April 2013 Vol. 111 No. 6 THE REVIEW

Are People Probabilistically Challenged?

Alex Stein

Daniel Kahneman's recent book, Thinking, Fast and Slow, is a mustread for any scholar or policymaker interested in behavioral economics. Behavioral economics is a young, but already well-established, discipline that pervasively affects law and legal theory. Kahneman, a 2002 Nobel Laureate, is the discipline's founding father. His pioneering work with Amos Tversky and others challenges the core economic concept of expected utility, which serves to determine the value of people's prospects. Under mainstream economic theory, the value of a person's prospect equals the prospect's utility upon materialization (U) multiplied by the probability of the prospect materializing (P). When the prospect is advantageous, its utility is a positive sum that augments the person's well-being. When the prospect is disadvantageous, its utility is a negative sum (a disutility) that decreases the person's well-being. Under both scenarios, the full amount of the person's utility or disutility is discounted by the prospect's probability of not materializing. Economic theory holds that the expected-utility formula, P · U, ought to determine a rational person's choice among available courses of action. The action yielding the highest expected utility is the one that the person ought rationally to prefer over the alternatives.

This normative assumption underlies all economic models that predict human behavior. For example, when a legal system apprehends 10 percent (0.1) of all drivers who run a red light and forces each violator to pay a $300 fine, the expected fine for each prospective violator equals $30. Economic theory consequently predicts that a risk-neutral driver will run a red light when her expected gain from doing so exceeds $30. Hence, when the average social loss from a red-light violation (including the marginal increase in society's cost of enforcing the law) exceeds $30, economically minded scholars and policymakers recommend upping the fine to a sum that will eradicate the drivers' antisocial incentive to violate.

 

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