Empirical results of relationship between income and subjective well-being distinguished in cross-sectional and panel analysis. That is, the relationship is found to be significantly positive in cross-section comparison, but weaker in panel analysis. Theoretical explanation in literature emphasis the role of relative income. However, new empirical evidences emerge of the importance of absolute income, mainly using exogenous income. This study tends to provide a new explanation for the paradox from perspective of permanent income hypothesis. In the study, we construct a theoretical model based on permanent income hypothesis. The intuitions from the model are mainly as following: (i) Consumption (and therefore utility) responds to innovation in the income process, but not to antici...[ Read more ]

Empirical results of relationship between income and subjective well-being distinguished in cross-sectional and panel analysis. That is, the relationship is found to be significantly positive in cross-section comparison, but weaker in panel analysis. Theoretical explanation in literature emphasis the role of relative income. However, new empirical evidences emerge of the importance of absolute income, mainly using exogenous income. This study tends to provide a new explanation for the paradox from perspective of permanent income hypothesis. In the study, we construct a theoretical model based on permanent income hypothesis. The intuitions from the model are mainly as following: (i) Consumption (and therefore utility) responds to innovation in the income process, but not to anticipated income changes. (ii) Marginal propensity to consume is higher of permanent income than that of transitory income. In cross-individual comparison, variance in income is mostly the variance of lifetime component of income; while in panel study, the permanent part in income innovation is much smaller. It explains the weaker income-SWB relationship is panel studies. We test our hypothesis by using a unique panel data from rural China, which collects the subjective expectation of future income, as well as income realization. It enables us to separately identify the permanent and transitory income shocks. Empirical results suggest that unexpected income shock has positive and significant effect on SWB, while expected income has no significant effect on SWB. Furthermore, empirical results show that the effect of permanent shock on SWB is smaller than that of transitory income shocks. Combining with the findings that the ratio of variance of permanent part among variance of income used for identification is higher in cross-section analysis than that in panel analysis, the empirical evidence approve the permanent income explanation.

Key words: Subjective Well-Being, Permanent Income, Transitory Income