A Behavioural Investigation of the Easterlin Paradox in Housing Markets

Abstract

The Easterlin Paradox states that average well-being is insensitive to average income growth over time. It also manifests itself in housing markets, where housing satisfaction does not rise as housing wealth increases in the long run. Based on prospect theory, we develop a behavioural framework to explain the Easterlin Paradox in housing markets. Two hypotheses, i.e., social comparison and adaptation, are tested by using household panel survey data from the UK. We find support to the social comparison hypothesis. Individual’s asymmetric response to changes in housing wealth distribution, i.e., loss aversion experienced by the worse-off group, could offset the gain from an increase in housing wealth at the aggregate level. As a result, housing wealth growth does not necessarily improve housing satisfaction for the society as a whole if it leads to housing wealth inequality. Although our empirical evidence is from the UK, regional disparity of housing prices is commonplace in many parts of the world. Our findings are particularly relevant to developing countries, where economic growth is often accompanied by widening income gap and rising wealth inequality. Policymakers should be mindful about the far-reaching effect of housing wealth inequality. Given the significant impact of housing wealth distribution on housing satisfaction, and ultimately people’s general wellbeing, it is important to tackle inequality in housing markets.