the population. It does not matter if the reference group is constituted by the poor, the rich or both groups because individual satisfaction is only defined within the reference group.

Theory would therefore suggest at least two mechanisms through which income inequality may affect individual satisfaction. The first is that a rise in income inequality signals future mobility and increases present satisfaction. This implies a positive relation between income inequality and life satisfaction (the Hirschman/Rothschild mechanism). The second mechanism is that a rise in income inequality leads to an increase in relative deprivation and a decrease in life satisfaction (the Runciman/Yitzhaki mechanism). Moreover, while the Hirschman/Rothschild mechanism does not have clear predictions on which income group benefits the most from increased inequality, the Runciman/Yitzhaki mechanism indicates that the poor are more deprived and should be more inequality averse than the rich.

It is important to clarify at this point what we mean by inequality aversion and how we interpret the sign of the happiness-inequality relation. Economics and statistics offer different definitions of inequality aversion. One is the definition derived from risk theory, which describes inequality aversion as the concavity of the utility curve. A second is the inequality aversion parameter used in statistical indexes of inequality which attributes a different weight to incomes located in different parts of the income distribution. One example is the Atkinson inequality measure. A third is the inequality aversion measured with experimental questionnaires and games specifically designed to capture the taste for inequality, for example the work conducted in recent years by Amiel and Cowell (1992). A fourth approach is to consider a negative relation between life satisfaction and income inequality as a sign of inequality aversion. For example, Clark (2003) argues that workers may not be inequality averse because he finds a positive relation between happiness and income inequality and Schwarze and Harpfer (2003) argue that Germans are only weakly inequality averse because a reduction in inequality does not increase well-being. In this paper we follow this last approach by interpreting a positive sign of the happiness-inequality relation as an indication that higher inequality is appreciated and provides a sense of satisfaction to individuals (the Hirschman/Rothtschild mechanism), and a negative sign as an indication that higher inequality is not appreciated and provides a sense of dissatisfaction (the Runciman/Yitzhaki mechanism).

Empirical evidence on the sign and significance of the happiness-inequality relation is controversial and heterogeneous. As described below, one can find positive, negative or non significant relations depending on the particular study considered.

Morawetz et al. (1977) have shown how two communities in Israel with different levels of income inequality differed in average happiness, where income inequality was found to be higher, average happiness was found to be lower. Schwarze and Harpfer (2003) find life satisfaction to be negatively correlated with inequality using the German socioeconomic panel over 14 waves and Hagerty (2000) using aggregated data for eight countries finds that average happiness levels are lower where income distributions are wider. On the contrary, 3