Difference between revisions of "AD/BC problem"

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(Briefly describe the opening example of "Risk Policies" in "Thinking, Fast and Slow")
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Revision as of 02:57, 30 April 2012

The chapter "Risk Policies", in Kahneman's "Thinking, Fast and Slow", opens with this example, which makes vivid the pitfalls of relying on our intuitions in choosing between bets:

Imagine that you face the following pair of concurrent decisions. First examine both decisions, then make your choices. Decision (i): Choose between

  • A. sure gain of $240
  • B. 25% chance to gain $1,000 and 75% chance to gain nothing

Decision (ii): Choose between

  • C. sure loss of $750
  • D. 75% chance to lose $1,000 and 25% chance to lose nothing

Most people, looking at both concurrently, choose A and D. Now consider this second choice:

AD. 25% chance to win $240 and 75% chance to lose $760 BC. 25% chance to win $250 and 75% chance to lose $750

Clearly, any sane person will choose BC here; it dominates option AD. However, AD is exactly the combination of options A and D, while BC is the combination of B and C.