What would you do?

"For example, consider a case where a person is presented with the following three options

"(a) Receive $500,000 with certainty.
(b) A 95 percent probability of receiving $1 million dollars and a 5 per cent probability of receiving just $100.
(c) A 50 per cent probability of receiving $900,000 and a 50 per cent probability of receiving $100,000

"For both shackles model and Prospect Theory, option (a) becomes the referenced point and the rival strategies have to be reframed as follows for Prospect Theory:

"(b) A 95 per cent probability of gaining $500,000 and a 5 per cent chance of losing $499,900
(c) A 50 per cent probability of gaining $400,000 and a 50 per cent probability of losing $400,000

"In terms of prospect theory, loss aversion guarantees that (a) will be preferred over (c); option (b) may also be rejected in favour of (a) due to the downside risk being assigned a much bigger weight than 5 per cent, whereas in terms of traditional subjective expected utility theory (b) would normally be expected to be favoured." -- G. L. S. Shackle, pp. 173-174

The authors go on to note that Shackle could explain the possible choice of (a) over (b) better than Prospect Theory. For Shackle, a likely reason one might favor (a) over (b) is that (a) might be seen as a "life-changing event": "At last! Now I can open that Italian restaurant I've dreamed of running. The additional $500,000 upside is unnecessary to the dream, while the $499,900 downside is absolutely destructive of it.

Indeed, offered the choice of (a), (b) or (c) right now, I probably would take (a). How about you?


  1. Anonymous9:59 PM

    I'm going to answer without calculating expected values.These questions never specify how much you have in the bank, which is actually always relevant . If the amount at stake is relatively trivial, it makes sense to go wìth the highest expected value.

    If I have some pressing need or use for the low payoff of the sure thing, then go with that.

    If I don't have a pressing need or use for the lower payout but the big money small odds would make life significantly better, I would go for the big money.

    Really, to answer a question like this you need to understand both the sums and your current position in terms of maslow's heirarchy of needs or something like it.

    1. Yes, this was Shackle point about a "life-changing event." For someone who has $10 in the bank, go for the sure $500,000. Bill Gates probably goes for the million.

  2. Anonymous10:10 PM

    I forgot to add that, I would currently go for choice C. 500,000 would mean a lot to me now. A million would be twice as good, but 100 would be essentially zero. 100,000 would still be very good and 900,000 would be just as good as a million to me.


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