29.4 * Everyday Application: Reference Points, Happiness, and Envy: The stylized results from the happiness literature suggest that happiness, at least as reported on surveys, is “reference-based” in the sense that people evaluate how happy they are not exclusively based on how much they have but, at least in part, based on how much they have relative to everyone else in their proximity.

A. This form of reference-based tastes differs from what we encounter in other settings in the sense that the “reference point” is typically something internal to the individual, such as the individual’s current endowment.

a. Explain how one might interpret the combination of the two empirical claims cited in the text as evidence of such reference-based determinants of happiness. (The two empirical claims are: (1) within countries, happiness is increasing with income; and (2) excluding countries and times of extreme poverty, there appears to be little relationship between average happiness and average income across countries or across time.)

b. Suppose we have a situation where we have to allocate a fixed amount of money between two individuals. Individual 1 has reference-based preferences, with his happiness increasing only in his own consumption but decreasing in individual 2’s consumption. Individual 2, on the other hand, has the usual preferences, with her happiness increasing only in her own consumption. In what sense is individual 1 driven in part by “envy” while individual 2 is not?