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3.3 SPECIAL PREFERENCES 97
In this chapter we have kept the discussion of preferences (including the graphs)
simple by analyzing cases in which the consumer buys two goods. But the principles
presented here also apply to much more complicated consumer choice problems,
including choices among many different goods. For example, as observed in
Application 3.2, a consumer typically considers many factors when buying an
automobile, including the dimensions of the car, the size of the engine, the fuel
used, fuel efficiency, reliability, the availability of options, and safety features. Using
the framework developed in this chapter, we would say that the utility a consumer de-
rives from an automobile depends on the characteristics of that vehicle. As the research
described in Application 3.2 shows, consumers are often willing to trade off one
attribute for another.

APPLICA TION 3.5
Does More Make You Happier?
However, once labor income ensures a certain
Reference-Dependent Preferences 13 level of material wealth guaranteeing basic
needs, individual and societal well-being no
longer increases with growing economic wealth.
As you consume more and more of the goods you
Social comparisons and changes in expected liv-
typically purchase, do you become ever and ever hap-
ing standard strongly influence individual well-
pier? In other words, does your utility increase? An being. . . . Overall, Easterlin’s research shows that
assumption that we have maintained throughout people in wealthy nations show no higher life
this chapter—”more is better”—would imply that satisfaction than people in poorer nations once
your answer would be yes. 14 As we will see in the the level of income is high enough to provide for
next two chapters, increases in your income will en- food, shelter and other fundamental needs. This
able you to purchase bigger bundles of goods and apparently contradictory finding became known
15
services, which in turn will move you to higher and as the “Easterlin Paradox.”
higher levels of utility. Is there a way to adapt the traditional theory of
If you are like most people, however, it is likely consumer choice from microeconomics, so that its
that increased consumption does not always bring implications are consistent with the empirical find-
with it feelings of greater happiness. Research on the ings from the literature on psychological well-being?
determinants of happiness suggests that more is Bridging psychology and economic theory is the cen-
often not better. One of the most influential re- tral purpose of an important area within economics
searchers in this field is Richard Easterlin, who in 2009 known as behavioral economics. Research in behav-
received the prestigious IZA Prize in Labor Economics ioral economics seeks to strengthen the psychologi-
for his pioneering research on the economics of hap- cal foundations of economic models so that they can
piness. (IZA is the Institut zur Zukunft der Arbeit, or make better predictions about individual decision
Institute for the Study of Labor.) To quote from the making.
press release announcing the prize: Behavioral economists Botond Koszegi and
Richard Easterlin first showed in the 1970s that ris- Matthew Rabin have proposed a theory of reference-
ing wealth does not necessarily improve individ- based preferences that yields implications consistent
ual well-being. It is true that wealthier societies with psychological research on happiness. 16 Koszegi
are more satisfied on average than poorer ones. and Rabin posit that an individual’s utility depends not

13 We would like to thank Eric Schultz for his comments and suggestions on this application.
14 We are, of course, talking about “goods” rather than “bads,” which would include phenomena such as pollution or traffic congestion.
15 IZA press release, May 4, 2009.
16 B. Koszegi and M. Rabin, “A Model of Reference-Dependent Preferences,” Quarterly Journal of Economics 12, no. 4 (2006): 1133–1165.