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A sure dollar or a one-in-a-hundred chance at a hundred

expected-valuerisk-aversionutilitydecision-theory

You are offered a choice: 1 dollar for certain, or a 1 per cent chance of winning 100 dollars (and 99 per cent chance of nothing).

  1. Compare the two by expected value.
  2. Most people are close to indifferent here. Now scale up: 1 million for certain versus a 1 per cent chance of 100 million. Almost everyone takes the sure million. Is that irrational?
  3. What principle explains both reactions?
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Compute the expected values. Then ask how much the second million dollars is worth to you compared with the first.

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