Shadow Pricing Explained

How does shadow pricing work? The statistical maths behind it is a little complicated but the basic idea can be illustrated with the following example: Let’s say you are earning £10,000 a year. At this point you may rate your happiness to be a six, on a scale of one to ten. However, the following year you get promoted and your salary is increased to £30,000. When you are asked how happy you are, you now reply with a happiness rating of eight. Assuming nothing else contributed to your happiness, one could infer that to increase your happiness by two points you require £20,000. Now, what if in another situation instead of an increase in salary, you got married and your happiness did also move from six to eight. One could then infer that the shadow price of marriage is £20,000.

Powdthavee’s methadology is more sophisticated than my example implies, and uses data from the British Household Panel Survery, which includes over 10,000 randomly selected individuals. What you get from such enormous data are estimates and valuations which are eye-opening. Powdthavee estimates, for instance, that if you move from seeing your friends or relatives less than once a month to seeing them on most days (more than twice a week), your life satisfaction could improve just as much as if you were handed £85,000!

What is the significance of this number? And why should we put ‘price-tags’ on friends? Well, for one, this figure is a reminder of how important it is to have a healthy social life if you want to be happy (and don’t forget, happy people often outperform sad people in a number of fields, including education). Secondly, such estimates can help with decision making. For example, when you graduate you might be faced with the dilemma of choosing between a high-paying job which requires you to relocate far away from your friends and relatives, and a lower-paying job nearer home. But with a monetary estimate of how much your social life is worth, you can make better-informed decisions in situations such as these.

Here are few other interesting estimates in Powdthavee’s paper (the reds are negative values):

• Seeing friends/relatives once or twice a month: £57,500
• Seeing friends/relatives once or twice a week: £69,500
• Seeing friends/relatives on most days: £85,500
• Marriage: £50,500
• Living as a couple: £82,500
• Unemployed: £143,000

My favorite positive psychology study is one published in Science by Liz Dunn and her colleagues at UBC. They found that people who spent their salary bonuses on other people were happier than those who spent it on themselves. And they did an experiment in which they gave students five dollars or twenty dollars and instructed them to either spend the money on themselves or on someone else. Like rational economists, other students guessed that it would make people happiest to get the larger amount and to spend it on themselves. But that is not what happened. Instead, the students were happiest when they bought someone else a gift, regardless of the amount. These findings are part of a heartening wave of new research suggesting that human beings are chock-full of mechanisms designed to make us feel good when we cement our bonds with those around us.

Excerpt from Sex, Murder, and the Meaning of Life by Douglas T. Kenrick

Two friends are hiking in the woods and come to a river. They take off their shoes and clothes and go for a swim. As they come out of the water, they spot a hungry bear that immediately starts to run toward them. One of the men flees immediately, but the other pauses to put on his shoes. The first man screams at the second, “Why are you putting on your shoes? They won’t help you outrun the bear!” To which the second man calmly responds: “I don’t need to outrun the bear; I just need to outrun you.”

Excerpt from Connected by Nicholas Christakis & James Fowler

This prediction error works as follows. You are about to buy a new car. It is going to change your life, elevate your status, and make your commute a vacation. It is so quiet that you can hardly tell if the engine is on, so you can listen to Rachmaninoff’s nocturnes on the highway. This new car will bring you to a permanently elevated plateau of contentment. People will think, Hey, he has a great car, every time they see you. Yet you forget that the last time you bought a car, you also had the same expectations. You do not anticipate that the effect of the new car will eventually wane and that you will revert to the initial condition, as you did last time. A few weeks after you drive your new car out of the showroom, it will become dull. If you had expected this, you probably would not have bought it.

Excerpt from The Black Swan by Nassim Nicholas Taleb.

It seemed that one might squander one’s life chances because of a high-handed disdain for books with titles such as The Will to Succeed, believing that one was above their shrill slogans of encouragement. One might be doomed not by a lack of talent, but by a species of pessimistic pride.

Excerpt from The Pleasures and Sorrows of Work by Alain De Botton.

Writers who are blessed with inborn talent can freely write novels no matter what they do—or don’t do. Like water from a natural spring, the sentences just well up, and with little or no effort these writers can complete a work. Occasionally you’ll find someone like that, but unfortunately, that category wouldn’t include me. I haven’t spotted any springs nearby. I have to pound the rock with a chisel and dig out a deep hole before I can locate the source of creativity. To write a novel I have to drive myself hard physically and use a lot of time and effort. Every time I begin a new novel, I have to dredge out another new, deep hole. But as I’ve sustained this kind of life over many years, I’ve become quite efficient, both technically and physically, at opening a hole in the hard rock and locating a new water vein. So as soon as I notice one water source drying up, I can move on right away to another. If people who rely on a natural spring of talent suddenly find they’ve exhausted their only source, they’re in trouble.

Excerpt from What I Talk About When I Talk About Running by Haruki Murakami.

Photo credit: familymwr.

The reason why we see so many rat racers around is that our culture reinforces this belief. If we get an A at the end of the semester, we get a gift from our parents; if we meet certain quotas on the job, we get a bonus at the end of the year. We learn to focus on the next goal rather than on our present experience and chase the ever-elusive future our entire lives. We are not rewarded for enjoying the journey itself but for the successful completion of a journey. Society rewards results, not processes; arrivals, not journeys.

Once we arrive at our destination, once we attain our goal, we mistake the relief that we feel for happiness. The weightier the burden we carried on our journey, the more powerful and pleasant is our experience of relief. When we mistake these moments of relief for happiness, we reinforce the illusion that simply reaching goals will make us happy. While there certainly is value in relief—it is a pleasant experience and it is real—it should not be mistaken for happiness.

Excerpt from Happier by Tal Ben-Shahar.

Photo credit: James Clar.