Presentation
A Classroom Experiment on
Risk and Uncertainty
John C. Bernard
Food and Resource Economics
University of Delaware
Presented at 16th Annual Conference
Teaching Economics: Instruction and Classroom Based Research
February 17-19, 2005
Robert Morris University, Moon Township, PA
Daria J. Bernard
Policy Analysis and Management
Cornell University
Course Information
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Economics of Biotechnology and New
Technologies
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Primarily juniors
Ranges from 15 to 30 students
Prerequisite: Intro. Microeconomics
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Risk Experiment
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In today’s experiment we will be
examining people’s decision making
under risk and uncertainty. Below, you
are presented with two different
situations. For each situation, please
select the choice that you would prefer.
Almost no students have had intermediate
Many students from outside majors
1
Risk Decision
„
Situation #1
Choice A
You will get 3 extra points
on exam one.
Risk Decision
„
Choice B
You have an 80%
chance of getting 4
extra points on exam
one, 20% chance of
getting 0 extra points
Situation #2
Choice A*
You have a 25% chance of
getting 3 extra points on
exam one, 75% chance of
getting 0 extra points
Purpose of Experiment
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Understand economic concepts:
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Rational
Expected Value and Expected Utility
Risk Averse (Risk Neutral / Risk Loving)
Choice B*
You have a 20% chance of
getting 4 extra points on
exam one, 80% chance of
getting 0 extra points
Purpose of Experiment
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Understand limits to theories and
alternative ideas:
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Allais Paradox
Framing and Certainty Effects
Prospect Theory
Anomalies
2
Design with Context: Farmer
Facing Risk
Purpose of Experiment
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Understand course content:
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Situation #1
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Relate to concerns over new technologies
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Especially GM Foods
Difference in lay person and scientists’
views of risks and uncertainty
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Situation #2
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Economic Rational Behavior
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Theory: a rational decision maker will
make choices to maximize expected
utility or expected value.
„
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More is better!
Remind them that economics is about
dealing with scarce resources
A: Plant non-GM crops and earn $3,000
B: Plant GM crops with 80% chance of earning $4,000
and 20% of earning 0 due to consumer rejection of GM
foods
A*: Plant non-GM crops with 25% of earning $3,000
and 75% chance of earning 0 because crop fails
B*: Plant GM crops with 20% chance of earning
$4,000 and 80% of earning 0 due to consumer
rejection of GM foods
Expected Value (EV)
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EV = (probability event occurs) *
(value of the event)
So, which choices in each situation had
the highest expected values?
3
Class Experiment
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Situation 1:
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Class Experiment
Situation 2:
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Theory therefore states that rational
decision makers should select B and B*
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Most pick A and B*
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Violates standard theory
Choice A: Expected Value = 1 (3) = 3
Choice B: Expected Value = 0.8 (4) = 3.2
Choice A*: Expected Value = 0.25 (3) =
.75
Choice B*: Expected Value = 0.2 (4) = .8
Past Results
Course
FREC 316
Spring
Spring
Spring
FREC 806
Spring
TOTAL
Class Irrational?
A-A* A-B* B-A* B-B*
01
02
03
2
2
3
5
6
7
0
1
2
1
0
0
01
0
4
2
3
7
22
5
4
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Was the class irrational by their
selections in the Risk Decision
Experiment?
Why or why not?
4
Possible Reasons:
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Avoid risk
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A risk averse decision maker would
select A and A*
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This would be consistent with Expected
Utility Theory under risk aversion
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Possible Reasons:
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Can’t overlook the sure thing!
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Called ‘Certainty Effect’
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People often want to take a sure gain
option and avoid a sure loss option
Debate: does this hold in low-stake
situations?
Possible Reasons:
„
View B as chance to lose 3 points rather
than to gain 4 points.
Prospect Theory
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Relates to ‘Framing Effect’
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Typically seen in subjects making opposite
choices when options phrased in terms of
gains (positive frame/risk averse)
compared to losses (negative frame/risk
seeking)
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Designed to explain behavior inconsistent
with EU theory
Uses concept of a value function, defined in
terms of gains and losses (deviations from a
reference point). The function has a different
shape for gains and losses. For losses it is
convex and relatively steep, for gains it is
concave and not quite so steep.
Framing and reference point matter
5
Anomalies
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Still have a choice (B-A*) that isn’t
explainable by either Expected Utility
theory or by Prospect Theory
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Demonstrates limits to economic theory
in explaining human behavior
Uncertainty and GM Foods
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Consider utility a consumer gets from an
Non-GM good (known, no risk
considered)
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For GM version: Two factors affect their
expected utility:
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p = scientific probability GM version posses a
health hazard
w = probability value for p is wrong
(subjective, goes beyond prospect theory)
Perception and Consumer
Utility
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If either p or w > 0, consumer has lower
expected utility, needs income
compensation
Calculating Risk
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People have trouble judging when:
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From experiment, know the amount of
compensation may need to be larger than
expected utility theory would suggest
Dealing with probabilities
Media coverage is unbalanced
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Especially true for very low levels
How has media coverage been for GM foods?
They’ve had misleading personal
experiences
Must rely on intuition
6
Factors Influencing People’s
Risk Perceptions
Compared with Experts (1987)
Activity / Technology
Smoking
Nuclear power
Motor vehicles
Alcoholic beverages
Surgery
Pesticides
Electric power plants (non-nuclear)
Police work
Genetically modified foods
X-rays
Irradiated foods
Swimming
Food preservatives
Vaccinations
Antibiotics
Food coloring
Class
Rank
1
2
3
4
5
6
7 (tie)
7 (tie)
9
10
11
12
13
14
15
16
Experts
Rank
2
11
1
3
4
6
7
10
5
8
9
14
13
12
Previous
Classes (2)
1 (tie)
4
1 (tie)
7
5
6
9
3
15
8
10
12 (tie)
14
11
12 (tie)
16
Educating the Public
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Claim: if public is educated / informed,
they will have the same risk
assessments as experts.
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Is this realistic?
Studies say no!
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Novelty
Nature of possible consequences / Ethical
concerns
Scientific findings, evidence
Reaction from:
„ Government
„ Activists
Previous bad experiences
Voluntary / Involuntary
Attitude of proponents
Risk Views: Public and Experts
Lay People (the public): use all the
factors we’ve discussed
„ Experts: base strictly on technical
estimates of possible fatalities
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Lay people will give rankings similar to
experts if asked to rank by fatality
possibilities instead of by risk
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Thank You!
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Copies of the paper are available under
working papers on my web page:
www.udel.edu/FREC/bernard/index.htm
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