Individual Utility Depends Only on Absolute Consumption

Abstract

Traditional economic theory assumes, preposterously, that a person’s loss in utility when he alone suffers an income decline is the same as his utility loss when everyone’s income declines by the same proportion. In fact, the person’s loss in utility is much smaller when everyone’s income declines. Traditional theory’s mistake is important because it causes people to overestimate the pain they’ll suffer if they pay higher taxes in support of public goods.