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Research Paper CEPR Discussion Paper Series 784

The marginal utility of income


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In both public economics and welfare analysis 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 cross-sectional surveys of subjective well-being and two panel surveys. Altogether, we use data from over 50 countries, and in a period extending from 1972 to 2005. In all six surveys we find a remarkably consistent relationship between reported well-being and income. We estimate the elasticity of marginal utility with respect to income at around (minus) 1.25. Thus, marginal utility declines somewhat faster than in the case (assumed by Dalton and others) when well-being is linear in log income. In the second part of the paper, however, we ask whether true well-being may not have a convex relationship to reported well-being, making it less concave with respect to income. We find some evidence of this, so that the correct elasticity of marginal utility with respect to income is roughly (minus) 1.15. These figures show that Dalton's theoretical assumption was not far from the truth revealed by empirical evidence, and provide scientific estimates which can be used in all branches of economics applied to public policy.


Economics, Income Dynamics, and Well Being



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