In the olden days, we used to define ‘utility’, as a narrow metric that measured satisfaction with the lower objectives of Life, i.e. power (a.k.a. money). In its simplest form, ‘Utility’ measured usefulness or profitability, which alluded to money (the most commonly and universally useful commodity), and the term came to be used interchangeably. Some confusion arose when money itself started to mean different things to different people, depending on what kind of money (income vs wealth, for example) it was and what kind of person (i.e. at what stage of economic/ social/ personal well-being) we were talking about.
Declaimer: This article was originally in October 2017, and some of the data points may be outdated
Things got even more complicated when we introduced the much wider term ‘Happiness’ as an objective of Economics. The first implication of this was that the human being was now seen as a satisficing person, rather than a maximizing person. In Prospect Theory, for example, the Value relationship with positive income (gains) was not linear, but tapering, i.e., with rising income, the incremental ‘value’ of each rise in income was diminishing, till it flattened and even reversed slightly. In an American study, they found that from $40,000 per annum to $60,000, Happiness levels increased, but their rate of change decreased from $60,000 – $250,000, and thereafter, it stagnated, even declined as income went higher. This was done over a very large sample, so the decline at higher levels should not surprise.
If you ask any rich uncle of yours, you will find that beyond a particular threshold, money issues come into relationships, with a singularly deleterious effect on overall happiness. Money is a very small part of overall happiness, ask any rich person. And to the extent that money issues distort relationships, it creates more unhappiness than it gives to you in the early stages of financial affluence.
This complex relationship with money is a big problem for Economics, which focuses solely on ‘utility’, without allowing for the multi-variable optimization that a real human being must do in the real world. Till you are poor, happiness is locking eyes with that pretty girl across the room, but once you get rich, your immediate thought is to filter-check whether she is a gold digger looking to manipulate you into some kind of relationship that leaves you without a home and hearth…..just saying, many of my older readers would have noticed how their thinking has changed over the years!
In Prospect Theory, we find multiple ideas that conflict with traditional ideas embedded in the old Economics. One, is that the Law of Diminishing Marginal Utility applies to money itself, so how does that affect all the old equations, which are based on the assumption that the Utility of money is fixed? Second, when it comes to losing money, we have this phenomenon called Loss Aversion, where the positive payoff has to be balanced many times (at least 2-3 times, sometimes more) to the negative one. This ‘kink’ in the Value curve, renders many of the old models useless. So, defining “Happiness” accurately is proving to be impossible. If Utility is discredited as the Unit Of Measurement, then how do we define Happiness accurately enough to incorporate it as a Unit of Measurement (UoM)?
There’s another problem. Being Happy IN our life (as we experience it), is not the same as being Happy WITH our life (as we remember it). The focusing illusion, when we can’t think about something without exaggerating its importance, brings in another cognitive bias. So our economic choices are made by the Remembering Self, rather than the Experiencing Self. This persona (Remembering Self) is a storyteller, who ‘fills in’ details of an experience, which are often imaginary or distortions of the truth, like getting your History Books written by the TV channels.
Not only does the Remembering Self distort memories of the past, but it takes decisions about the future based on ‘anticipated memories’. It has no sense of time and compresses its entire experience into a single, uni-dimensional snapshot. So if you have to wait 45 minutes outside a restaurant for a dosa that provides 30 minutes of culinary satisfaction, it makes no difference to your subsequent choice of restaurant. How rational is that?
Many decisions in life are distorted by this separation of the Remembering Self from the Experiencing Self. A failed marriage, for example, is remembered not for the beauty of the honeymoon, but by the horror of the divorce. In derivatives trading, we do not remember the huge MTMs that we suffered, but the small, subsequent profit that we earned at the end of a huge struggle. Actual Happiness is measured by the MEMORY of the experience, distorted as it sometimes is by the subconscious mind, rather than the experience.
Being a hygiene factor, money goes to the top of the mind when it’s in short supply, but contributes nothing to overall Happiness once it is in easy and excessive supply. With rising affluence and basic needs being met everywhere in most of the world, the relevance of the old Economics to actual decisions that are made in the real economy has reduced dramatically. Many people are at the stage where the meaning of money has changed from what it used to be at more basic levels of existence.
The more important issue is that mathematics finds it very difficult to work with optimizing equations, rather than with fixed variables. Complexity can be handled up to a point, after which a prescriptive equation (like say, the Phillips Curve) has to become a toolkit, a support for decision-making rather than a supplier of the actual decision itself. It is therefore incumbent on the actual user to decide when to move to a fuzzy decision-making model that incorporates the complexity and gives uncertain answers, rather than the ‘lazy way’ of feeding in some discrete numbers into an equation and going all in with the answers.
