periods, and the difficulty in mapping incomes into current and expected consumption. It is also the case that most datasets do not contain reliable (if any) ex ante information regarding the group (the reference point) to which individuals compare themselves. Similarly, no dataset can contain all the variables of importance, so that researchers will continue to face the issue of endogeneity with respect to income and other variables such as marriage, education, and the reference group.

Finally, natural experiments producing exogenous variation in income are only rarely observed, making the issue of establishing the causal effect of income on happiness a major challenge.

Our final conclusion is that taking relative income seriously is an important step towards greater behavioural realism in Economics, such that our models and empirical analysis move closer to how real people feel and behave. Some may not like the insertion of additional arguments into individual utility, and remark that any behaviour can be rationalised by an appropriate manipulation of the utility function. While this is formally true, it does not applies wholesale to the issue of relative income. As we have tried to demonstrate, utility functions including relative income terms produce a wide variety of testable predictions regarding both well-being (measured by survey or neurologically) and observable behaviours: it is not true that "anything goes". To our mind, this is precisely why we need to appeal to both direct measures of utility and observed behaviour in order to obtain a better idea of what the utility function looks like, and make policy recommendations in the best interest of society. Testing these predictions not only allies theory and empirical analysis in economics, it also spills across many disciplines in the social and natural sciences; it is arguably the most important and the most promising of the research avenues open to this thriving literature.

  4

FIGURE 1 :

 1 FIGURE 1: Happiness and Real Income Per Capita in theUS, 1973-2004 5

FIGURE 3 :

 3 FIGURE 3: Life Satisfaction and Income in East Germany, 1991-2002 7

  income in the country where individual i lives, and A being a positive constant.

FIGURE 4 :

 4 FIGURE 4: The Relationship between Income and Happiness at the Individual and the Aggregate Level

Figure 5 :

 5 Figure 5: The Marginal Happiness of Additional Income for an Individual versus a Country

  [START_REF] Alpizar | How much do we care about Absolute versus relative income and consumption[END_REF],[START_REF] Johannsson-Stenman | Measuring future grandparents' preferences for equality and relative standing[END_REF] and[START_REF] Solnick | Is more always better?: A survey on positional concerns[END_REF] present respondents with states of the world which differ in both the absolute and relative domains. For example, in Solnick and Hemenway, individuals are asked to choose between states A and B, as follows:

Figure 6 :

 6 Figure 6: Change in Happiness following an Income Shock

  uses two waves of BHPS data to look at the relationship between workers' job satisfaction and their current and past labour income. The panel nature of the BHPS makes it possible to concentrate on individuals who stay in the same firm, and in the same position (i.e. have not been promoted or moved job in any other way). Both current and past labour income and hours are used as explanatory variables. Past income attracts a negative coefficient in the job satisfaction equation, and past hours a positive coefficient, consistent with a utility function that depends on changes in these variables. The data suggest a completely relative function, with job satisfaction depending only on annual change in the hourly wage.[START_REF] Grund | The Further We Stretch the Higher the Sky" -On the Impact of Wage Increases on Job Satisfaction[END_REF] find similar results in German GSOEP panel data.[START_REF] Weinzierl | Estimating a Relative Utility Function[END_REF] introduces both past income and reference group income (calculated as a cell mean by gender, age and education) in life satisfaction equations using the GSOEP data, and finds negative and significant coefficients for both. Last,[START_REF] Burchardt | Are one man's rags another man's riches? Identifying adaptive preferences using panel data[END_REF] finds evidence of adaptation in income satisfaction in ten years of BHPS data, with a suggestion of greater adaptation to rises in income than to falls in income.A recent detailed study of life satisfaction and income adaptation was carried out by Di Tella et al. (2005), who analyse longitudinal data for around 8,000 individuals drawn from the West German sample of the GSOEP over the period 1984 to 2000. They find that the effect of an income increase after four years is only about 42% of the effect after one year: the majority of the short-term effect of income vanishes over time.An alternative to using individual income, and its lags, is to concentrate on aggregate income. Di[START_REF] Di Tella | The macroeconomics of happiness[END_REF] examine individual happiness in data covering 18 years across 12

  Neither absolute nor relative poverty lines introduce any explicit role for the non-material aspects of utility, and are therefore not yet based on happiness. To make the distinction clear between happiness and whatever we currently mean by poverty, think of a factor like sunshine.

  the individual's consumption rank with respect to the positional good: this term corresponds broadly to . The third term denotes a effect of the increased consumption of the positional good via the (reduced) consumption of the non-positional good.

c

  f c c based on observing . Exactly as in[START_REF] Frank | Choosing the Right Pond[END_REF], Ireland derives a general tendency to over-consumption of the observable good for a wide class of possible information regimes. He also illustrates the Pareto improvements that can be attained via income taxation coupled with direct transfers of to the poor.Ljungqvist and Uhlig (2000) use a similar utility function, but concentrate on changes in optimal tax policy over the business cycle. Their main utility function is: population average of individual consumption , and denoting labour supply. This utility function is analogous to that in equation (1externality embedded in the presence of t c leads to labour supply that

  denotes a kind of 'weight' for relative concerns in individual utility; and α >0 reflects risk-aversion (α =0 implies risk-neutrality). The key characteristics of this utility function are revealed when we consider that the individual's marginal utility from own consumption

Figure 8 :

 8 Figure 8: Utility of Consumption with High/Low Reference Consumption, and α <1 and α >1

  income is subject to decreasing returns.19 This type of happiness function can help explain why countries are locked in an arms race over growth, even though, on aggregate, that growth will only bring utility via the consumption function. In each country the component produces a strong relationship between GDP and happiness. However, analogously to the individual argument within a country, the happiness return from being richer than other countries is, from the world perspective, a zero-sum game.Status-races can lead to sub-optimal outcomes if they crowd out non-status activities. This can be illustrated using the general utility function (1), where a higher income for individual i reduces the utility of everyone whose reference group includes i. In the specification proposed, higher income comes about at the expense of leisure time. Consider the parameterisation

								β	* 3 ln( / ) * jt t y y
		U	it	1	ln( ) it y	2	ln( / ) it t y y	ln( T y w / ) it t
								jt y y	t
	jt y y	t

* / * /

  Stepping outside of the realm of work, a number of recent papers have found comparison income effects using cell means. Ferrer-i-Carbonell (2005) calculates comparison income as an average within fifty cells defined by sex, age and education in six years of German GSOEP data;

	McBride (2001) uses 1994 data from the General Social Survey, and defines comparison income
	as average earnings of the individual's cohort, defined as those who are between 5 years
	younger and 5 years older than her. Blanchflower and Oswald (2004) use GSS data over the
	period 1972-1998, with	defined as average income by State. Luttmer (2005) also takes a
	geographic approach to reference groups, and calculates average income by local area identified
	in a number of waves of the US National Survey of Families and Households; this is shown to
	be negatively correlated with respondents' life satisfaction, conditional on their own income.
	Helliwell and Huang (2005) is in the same vein, calculating average household income by

find a negative relationship between job satisfaction in BHPS data and average earnings by hours of work matched in from the UK Labour Force Survey. census tract in Canadian GSS data. The estimated coefficient on this variable in life satisfaction equations is negative, and equal in size to the positive coefficient on household income, suggesting that life satisfaction is totally relative in income. As the estimated coefficient on income refers to β 1 +β 2 in equation (

2

), and that on relative income to -β 2 , the finding that the coefficients are equal and opposite is tantamount to saying that the consumption benefit of higher income (β 1 ) is essentially zero, which is consistent with Figures 1 to 3.

* t y A novel paper dealing with social comparisons is

  uses BHPS data to relate individual job satisfaction to the wages of their partners, and the average wage of other household members, conditional on their own wage. The results show that individuals do indeed report lower job satisfaction scores the higher are the wages of other workers in the

household.

[START_REF] Mcbride | Relative-income effects on subjective well-being in the cross-section[END_REF]

also introduces a family benchmark, appealing to the question in the GSS: "compared to your parents when they were the age you are now, do you think your own standard of living now is: much better, somewhat better, about the same, somewhat worse, or much worse?". While this is a valid approach, it is worth noting that it is perhaps a poor candidate to explain the flat income-happiness relationship, as it remains fixed over time. In other words, for the same individual, does not change with y, although new cohorts will have higher values of than will older cohorts. Last, as above, it is possible to appeal to indirect evidence regarding intra-family comparisons. One of the best-known is Neumark and Postlewaite (1998), who model women's labour force participation as a function of the income of their sisters and sisters-in-law, and find broad supporting evidence of relative income effects. * t y * t y Modelling the utility function via proxy variables, such as life or job satisfaction, is not the only way to demonstrate social comparisons. One method that essentially inverts the question is that of the Welfare Function of Income, associated with the Leyden school in the Netherlands, and, particularly, with Bernard van Praag. This predates the work on satisfaction by some years, with the first published article being Van Praag

  . He uses 1985 and 1986 Dutch Socio-Economic Panel data in which individuals are asked about their social environment -the "people whom you meet frequently, like friends, neighbours, acquaintances or possibly people you meet at work". Respondents are asked to indicate the average age, household size, income, education and labour force status in this group. Melenberg shows that the average income of this

  Concerns about relative standing in Solnick and Hemenway are found to be strongest for attractiveness and supervisor's praise, and weakest for vacation time; in Alpizar et al. they are stronger for cars and housing, and weaker for vacations and insurance. 21

  Mandeville's observations have since been echoed by many others. Adam Smith, for example, in his Theory of Moral Sentiments, noted, 'To what purpose is all the toil and bustle of this world?... It is our vanity which urges us on.' The modern-day equivalent of the argument by

	t U y y t
	* 2 ( | ) t t U y y

  The average number of hours worked per week per working age person over 1981-2003 in US states with the highest level of internal mobility is about 28, as compared to 26 hours in a standard week for states with the lowest level of internal mobility. The authors advocate mobility taxes to help restore the balance between conspicuous consumption and[START_REF] Kahneman | The endowment effect, loss aversion, and status quo bias[END_REF] conclude from choice experiments that individuals are, at the margin, about twice as sensitive to losses as they are to gains; this is labelled loss-aversion or status quo bias. To reflect loss-aversion, we can appeal to a specification of the status component of utility,

	conspicuous leisure.
	4.3 Wage Profiles
	* 2 ( | ) t t U y y	, as follows:
		* ( | ) 2 ( t t U y y 2 f y y t	* t	)	( f y y t	* t	)*	I	[	* t y y t	]
			t
		y	* t	s ts w y
			s	0

1 ( )

t U c

Throughout this review we will use the terms (subjective) well-being (SWB), happiness and life satisfaction interchangeably.

This covers articles published until April 2006. The search of ECONLIT was conducted on the 9 th August, 2006.Only journal articles written in English were included in the search. There were also 149 papers identified by ECONLIT as being published since 1960 with 'Job Satisfaction' in the title, and 78 (52%) of these were published between 2000-2006. This growth in Economics in the use of various measures of well-being has been mirrored to a certain extent in other Social Sciences, for example the expansion of positive psychology (http://www.ppc.sas.upenn.edu/), and has spilled over into a number of 'popular science' reviews[START_REF] Frey | Happiness and Economics[END_REF][START_REF] Layard | Happiness. Lessons from a New Science[END_REF][START_REF] Nettle | Happiness: The Science Behind Your Smile[END_REF].

It is interesting to note that this 'modern' viewpoint of the role of government in promoting happiness contrasts sharply with that of the ancient Greeks and much of the world of antiquity (see[START_REF] Mcmahon | Happiness: A History[END_REF], for a history of the philosophy of happiness).[START_REF] Angner | The evolution of Eupathics: The historical roots of subjective measures of well-being[END_REF] provides a fascinating account of the modern history of Subjective Well-Being.

Source: World Database of Happiness and Penn World Tables. Average reply to the following question: 'Taken all together, how would you say things are these days? Would you say that you are…?' Responses are coded as (3) Very Happy, (2) Pretty Happy, and (1) Not too Happy. Happiness data are drawn from the General Social Survey.

Source: World Database of Happiness. Average responses to the following question: 'On the whole how satisfied are you with the life you lead'. Responses are coded as (4) Very Satisfied, (3) Fairly Satisfied, (2) Not Very Satisfied, and (1) Not at all Satisfied. Life satisfaction data are drawn from the Eurobarometer Survey.

Source:Frijters et al. (2004a). Data are drawn from the German Socio-Economic Panel Study (GSOEP). Respondents are asked: 'How satisfied are you at present with your life, all things considered?' The responses run from 0 (completely dissatisfied) to 10 (completely satisfied).

Of course, economists have also known this for many years (see, for example,[START_REF] Layard | Human satisfactions and public policy[END_REF][START_REF] Frank | Choosing the Right Pond[END_REF].

[START_REF] Davidson | Well-being and affective style: neural substrates and biobehavioural correlates[END_REF] notes that 'The identification of the brain circuitry responsible for different aspects of affective processing has helped to parse the domain of emotion into more elementary constituents in a manner similar to that found in cognitive neuroscience, where an appeal to the brain has facilitated the rapid development of theory and data on the subcomponents of various cognitive processes' (p.1395).

Other approaches have also been explored.[START_REF] Knutson | Anticipation of increasing monetary reward selectively recruits nucleus accumbens[END_REF] explore the relationship between positive emotions and activity in subcortical circuits including the nucleus accumbens.

This is an oversimplification, and recent work has cast the left-right opposition in terms of approach versus withdrawal (anger, a negative approach-related emotion, is associated with more alpha power in the left prefrontal cortex): see[START_REF] Urry | Making a life worth living: Neural correlates of well-being[END_REF].

A recent review article by[START_REF] Pressman | Does positive affect influence health[END_REF] describes the relationships between affective "style" and physical health; see also[START_REF] Steptoe | Positive affect and health-related neuroendocrine, cardiovascular, and inflammatory processees[END_REF].

A final point worth making is that when asked to report their level of happiness, life satisfaction or well-being in surveys, only a small minority of respondents do not provide an answer (less than 1% of respondents in the BHPS or GSOEP). The concept of happiness is intuitively understood by almost everyone.

Note that if the 'true' happiness function does indeed depend (negatively) on some measure of reference group income, but we instead estimate a happiness equation that does not include y*, then the negative effect of higher levels of y* over time will show up as a negative time-trend (as in Di Tella et al.,

2003).

Comparisons and fairness are not synonyms however: while the former implies that an individual is happy to receive more than others, fairness considerations suggest that they would prefer not to.

Not only do rising wage profiles discourage turnover for incentive reasons, in this model they also provide utility to the worker.

Important though this paper is, it is worth noting that the paper is cross-section ex post: no shock is observed. Further, winners were actually more satisfied than non-winners, but given the small sample size the difference was not significant.

Suggestive indirect evidence is easier to come by.[START_REF] Clark | Job Satisfaction and Gender: Why are Women so Happy at Work?[END_REF] suggests that the stubbornly higher job satisfaction reported by British women in BHPS data might partly reflect their lower expectations.

Where individuals are asked to indicate the sum per period they think is the absolute minimum net family income their family requires to make ends meet. This was introduced in[START_REF] Goedhart | The Poverty Line: Concept and Measurement[END_REF].

[START_REF] Weinzierl | Estimating a Relative Utility Function[END_REF] includes both cell-average reference group income (by age, sex and education) and lagged income in a life satisfaction equation. The estimated coefficients imply that satisfaction is completely relative with respect to income. We do not know, however, whether this definition of the reference group is apt.

A related question is treated in[START_REF] Oxoby | Cognitive Dissonance, Status and Growth of the Underclass[END_REF]: what if individuals can choose the domains over which status comparisons take place?

An alternative is to instrument income, although the task of finding instruments which affect income but not subjective well-being is a hard one.[START_REF] Lydon | Estimates of the effect of wages on job satisfaction[END_REF] instrument income via spousal characteristics in a sample of UK University graduates, which leads to a doubling of the size of the income coefficient in a job satisfaction equation.

A related issue is how hard individuals work once employed: their effective labour supply. A recent paper[START_REF] Clark | Effort and Comparison Income[END_REF] appeals to both survey and experimental data to show that effort at work is a function of income relative to that of one's reference group.

Frijters and Shields would thank to thank the Australian Research Council (ARC) for funding.

Given this preference for income growth, independent of the income level, employers can save money by offering an increasing profile with lower actuarial value rather than a decreasing profile with higher actuarial value; individuals prefer the former even if they are perfectly rational. [START_REF] Frank | Wages, seniority, and the demand for rising consumption profiles[END_REF] and [START_REF] Loewenstein | Do workers prefer increasing wage profiles[END_REF] use evidence from small-sample surveys to show that individuals do indeed express a preference for wage profiles which rise over time, even though these have lower present discounted values than alternative profiles with constant or decreasing wages.

Kinks in the utility function, also termed loss-aversion, have more implications than simply helping to explain upward-sloping wage profiles within firms. We would also expect employers to be likely to offer contracts guaranteeing no income reductions over the working life i.e. an endogenous absence of demotion and institutionalised downward wage rigidity. [START_REF] Mcdonald | How social preferences can improve our understanding of the inflationunemployment relation[END_REF] motivates an asymmetric utility function including loss-aversion, and then argues in a simple micro-macro model that it creates downward wage rigidity at the level of firms which in turn generates Keynesian business cycles. This also fits well with the empirical observation of [START_REF] Teulings | Corporatism or Competition: An International Comparison of Labour Market Structures and their Impact on Wage Formation[END_REF] that wage decreases are virtually never observed within organisations in Europe because individuals are sacked rather than demoted. [START_REF] Patacconi | Interpersonal comparison, status and ambition in organisations[END_REF] also invoke sensitivity to relative decreases in job status to rationalise the lack of observed empirical demotions within organisations.

A potentially fruitful avenue for future research along these lines is to test the hypothesis that retirement partly results from individuals being unwilling to take a step back within their organisation, and thus choosing retirement over wage cuts or demotion. Retirement would then generically follow the moment at which individual productivity peaks, even though workers may still have many highly productive years left. This comes about simply because individuals are loath to accept jobs and wages that are below their current reference position. In this situation, there is a case for deferring rewards for production until later in life i.e. to smooth wages such that they will increase up to some fixed age, which in turn raises the issue of credible long-term contracts and mandatory retirement.

Poverty

The relative importance of the three components of the utility function in (1) is crucial for the measurement of poverty. One common representation is that individuals are in poverty if their material consumption levels falls below some subsistence level; this appeals to a critical level of rather than to overall happiness. This approach is behind concepts like the absolute poverty line, the cost of minimum calorie intake line, and minimum living standards, such as the 1 ( ) t U c whereby potential migrants have to offer something exceptional to the host country in order to attain a visa, arguably attempt to attract the first type of economic migrant. Countries in the EU that are introducing legislation trying to stop 'family reunions' could be interpreted as trying to reduce the second kind of economic migrant. More empirical work on the relationship between happiness and reference incomes, especially looking at the differences across migrant groups in reference incomes, would greatly inform this debate.

Normative Implications

Section 4.5 discussed the tax implications of relative utility. These arise due to externalities between individuals. Somewhat more subtle are the policy implications of adaptation, which can be thought of as externalities within individuals. We discussed above how changing reference incomes can affect inter-temporal trade-offs in consumption, wage profiles, and the costs and benefits of migration. The general implication is that movements in y t * affect inter-temporal trade-offs: events to which individuals adapt quickly only have a happiness payoff in the short run, while events where adaptation is slow (or absent), have long-run happiness payoffs. The impact of a particular circumstance on current happiness is then only a snapshot of the stream of effects on happiness associated with that circumstance, and is therefore in principle not necessarily informative about life-time trade-offs.

What is often not well-understood is that as long as individuals are rational, the mere presence of adaptation is no reason for policy intervention unless it is accompanied by an externality (such as those found in social comparisons). We may not necessarily want to counteract activities which produce only a short-lived happiness 'buzz' at the expense of a longrun happiness cost, unless we believe that individuals are unaware of the fact that the 'buzz' may indeed only be ephemeral.

When individuals do not in fact realise that they will get used to some things (but not to others), a basic paternalistic question arises. This has been well-stated by many, including [START_REF] Kahneman | Back to Bentham: Explorations of experienced utility[END_REF][START_REF] Kahneman | Foundations of Hedonic Psychology: Scientific Perspectives on Enjoyment and Suffering[END_REF] and Rabin (1998): Should we only care about what Self 0 (who makes the decisions) wants or should we also care about what Self 1 (in the future) experiences? Individuals who care only about their desires at time 0 (i.e. Self 0) will take decision utility as the normative reference point. If instead we were to take the experiences of Self 1 as the guiding principle for policy design, we would potentially act against the explicit wishes of an 'ignorant' (Self 0) electorate by taxing activities that lead to only short-run happiness gains. An interesting political economy question then arises of how governments can do so without being voted out by myopic Self 0's. This question only arises when individuals mis-forecast their degree of