The Marginal Utility of Income

27 Pages Posted: 21 Feb 2008 Last revised: 22 Apr 2008

See all articles by Richard Layard

Richard Layard

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP)

Guy Mayraz

Department of Economics, University of Melbourne; CIFAR

Stephen John Nickell

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP); Centre for Economic Policy Research (CEPR)

Date Written: April 18, 2008

Abstract

In normative public economics it is crucial to know how fast the marginal utility of income declines as income increases. One needs this parameter for cost-benefit analysis, for optimal taxation and for the (Atkinson) measurement of inequality. We estimate this parameter using four large cross-sectional surveys of subjective happiness and two panel surveys. Altogether, the data cover over 50 countries and time periods between 1972 and 2005. In each of the six very different surveys, using a number of assumptions, we are able to estimate the elasticity of marginal utility with respect to income. We obtain very similar results from each survey. The highest (absolute) value is 1.34 and the lowest is 1.19, with a combined estimate of 1.26. The results are also very similar for subgroups in the population. We also examine whether these estimates (which are based directly on the scale of reported happiness) could be biased upwards if true utility is convex with respect to reported happiness. We find some evidence of such bias, but it is small - yielding a new estimated elasticity of 1.24 for the combined sample.

Keywords: Marginal utility, income, life satisfaction, happiness, public economic, welfare, inequality, optimal taxation, reference-dependent preferences

JEL Classification: I31, H00, D1, D61, H21

Suggested Citation

Layard, Richard and Mayraz, Guy and Nickell, Stephen John, The Marginal Utility of Income (April 18, 2008). SOEPpaper No. 50. Available at SSRN: https://ssrn.com/abstract=1096202 or http://dx.doi.org/10.2139/ssrn.1096202

Richard Layard

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP) ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Guy Mayraz (Contact Author)

Department of Economics, University of Melbourne ( email )

Melbourne, 3010
Australia
+61 3 9035 8141 (Phone)

HOME PAGE: http://www.mayraz.com

CIFAR ( email )

180 Dundas Street West, Suite 1400
Toronto, Ontario
Canada

Stephen John Nickell

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP) ( email )

Houghton Street
London WC2A 2AE
England
+44 20 7955 7497 (Phone)
+44 20 7831 1840 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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