Traditionally, psychology has devoted far more attention to negative emotions than to positive emotions. Perhaps because of the medical origins of clinical psychology, psychological research has concentrated on healing the sick and reducing suffering. While it is hard to argue with those aims, this focus has meant that the study of happiness and of positive emotion has been relatively neglected until recently. So why study happiness? Well, if all we do is reduce sadness and relieve depression, then the goals of life become no more than the absence of misery. Surely, we would all like more from our lives than that. By studying happiness and positive emotion, psychology can learn how people can best enhance their life and work towards fulfillment and self-development.
How do we define happiness? Happiness can be defined as a mental state characterized by consistently positive emotions. Positive emotions can include curiosity, joy, contentment, excitement, interest, and/or pleasure. Life satisfaction is also considered in many happiness studies. Most researchers are more interested in the effects of chronic happiness, or the ongoing propensity to experience positive mood, than in the immediate effects of a momentary happy feeling.
Happiness researchers believe that positive emotions signal to us that we are in good shape. Our needs are being met, we have adequate resources, and we are reaching our goals. Positive emotional states also encourage people to engage with the environment, to seek out and take on new goals. We can contrast the effects of positive emotions with those of negative emotions, such as depression or fear. These emotions signal to the individual that something is not right, that the environment is not safe, and that the best course of action is withdrawal and avoidance.
Apparently, the consistency of positive emotions matters more than the intensity of them. In a 1991 study by Ed Diener and colleagues, the proportion of time that people felt positive emotions was a better predictor of their evaluation of their overall happiness than the intensity of their positive emotions. In other words, happy people tend to feel mildly or moderately happy most of the time, but may not feel intensely happy all that often.
Because happiness is a subjective state, the only way to directly measure happiness is to ask people how they feel. There may be physiological indications of positive mood, such as low levels of stress hormones, but there are no objective measures of happiness per se. Self-report measures pose a number of problems, however. People may not always know exactly how they feel. Alternatively, they may bias their reports according to how they want to see themselves or what they feel is socially desirable. Nonetheless, self-reports of happiness have yielded meaningful data in a large body of research. Researchers also distinguish between rating overall happiness (How happy are you in general?) and tracking moment-by-moment emotional states. The second type of rating allows researchers to connect emotional reactions to the specific activities people are engaging in at the time.
Certainly many things can make us happy (or unhappy), but a consistently positive mood also brings significant benefits in and of itself. Let us consider what happiness does for us. In 2005, Sonja Lyubomirsky, Laura King, and Ed Diener published a meta-analysis on research looking at the relationship between positive mood and life functioning. They found that people who are generally happy also demonstrate adaptive psychological traits, such as optimism, resilience in the face of frustration, and enhanced goal seeking. In other words, happy people are upbeat, resilient go-getters. These traits in turn are related to a wealth of positive outcomes, including increased popularity, social engagement, pro-social (helpful) behavior, coping skills, and even physical health.
How can we tell if happiness leads to better health? Any study of this question is plagued by the chicken and egg problem. Which came first, happiness or good health? There are many studies showing cross-sectional correlations between happiness and health. In other words, at any given point people who are happier are also healthier. While these studies show a clear relationship between positive mood and physical health, we cannot know which came first. Unlike cross-sectional studies, however, longitudinal studies can show whether high levels of positive mood actually precede healthy outcomes. For example, in a recent study of five thousand people, high levels of positive mood predicted to fewer hospitalizations five years later and a lower incidence of stroke six years later.
Ameta-analysis is a statistical analysis of a group of different studies. It is a way of examining the effect of one variable on another variable across a whole body of literature—and not just a single study. For example, if we want to look at the effect of happiness on coping skills, we can perform a meta-analysis on all the available studies on this topic in order to determine the overall effect size of this relationship. Meta-analyses give us much more robust and reliable information than data from individual studies.
The chicken-egg problem also applies to studies on happiness and social relationships. Many cross-sectional studies show strong correlations between happiness and successful friendships, marriages, and family relationships. Longitudinal studies, however, demonstrate that the tendency toward happiness precedes strong relationships. In other words, happy people are more likely to get married, have successful marriages, and even have more friends. For example, in an Australian study carried out over fifteen years by Gary Marks and Nicole Fleming, people who scored high on happiness scales were more likely to be married in the following years than those who did not. Similar results have been found with German and American samples. Moreover, a 1989 study published by Bruce Headey and Ruut Veenhoven showed that happiness levels predicted quality of marriage. Over a six-year period, people with higher levels of happiness earlier in the study were more likely to have a happy marriage later in the study.
Does research show the same effect of happiness on our work life? Here too, most research is cross-sectional. Thus, at any given time people with high levels of positive mood tend to have better jobs, higher income, and more autonomous and meaningful work than less happy people. Obviously, the chicken-and-egg problem is relevant here as well. Certainly, many people (if not most) have experienced the negative emotional effects of working at an unpleasant job at some point in their lives. Longitudinal research, however, shows that high levels of positive emotion early in life predicts occupational and financial success many years later. For example, Ed Diener and colleagues found in a 2002 study that college students who displayed more cheerfulness in their first year of college made more money sixteen years later than did their less cheerful counterparts. This effect was found regardless of family income. In fact, the effect was particularly pronounced with students from higher-income families. Presumably, these students had fewer barriers to occupational success than students from lower-income families. Consequently, their emotional state had that much more influence.
Clearly our mood is not simply a function of our own personalities. We are also subject to the circumstances in which we find ourselves and the effects of our own choices. What kinds of things truly contribute to sustained happiness and which do not?
The research on what makes us happy is far more complicated than the literature on the benefits of happiness-on what happiness does for us. The earlier happiness researchers were quite pessimistic about the degree of control we have over our own happiness, assuming that we can do little to affect our happiness in any sustainable way. Later researchers had a far more optimistic view, however, suggesting that our activities and circumstances can definitely impact our general level of happiness.
In the early 1970s Phillip Brickman and Donald Campbell introduced the notion of the happiness set point. In this view, our general level of happiness is genetically determined and largely untouched by life events. While significant life events may knock us above or below our set point, the effect is only temporary and we return to our baseline in relatively short order. Although most happiness researchers have since tempered this extreme stance, a fair amount of evidence suggests there is some merit to this idea.
For one, twin studies suggest there is a large genetic component to happiness ratings, suggesting our level of happiness is at least partly pre-wired. In other words, the happiness ratings of identical twins, who share 100 percent of their genes, are more similar than those of fraternal twins, who share only 50 percent of their genes. Secondly, external conditions often have little to do with happiness levels. For example, demographic characteristics, such as age, gender, and income, have been shown to have weak correlations with life satisfaction. Even physical attractiveness has little to do with happiness. Moreover, research on people suffering negative life events, such as the loss of a spouse or a disabling accident, pointed to significant recovery in life satisfaction over time despite an initial drop in happiness ratings. Likewise, a famous 1978 study of lottery winners by Brickman and colleagues showed little difference in happiness ratings between lottery winners and a comparison group.
A famous study conducted by Philip Brickman, Dan Coates, and Ronnie Janoff-Bulman in 1978 compared people who had come into enormous good fortune (lottery winners), people who had suffered tremendous misfortune (paraplegic and quadriplegic accident victims), and their neighbors. The findings from this study have been used to justify the idea of the happiness set point. The authors found that lottery winners were only slightly (and not statistically significantly) happier than their neighbors and that paralyzed accident victims were only modestly less happy than their neighbors. On a 0-5 scale of happiness, lottery winners scored an average of 4.00, accident victims 2.96, and neighbors 3.82. All three groups believed they would be equally happy in the future but, compared to the other two groups, accident victims believed they had been happier in the past.
Does sudden good fortune, like winning the lottery, make us happier? One important study concluded: not by much (iStock).
The concept of the hedonic treadmill is closely related to the concept of the happiness set point. If we are destined to return to our happiness set point over time, then positive life events can only give us a temporary lift. People who are constantly in search of a higher state of happiness may deny this to themselves, repeatedly pursuing temporary pleasures as if the effect will not, in fact, be temporary. It is as if they are continuously marching on a treadmill, thinking they are going forward when they are really staying in place.
Money clearly matters to some extent and not having enough money definitely has a negative effect. But we can also ask how much money is enough? It is likely that social comparison plays some role here. We may be perfectly happy with our cute little cottage as long as our neighbors and friends live in similar houses. When our peers start moving into spacious mansions, however, we become dissatisfied with what we have. The term “social comparison” refers to the way we evaluate our own belongings through comparison with our neighbors’ belongings.
In a 2005 paper, Ed Diener, Richard Lucas, and Christie Napa Scollon revisited the concept of the happiness set point. In their view, external events do affect our overall sense of wellbeing—we are not immune to our environment. Nevertheless, over time we do tend to adapt to our circumstances, both good and bad. Moreover, in a 2007 study by Richard Lucas, two fairly large groups of disabled people showed a distinct downturn in their life satisfaction following the onset of their disability, with little to no recovery over time.
In recent years happiness researchers have looked at several factors that may influence our level of happiness. More specifically, researchers have studied the contributions of genetics, demographic characteristics, interpersonal relationships, money, attitude toward life, and sense of control.
Genetics probably contribute a fair amount to our general level of happiness, up to 50 percent according to a 2005 review by Sonja Lyubormirsky, Kennon Sheldon, and David Schkade. However, this figure should be considered with some caution. Most genetic studies use samples that do not vary dramatically in their environment or life circumstances. When people’s environments are fairly similar, the influence of genetics is heightened. When there is a broad range of environmental conditions, however, the role of genetics is less important. Therefore, because most genetic studies do not include samples from a wide range of environments, the importance of genetics may be exaggerated.
According to this same review of the literature by Lyubormirsky and colleagues, life circumstances such as income, social status, and demographic characteristics (e.g., age, gender, ethnicity) matter, but not as much as we might expect, accounting for 10 to 20 percent of overall happiness scores. Estimates similar to this have been reported in other happiness studies.
Supportive social relationships likely play a very important role in happiness, judging by many studies showing strong correlations between these two domains. There is also a large body of literature attesting to the powerful effect of social support on our resistance to stress and physical illness, as well as our general wellbeing.
Several lines of research point to the importance of the way we engage with life, in effect, our attitude toward life. Lyubormirsky and colleagues suggest that 40 percent of our overall happiness depends on our active attempts to foster our own happiness through our thoughts, activities, and goals. This viewpoint is echoed by Martin Selig-man in his work on positive psychology.
Some research shows that people with higher incomes are happier than those with lower incomes, but other studies suggest that money has little effect on happiness. An ingenious 2006 study by Wendy Johnson and Robert Krueger sheds some light on these confusing findings. In their view, the objective amount of financial resources is less important than the subjective perception of financial status. In a study of 719 twin pairs, Johnson and Krueger found that people’s perception of their financial circumstances—that is, whether they believed they had enough money—had only a modest relationship with their actual income and assets. Likewise, their satisfaction with their life was far less related to actual prosperity than to perception of prosperity. In other words, the degree to which people felt satisfied with their life had less to do with how much money they actually had and more to do with their beliefs about how much money they had—i.e., feeling that they had enough money.
A wealth of evidence suggests that happiness is mediated by an area of the brain known as the left pre-frontal cortex. The frontal cortex takes up about half of the entire cortex, which is the outer covering of the brain. The prefrontal cortex is the most anterior (or forward) part of the frontal cortex (see Chapter 3 for more on brain anatomy). Brain imaging studies, electro-encephalogram (EEG) studies, and even research on the effect of strokes all support the role of the left prefrontal cortex in positive emotions.
Meditation has been shown to have a positive effect on mood (iStock).
Richard Davidson has conducted a number of investigations in this area. In one 2003 study conducted with John Cabott Zinn and a group of other colleagues, 25 subjects trained in meditation techniques were compared to a control group who had been put on a wait list. Meditation has been shown to have a strong impact on positive mood. Study subjects who completed the eight-week course in meditation showed a much greater increase in electrical activity in the left frontal regions than did wait-listed controls. Moreover, this group also showed a better immune response to a flu vaccine they received after their meditation course.
In Johnson and Krueger’s study, life satisfaction was also strongly related to beliefs about how much control people felt they had over their life. In fact, out of the twelve factors studied, perceived control over one’s life was the single most important factor contributing to life satisfaction.
Positive psychology is a branch of happiness studies championed by Martin Seligman (1942—). Positive psychology came into its own in 2000, when Seligman was elected president of the American Psychological Association and was in a position to direct the field’s attention. Unlike previous happiness researchers, Seligman is a staunch believer in the ability of each person to improve his or her general emotional well-being. His earlier seminal work on learned helplessness contributed to the development of cognitive behavioral therapies for depression. Consequently, Seligman brought a psychotherapist’s point of view to the study of positive emotions, asking how psychologists can help people to feel better.
Although Seligman has tested his techniques on depressed patients, positive psychology differs from traditional psychotherapy by its emphasis on happiness and wellbeing rather than on the relief of suffering and mental illness. Seligman is not the first to think about the human potential for happiness, however, and he acknowledges the influence of earlier writers such as Carl Rogers, Abraham Maslow, and Erik Erikson.
Seligman actually rejects the use of the term “happiness,” stating that it is too vague and unscientific. Instead, he breaks happiness or “the good life” into three components: positive emotion (the pleasant life), engagement (the engaged life), and meaning (the meaningful life).
This refers to the experience of high levels of positive emotion regarding our present, past, and future. Positive emotions about our past include feelings of contentment, fulfillment, satisfaction, serenity, and pride. Positive emotions about our future include confidence, optimism, hope, faith, and trust. Positive emotions about our present include the ability to experience pleasure from immediate experience. This also involves the ability to attend to immediate experience and not be distracted by concerns about the future or past. Interestingly, this aspect of “the good life” appears to be the least important in that it has the lowest correlations with a person’s ratings of life satisfaction.
The engaged life involves the ability to invest in and make connections with work, intimate relationships, and leisure activities. In the engaged life we are not isolated individuals, floating on a self-imposed island of alienation, but rather we are actively engaged with the world around us. Seligman believes that increasing life engagement involves identifying signature strengths—one’s own particular strengths and interests—and then putting them to use. For example, people who are interested in art can take a painting class. Those who like animals can volunteer at an animal shelter.
Seligman believes that giving back to the larger community is an important part of happiness (iStock).
In the meaningful life, people use their signature strengths to commit and contribute to causes larger themselves. The particular cause does not matter and might include politics, religion, community service, or family. In this way, people gain a sense of belonging to a larger group, cause, or institution and they enhance their sense of self-worth and life purpose. A series of studies shows the relationship between such commitments and life satisfaction. The importance of a meaningful life suggests that a life devoted to self-centered aims ultimately provides limited life satisfaction.
Multiple studies show that the engaged and meaningful life have stronger positive correlations with life satisfaction and stronger negative correlations with depression than does the pleasant life, although all three aspects of the good life relate to overall happiness.
Seligman’s findings that the pleasant life is least predictive of overall happiness compared to the engaged and meaningful life helps explain some of the contradictory findings in happiness research. It seems that pleasure, what we feel after we achieve a desired goal, is most likely to be short-lived. This is consistent with the notion of the hedonic treadmill, which presumes that any satisfaction derived from an achieved goal is bound to be temporary. Our way of engaging with our life, however—whether we are involved with other people in a meaningful way or meeting our own potential for growth—appears to have significant impact on our general happiness. Thus, if we want to increase our level of happiness, we are better off considering the way we live our life rather than solely focusing on the pursuit of pleasure.
Assuming that happiness has three components (listed above as the pleasant, engaged, and meaningful lives), Seligman and his colleagues believed it was important to identify personality traits that promote these positive modes of living. Consequently, they identified six overarching virtues which they claim to be culturally universal. These are: wisdom and knowledge, courage, humanity (which involves compassion and concern for others), justice, temperance (the capacity for self control), and transcendence (the ability to find connections with a larger universe).
The six overarching virtues were broken down into twenty-four character strengths. These included: creativity, curiosity, open-mindedness, love of learning and perspective for wisdom and knowledge; authenticity, bravery, persistence, and zest for courage; kindness, love, and social intelligence for humanity; fairness, leadership, and teamwork for justice; forgiveness, modesty, prudence, and self-regulation for temperance; appreciation of beauty and excellence, gratitude, hope, humor, and religiousness for transcendence.
Seligman and his colleagues have conducted research to see how universal these concepts are and how well they correlate with life satisfaction. A study conducted in forty different countries asked people to rate how much they could identify with each of the twenty-four character strengths. The rankings of the character strengths were notably similar from country to country, with kindness, fairness, authenticity, gratitude, and open-mindedness most commonly endorsed (“most like me”). Less frequently endorsed strengths included prudence, modesty, and self-regulation. The authors also noted that the strengths pertaining to emotional traits (zest, gratitude, hope, love) were more strongly associated with ratings of life satisfaction than the strengths relating to intellectual traits (curiosity, love of learning).
In a 2005 paper, Seligman, along with Tracy Steen, Nansook Park, and Christopher Peterson, reported results from an extremely simple and cost-effective intervention to increase happiness. They conducted their study through an Internet Website. Visitors to the Website were invited to participate in exercises designed to increase their happiness, with a warning that some visitors would be assigned to a placebo condition. Placebo conditions are routinely used as a comparison against the active treatment condition. Study participants were assigned to perform one of the following exercises for one week only. In the placebo condition, subjects had to write about early memories each night.
There were five treatment conditions: the gratitude visit (within one week participants had to write and deliver a letter of gratitude to someone who had never been properly thanked for their kindness); three good things in life (each day participants had to record three good things that happened and consider what caused them); you at your best (subjects were asked to write about a time when they were at their best, identify their signature strengths at that time, and then reflect upon what they wrote every day for a week); using signature strengths in a new way (participants were asked to identify their top five character strengths and to put them to use in a novel way each day for a week); and identifying signature strengths (participants had to identify their top five signature strengths and to use them more often in the following week).
All of the conditions, including the placebo condition, improved happiness scores and reduced depression scores immediately after the exercises were completed. One week after that, scores for the placebo condition returned to baseline and stayed there for the next six months. The effect of “you at your best” and “identifying signature strengths” also disappeared within one week after the exercises ended. The effect of “the gratitude visit” lasted somewhat longer, persisting for a month. Remarkably, the effects of “the three good things” and “using signature strengths” interventions lasted for the entire six months of the study period. It appears that people who maintained improvement had continued performing their exercises throughout the six-month study period.
In a 2006 publication, Seligman, Taayab Rashid, and Acacia Parks reported their results from their more formal study of positive psychotherapy (PPT). Here they adapted the exercises used in their Web-based study to more intensive forms of psychotherapy. The first study included forty mildly-to-moderately depressed undergraduate students. Nineteen students were assigned to two hours per week of group therapy for six weeks, while twenty-one were assigned to a no-treatment control group. Treatment involved a package of six exercises similar to the ones assigned in the earlier Web-based study. The last session focused on how to maintain therapeutic gains and continue the exercises after the study ended.
Statistical analysis showed that the students in the PPT group had lower depression scores and higher life satisfaction scores than the controls and that the improvement lasted for at least one year after the treatment ended. In a second study, more severely depressed patients were treated in individual therapy and compared to equally depressed patients in usual treatment (psychotherapy with or without medication). The individual therapy utilized many of the same techniques as the earlier two studies, but adapted the interventions to address the greater severity of depression. After a maximum of twelve weeks, patients in PPT showed more improvement than patients in treatment as usual, with greater reductions in depression and higher increases in positive emotion.
There is a growing body of literature that looks at happiness from an international point of view. Studying happiness across different countries can be very helpful for public policy planners, allowing them to identify the social and political factors that promote well-being. As with other happiness research, the best way to measure the subjective sense of happiness is to ask someone directly, “How happy are you?” Happiness researchers also ask people about their satisfaction with their life.
There are two main problems with this kind of research. The first involves potential cultural differences in the understanding of what happiness means. The second has to do with the selection of study subjects. The sample from each country should be representative of the entire population. For example, if the sample is too heavily weighted toward educated, urban dwellers—who are much more likely to take surveys than uneducated rural villagers—then the happiness ratings may not accurately depict that country’s population. Cross-cultural happiness researchers are aware of these problems, however, and try to account for them in their study design.
Ruut Veenhoven is a Dutch sociologist who has conducted cross-cultural research into happiness since the 1980s. In his World Database of Happiness, he has compiled data on happiness studies from countries all over the world into a publicly available Website (www.worlddatabaseofhappiness.eur.nl). There is also data on the correlates of happiness. For example, how much do political freedom and gender equality correlate with happiness? Veenhoven derives much of his findings from a ten-point scale ranging from 0 = most dissatisfied to ten = most satisfied.
On the whole, wealthier countries have happier citizens. Nonetheless, a country’s wealth and its happiness ratings are not entirely aligned. Therefore money only accounts for part of the story. According to Veenhoven’s studies, war, political instability, totalitarian governments, and economic chaos pull happiness ratings down. It also seems that democracy, security, gender equality, strong social programs, political stability, and greater political and economic freedom promote happiness in a country’s citizens. Social cohesion, which Veenhoven refers to as “brotherhood,” is also an important contributor to happiness.
Of the top ten wealthiest countries in terms of per capita income, only four (Iceland, Switzerland, Norway, and Luxembourg) ranked among the top ten happiest countries. The other six countries ranged from the fourteenth happiest country (Ireland) to the fifty-fifth (Hong Kong). Singapore ranked thirty-second in happiness ratings.
The United States is the fourth wealthiest country in terms of per capita income with an average income of $47,000 per year, yet we ranked twenty-seventh in happiness ratings, with an average happiness rating of 7.0.
Veenhoven is also interested in the inequality of happiness ratings within countries. In other words, how similar are the happiness ratings of various individuals within any given country? He constructed a measure called Inequality-Adjusted Happiness, which was based on the standard deviation of happiness ratings. The standard deviation is a statistical measure that reflects how much individual cases vary from the average. According to his calculations, the top five countries with both the highest and most equal happiness ratings were Malta, Denmark, Switzerland, Iceland, and the Netherlands. The middle five were the United States, the Philippines, Iran, South Korea, and India. The bottom five were Armenia, Ukraine, Moldova, Zimbabwe, and Tanzania.
According to Veenhoven’s work, there have been increases in average levels of reported happiness over time. In wealthy countries, these changes have been slight, but in less developed countries, the changes have been pronounced. In the United States, however, there has been essentially no change in the reported levels of happiness over the past sixty years. These findings have been used by Richard Easterlin to support a theory that living conditions, which have risen steadily in the United States over the past sixty years, do not affect happiness. If we consider the findings on both developed and less-developed countries, we can see that happiness is most strongly related to living conditions when money is scarce and living conditions are less than optimal. After people reach a reasonable standard of living, however, affluence does not add much to happiness.
The list of happiness ratings below was collected from the World Database of Happiness, which compiles data on happiness studies from all over the world. These ratings apply to the years 2000 to 2008. The information on each country’s income was gathered from the CIA World Fact Book. Per capita income refers to the average income of each country’s citizens. As we can see from the table, the average happiness ratings, which range from 0 (least happy) to 10 (most happy), vary across the four income quartiles. On average, wealthy countries have higher happiness ratings.
The table below lists the 10 countries with the highest happiness ratings and the 10 countries with the lowest ratings during the period from 2000 to 2008. On the whole, the happier countries are among the most wealthy, while the least happy countries have much less wealth. However, per capita income does not tell the whole story. Some countries that are listed as among the top 10 happiest have very similar, if not lower, per capita incomes than those of countries listed in the bottom 10. For example, Columbia has a per capita income of $8,900 while Bulgaria has a per capita income of $12,900. Likewise the per capita income of Mexico is not much higher than that of either Bulgaria or Macedonia.
According to the World Database of Happiness, Iceland ranks as the happiest country in the world (iStock).
Ever since the 1700s when the seeds of modern economic theory first developed, economists have assumed that people have a very simple relationship with money. The rational economic man is seen to act more or less like a calculating machine. Financial decisions regarding how we spend, borrow, and save, are based on a rational assessment of our losses and gains. We compare the value of what we pay out to the value of what we take in and make decisions accordingly. If we make mistakes in these calculations, we eventually recognize them and correct our behavior.
The problem with this theory is that it is often wrong. As the great financial crisis of 2008 has shown us, people’s economic behavior is often anything but rational. Leading up to this crisis, the whole country gorged on unaffordable debt. In 2007, according to the U.S. Federal Reserve, the median savings rate for American households was just above zero and the median income for a large section of the population had remained flat for several years. Nonetheless, our household debt continued to grow, 11 percent between 2004 and 2007, and 34 percent in the three years preceding that. In fact, from 2004 to 2007, the median credit card balance rose 25 percent. In other words, we were spending more than we could afford. This was not due to the cost of living, as inflation had remained quite low. We were on a giant national binge. While psychology cannot account for the full complexity of economic events—larger political, legislative, environmental, and cultural factors play a central role—more and more economists are recognizing the critical importance of people’s emotional responses to money.
Behavioral economics is a multi-disciplinary field, linking economics, psychology, and neuroscience. It developed as a reaction against the prevailing view of rational economic man. The focus of behavioral economics is the actual psychology of human financial decision making. How do people make decisions about money? What are their blind spots? Where does emotion come in? The first decade of the twenty-first century has brought an explosion of research in this area of study. Some of the scientists involved include Daniel Kahneman, Amos Tversky, Daniel Ariely, Read Montague, and Richard Thaler. There have also been a number of books written by science journalists, such as Jonah Lehrer and Jason Zweig.
The table below is based on data taken from the Federal Reserve and shows the nature and amount of Americans’ debt in 2007. The third column shows the percentage of American families (perhaps more accurately referred to as households) that hold each kind of debt. The fourth column shows the median amount of debt of the households that hold debt. Remember the median refers to the amount that equally divides the top and bottom half of the population.
Every financial decision involves risk and reward. The risk is the loss of money, for example, through a bad investment or through spending too much on something of little value. The reward is the possibility of making more money or the purchase of something we value.
In order to survive, an animal needs to be highly attuned to both risk and reward. Examples of reward include food, sex, and social status; examples of risk include danger from predators, within-species aggression, and loss of resources. Our emotional life evolved as a means for us to quickly and efficiently recognize and respond to cues in the environment that are relevant to our survival. Our core emotions—such as desire, happiness, sadness, fear, and anger —help us process information about risk and reward. Because emotions and the parts of the brain that mediate them are relatively old on an evolutionary scale, we share many of our core emotions with other mammals, such as primates, cats, and dogs.
Anyone who has studied the stock market realizes that investors behave emotionally more than logically. Humans instinctively try to react quickly to potential risks, which tends to put logic second after gut reactions (iStock).
Although we may think we make financial decisions through thoughtful analysis, in truth it is our emotions that do the lion’s share of the work. Brain imaging studies show that the emotional parts of our brain are extremely active when we make decisions about money. In fact, the emotional brain is frequently more active than the parts of our brain involved with thought. Therefore, in order to understand the psychology of money, we have to understand how emotion affects our decisions about money.
These are the primary emotions involved in financial decisions. Our fear motivates us to avoid loss, in this case the loss of money. Desire motivates us to pursue reward, such as money or the goods that money can buy. When desire for money becomes excessive and poorly controlled, we call it greed.
Even though our emotions have evolved over millions of years to help us adapt to our environment, they are not perfect tools and can often lead us astray. For one thing, our emotions are geared almost entirely toward the present. Our emotions can tell us a lot about our needs in the present, but they are not good at telling us what we will need in the future. For that, we need thought and careful analysis. Secondly, our emotions are stimulus bound, in other words they are highly and sometimes excessively responsive to cues in the environment.
There is clear evidence that the short term generally has far greater influence on our decision making than concerns about the long term. In fact, it takes considerable mental effort to put long-term consequences ahead of immediate gratification. Our use of credit cards provides a perfect example. A 2001 experiment by Drazen Prelec and Duncan Simester shows how the use of credit cards increases our spending, presumably because the money spent seems less immediate. The researchers set up an auction for basketball tickets, in which half the participants in the auction were instructed to pay with credit cards and the other half with cash. As expected, the bids made from credit cards were much higher, in fact twice as high, as those made with cash. In another study, Laurence Ausubel looked at consumer response to two commercial mortgages. The first mortgage offered a low teaser rate (4.9 percent for six months) that was followed by a lifetime rate of 16 percent. The second mortgage offered a higher teaser rate (6.9 percent) but a lower lifetime rate of 14 percent. Ausubel found that consumers chose the first mortgage almost three times more often than the second mortgage. Hence, they chose the mortgage that would save them money in the short run but cost far more money in the long run.
Not only are we primed to put immediate considerations over long-term ones, we are primed to respond to cues in our environment that signal immediate risk or reward. These cues can then influence our appraisal of risk and reward—and sometimes throw us entirely off course. For example, when are people most motivated to stick to a diet: when they are in the store trying on bathing suits or when they are walking past an ice cream parlor?
The anchoring effect refers to the way an irrelevant stimulus can have a strong effect on further decisions. For example, Dan Ariely and colleagues held an auction for a range of items. Before people were allowed to bid in the auction, they were asked to write down the last two digits of their social security number. Although the social security number had no logical relationship to the auction, people who wrote down higher numbers bid an average of three times more money for the same items than people who wrote down low numbers.
In the framing effect, the way that information is presented influences our response to it. In other words, whether the risk or the reward is highlighted drastically affects our own appraisal of risk and reward. In a 2006 study, Benedetto de Martino and his colleagues ran an experiment in which people were handed fifty dollars and then given two choices. Their first option was to keep twenty dollars. They were then offered a gamble with a chance of keeping or losing the whole fifty dollars. In this scenario, only 42 percent chose the gamble. When the same choices were framed in terms of loss instead of gain (subjects would lose thirty dollars rather than keep twenty dollars), 62 percent of the subjects took the gamble. Decisions were strongly influenced by the way that risks and rewards were framed. As we can imagine, advertisers are well aware of this tendency and put it to good use.
Our emotions are not very good at considering probability. We are highly attuned to the intensity of a risk or reward and get emotionally aroused by high value rewards or risks, but we do a poor job of balancing the intensity of a consequence with its probability. For example, many people are more afraid of a terrorist attack than of hypertension, although far more people in the developed Western world will die from heart disease than from a terrorist attack.
This concept, introduced by Daniel Kahneman and Amos Twersky as far back as the 1970s, refers to our emotional reaction to cues of immediate loss. Emotionally, we are primed to hold onto what we have and to strenuously try to avoid loss. Consequently, we tend to avoid a choice that will lose us money in the short run, even if it will make us more money in the long run. It is important to remember that this tendency is stimulus bound. So we are not responding to the actual possibility of loss as much as the cue that signals the possibility of loss. In the absence of such loss cues, we can be sideswiped by reward cues, as happens when we overspend on our credit cards. Because of this, manipulation of cues will strongly influence our behavior.
The deMartino experiment on the framing effect described above supports our tendency toward loss aversion. Another experiment reported by Jonah Lehrer in his book on decision making shows the effect of loss aversion. A group of physicians was given a scenario involving an outbreak of a lethal disease. In the first condition, two options were described in terms of the number of people that would live. In option 1, 200 (of a group of 600) people would survive. In option 2, there was a one-third chance that 600 people would be saved and a two-thirds chance that no one would be saved. Only 28 percent of the physicians chose the second, riskier strategy. When the same options were described in terms of the number of people that would die, 78 percent of the physicians chose the risky strategy. Here we see how emotional biases affect the decisions even of highly trained people in responsible positions.
This is the basic wisdom of the stock market: buy a stock when it is undervalued and sell it when it gains in value. This way you maximize your profit on the sale of the stock. Leaving aside the difficulty of predicting whether a stock is going to increase or decrease in value, this action goes against our basic emotional nature. As detailed in the section on behaviorism, we are primed to repeat behaviors that are rewarded and discontinue behaviors that are punished. When a stock is going up, our purchase is rewarded, so we are likely to want to buy. When a stock is going down, we are punished for our purchase, so we are less inclined to buy.
Of course we do use thought when making financial decisions. There is more to our psychology than just our emotions. We use cognition when we plan for the future, analyze complex situations, and calculate numerical amounts (after all, money is based on numbers). However, there are important limits to our analytic capacities and these limitations play out in our financial decisions.
Despite the remarkable intellectual abilities humans do enjoy, there are clear limits to our ability to analyze economic information. For one, the frontal lobe, the area of the brain that mediates complex thought, has a limited amount of processing capability. The complex cognitive capacities that the frontal lobe provides take up a good deal of energy and calories, and incorporate a large amount of neurocircuitry. In other words, intellectual analysis of financial information is very “expensive.” Consequently, our brain is highly dependent on energy-efficient shortcuts that allow us to process a lot of information very quickly. While these shortcuts allow us to function in the real world, they can also lead us astray. Three cognitive shortcuts that influence our thinking about money include: chunking, sensitivity to context, and the zero-sum game between our emotions and cognition.
As was first pointed out by George Miller in 1956, we are capable of keeping only seven plus or minus two pieces of information in mind at a time. In order to expand the capacity of our memory, we group information into larger chunks. This is useful until we forget that the larger chunks were originally made up of smaller units. For example, as documented in a 2006 study by Andrew Geier, Paul Rozin, and Gheorghe Doros, people will eat more pieces of candy when using a large scoop than when using a smaller scoop. Further, as noted in Jonathon Lehrer’s 2009 book on decision making, it is also well recognized that people will eat more food when their portion sizes or plates are larger. Instead of counting how many pieces of candy or ounces of food they are consuming, people count number of scoops or plates of food. When fast food restaurants offer jumbo-size servings they are taking advantage of this tendency.
People are not very good at evaluating the absolute value of an item. We tend to see value as relative. In other words, our estimation of the value of an object will vary tremendously depending on the situation. The economist Richard Thaler asked people if they would go twenty minutes out of their way to save five dollars on either a $15 calculator or a $125 leather jacket. Sixty-eight percent of people said yes for the calculator, but only 29 percent said yes for the leather jacket. Even though the amount of money was exactly the same, the five dollars seemed like it was worth more in the first condition, as it was a larger amount relative to the cost of the calculator. In the second condition, the five dollars seemed like it was worth less because it was smaller relative to the cost of the leather jacket.
There is somewhat of a zero-sum game between our intellect and our emotions. The brain depends on energy, just like a car depends on gas. If too much fuel is going to our pre-frontal cortex to support cognition, less fuel is available to the parts of the frontal lobe that inhibit our emotional impulses. This was shown in a 1999 experiment by Baba Shiv and Alexander Fedorikhin. Subjects were given two different memory tasks, an easy task (to remember two digits) and a difficult task (to remember seven digits). Remember we can only hold about seven digits in mind at a time. Subjects were then offered their choice of either chocolate cake or a healthy fruit salad. People with the easy task were more likely to take the healthy food while people with the difficult task were more likely to take the chocolate cake. The authors interpreted this to mean that energy expended to perform the harder memory task depleted the brain’s ability to resist temptation.
Our evaluation of worth and value is also powerfully influenced by social factors. Consider the amount of money people are willing to spend for high-status belongings. Is a purse really worth $1,000? Is a watch? How many people would pay $80,000 for a BMW if the logo was removed and nobody could tell it was a BMW? People pay outrageous prices for luxury brands not because they believe the products themselves are worth the money, but because the product takes on social meaning. In effect, people are buying social status. This is why high-status people, such as movie stars or star athletes, are paid millions to endorse products such as athletic wear, cereal, or mattresses. Likewise, our sense of a fair salary, a reasonable price, and the worth of a purchase is often judged according to the social context. How much are our colleagues getting paid? How much did our neighbors pay for their car? Once again, advertisers are well aware of this tendency and have learned how to position their products to benefit from the social context.
Advertisers have long understood the importance of the emotional brain in making purchasing decisions, even before fMRI research. For example, a company selling lipstick associates the product with a life of beauty, youth, and glamour, even though it’s unrealistic to believe lipstick will provide all these things (iStock).
Neuroeconomics involves the study of the regions of the brain that are involved in our responses to money. As we learn more about the psychological processes underlying our financial decisions, we are better able to investigate which parts of the brain are active when we make financial decisions. We can now ask: What parts of the brain turn on when we see something we want to buy? How about when we see the price tag, or when we take a financial gamble? What about when we lose money?
There are now many ways to look inside the brain. Older brain-imaging technologies like MRI, PET, and SPECT allowed us to take a snapshot of the brain. By recording blood flow or glucose uptake, we could map a pattern of brain activity at a given point in time. However, the development of fMRI brain-imaging technology has completely changed the game. Now, by recording the behavior of magnetized atoms, we can watch brain activity over time. We have moved from still shots to movies. This is critically important if we want to investigate brain activity during a sequence of mental processes. With fMRI technology, we can put people in scanners and watch how their brains respond while we run an experiment.
This is a photograph of an MRI brain scan. Arrows point to areas of the brain that are close to those regions involved with our response to money. The prefrontal cortex (PFC) is involved in our analysis of long-term consequences of financial decisions. The amygdala is particularly responsive to fearful cues, and the nucleus accumbens is a key player in the reward system, mobilizing us to pursue rewarding stimuli (iStock).
There are several areas of the brain that have been implicated in the mental processes involved with financial decisions. These divide fairly neatly into areas associated with cognitive or emotional processes. The prefrontal cortex is involved with careful analysis, quantitative reasoning, and consideration of future consequences; it is the seat of planning for the future. Several smaller areas deep within the middle of the brain mediate the emotional aspects of our financial life. The nucleus accumbens, a central point in the dopaminergic reward circuitry, is involved with desire and motivation to pursue reward. The amygdala is particularly sensitive to fearful stimuli. The insula, which is actually part of the cortex but is sandwiched inside the frontal, parietal and temporal lobes, is responsive to feelings of pain and disgust. The insula is activated when we lose money.
The prefrontal cortex is the most anterior (or frontal) part of the frontal lobe. The frontal lobe makes up the front half of the cerebral cortex, which is the wrinkled outer covering of the brain. The pre-frontal cortex integrates information from the rest of the brain, creating an overview of our current situation. Not only does the prefrontal cortex create a representation of our self in our environment, but it can create representations of future conditions. In this way, the prefrontal cortex supports our ability to plan, set future goals, and correct our behavior in pursuit of these goals. The pre-frontal cortex is also involved with the precise, careful analysis of information, such as the calculation of cost over time.
Because the prefrontal cortex can create and hold representations of possible events and not just current events, our prefrontal cortex allows us to be more flexible in our thinking and even to come up with creative new solutions to problems. This is in contrast with the evolutionarily older parts of the brain involved with emotion. These areas are more stimulus dependent, more bound to cues in the present. The frontal lobe is also involved in inhibiting our emotional reactions; it inhibits the lim-bic system and other parts of the brain that mediate drive and motivation. In other words, the frontal cortex allows us to regulate emotion and impulse with thought.
As mentioned above, the frontal cortex takes up an enormous amount of energy, and mobilizes a large portion of the brain. Although the prefrontal cortex is powerful, it is slow and inefficient. Thus we would miss a good deal of information if we were solely dependent on our frontal lobe for reading our environment. Additionally, the pre-frontal cortex does not address personal value.
It is our emotions that tell us the value of any given situation, whether and how something matters to us. In fact, without a sense of something’s personal value, we are unable to make decisions. For example, people with lesions in their orbital frontal cortex cannot make decisions. This is a region that integrates information about our emotions into our reading of current and future events. Furthermore, if we think about a decision too much, it distorts our decisions.
In a 1993 study by Timothy Wilson and colleagues, undergraduate women were given the option to pick one of five posters. The subjects were divided into two groups. In one group, the subjects were instructed to rate from 1 to 9 how much they liked each poster prior to picking one. In the second group, subjects filled out a questionnaire about why they liked or disliked each poster before making their choice. Several weeks later, 75 percent of the second group regretted their decision, while none of the first group did. In this case, over-analysis interfered with effective decision making.
Because purchasing decisions are primarily about personal value, about how much we gain or lose, the prefrontal cortex does not seem to be the dominant player in our brain’s response to purchasing decisions. According to a 2007 fMRI experiment by Brian Knutson, George Lowestein, and colleagues, the frontal cortex was less activated during purchasing decisions than either the nucleus accumbens (which processes rewards), or the insula (which processes pain). This suggests that purchasing decisions are driven more by the balance of pain and desire than by a rational assessment of our options.
In a 2007 experiment by Hilke Plassman and colleagues, subjects were invited to participate in a wine tasting while sitting in an fMRI scanner. Three bottles of wine were poured into five different bottles, giving the impression that all five bottles contained different wines. The bottles’ original labels were removed and replaced with new price tags. Even though some bottles with different prices actually contained the same wine, subjects clearly preferred the most expensive wine. Moreover, the pre-frontal cortex was the area of the brain that most strongly responded to the price tag. This suggests that our prefrontal cortex is involved in evaluating our experiences according to what we think should be important regardless of what we actually feel. In this way, if we rely too much on our intel lect when making decisions, we might focus on the wrong features. A balance between thought and emotion is necessary for effective decisionmaking.
Do we judge wine based on the price tag? One study says we do, believing that a costlier wine must be better than a cheaper wine, even if the same wine is put in both bottles (iStock).
The dopaminergic reward system is a circuit that runs through the middle of the brain. In the last decade or so it has received considerable attention because of its central role in a wide range of psychological phenomena. The dopaminergic reward circuitry starts in the ventral tegmentum, an area in the midbrain. This is where we find the cell bodies for the neurons that contain the neurotransmitter dopamine. This particular dopamine tract is called the mesolimbic dopaminergic tract, meaning it runs through the limbic system in the middle of the brain.
The dopaminergic neurons eventually connect to the nucleus accumbens, which is a critical node in the reward circuitry. The reward circuitry responds to reward cues and serves to mobilize the organism to pursue reward. Subjectively, we experience this kind of mobilization as desire, excitement, or craving. The reward system is centrally involved in our financial life. Whenever we experience desire for money or for the goods that money can buy, our reward system is activated.
It must be kept in mind that the reward system has a very powerful effect on motivation. When it is really firing, our desire can be overwhelming. In the most extreme state, we experience addictive craving, which can overpower any consideration of danger or future consequences. So, when we are caught up in the thrill of making money, our reward system can overpower the inhibiting (and cautionary) effect of the frontal lobe.
The dopaminergic reward system not only responds to the presence of rewards, it learns which cues signal reward and which do not. Therefore the reward circuitry is centrally involved with setting expectations. It is in the business of distinguishing which cues do and do not signal reward and in priming us to pursue a reward when it detects a relevant cue.
The reward system has evolved over millions of years to help us recognize the presence of rewards and to motivate us to expend considerable energy to pursue and obtain them. However, it is not foolproof. For one, it responds to the intensity of a reward but not the probability. Secondly, it is over-responsive to novelty, or intermittent reinforcement. Thirdly, it does not do well with randomness.
The dopaminergic reward system is clearly reactive to the intensity of a reward. For example in an fMRI study by Brian Knutson, the nucleus accumbens was twice as activated in response to a promised reward of five dollars as to a reward of one dollar. However, this system does not process the probability of a reward, how likely it is for this reward to actually occur. This lack of discrimination between low-probability and high-probability rewards can explain our attraction to lottery tickets. Why does the purchase of lottery tickets skyrocket when the prize money hits the millions? Because, even though the intensity of the reward stimulates our dopaminergic reward system, the low probability of winning does not register. To the extent that our frontal lobe does process probability information, our reward system may overpower it.
Our dopaminergic reward system is particularly sensitive to intermittent reinforcement. When a behavior is intermittently reinforced, the reward for a given behavior is irregular and unpredictable. Dopamine neurons are particularly sensitive to novelty and surprise, so when behavior is unpredictably reinforced, each experience of reward comes as a surprise. In fact an unpredicted reward is perhaps three to four times as activating as a predictable reward. This pattern contributes to our vulnerability to gambling, which is defined by intermittent reinforcement.
There is evidence that gambling activates the dopaminergic reward system and that people suffering from pathological gambling have abnormalities in this system. Jonah Lehrer relates one particularly telling example involving a woman who developed Parkinson’s disease. Parkinson’s disease is caused by cell death of the dopamine neurons in the basal ganglia. The treatment usually involves medication that increases the amount of dopamine in the brain. When this woman was treated with a dopamine agonist (a medication that increases dopamine activity), her Parkinson’s drastically improved. Unfortunately, she also suddenly developed a serious gambling condition, which ultimately robbed her of her money, her house, and her marriage. When the medication was discontinued, her gambling problem disappeared.
Additionally, the dopaminergic reward system does not do well with randomness. This system has evolved to detect patterns and still tends to interpret patterns even when no pattern is really there. Consequently, we tend to overestimate our ability to predict future events from past events. We can see this when we consider how people demonstrate frequent overconfidence when picking stocks. If there is a good run in the stock market or in the real estate market, people tend to assume this run will continue forever. In truth, a streak of good luck can end at any time. When we assume that past fortune guarantees future fortune, we make foolish investments. Hence, we become overconfident at our ability to predict future events. This mechanism is a central contributor to financial bubbles.
Amygdala is a critical part of the limbic system. The amygdala is particularly responsive to fearful cues, that is, cues of danger. When amygdala is activated, it stimulates activity in the hypothalamus, which in turn sends messages to the autonomic nervous system. This activates physiological stress responses, such as rapid heart beat, perspiration, shallow breath, etc. The amygdala is highly responsive to cues of financial loss. Cues signaling immediate danger of loss activate the amygdala. This in turn stimulates an emotional reaction which may or may not reach consciousness, but will nonetheless affect our decision making. This reaction underlies our tendency to loss aversion. Like the nucleus accumbens and the dopaminergic reward system, the amygdala is highly attuned to immediate cues, but not very good at evaluating the meaning of the cues in the context of current and future circumstances. That role falls to the frontal lobe.
The insula is an area of the cortex that is sandwiched between the frontal, parietal, and temporal lobes. It communicates information about our internal bodily states to our cortex. In this way, it contributes to experiences of disgust and pain. The insula is activated when we experience the pain of losing money. For example, activity in the insula increases when we look at the price tags of our purchases and it decreases when we pay with credit cards as opposed to cash.
As social animals we feel an extraordinary pull to act within socially condoned ways and we resist behaving in ways that go against the group. In a study conducted by Gregory Burns and reported by the journalist Jason Zweig, people made correct choices in a cognitive test 84 percent of the time when they made the decisions by themselves, but only 59 percent of the time when they were exposed to incorrect decisions made by four peers. When the subjects conformed to the decisions of their peers, there was decreased activation in their prefrontal cortex, perhaps reflecting a reduction in independent thought. However, when they went against group norms, there was increased activation in the amygdala, suggesting a fear response.