Definition
A paradox in decision theory where a lottery with an infinite expected value is only considered to be worth a small finite amount by rational participants.
Why It Matters
This paradox exposes the fatal flaw in “pure” mathematical expectation, proving that human decision-making is governed by utility and survival rather than just probability—a realization that forms the bedrock of modern behavioral economics and insurance.
Core Concepts
- Expected Value: The probability-weighted sum of all possible outcomes.
- Diminishing Marginal Utility: The concept that each additional unit of wealth provides less utility than the previous one.
- Risk Aversion: The preference for a guaranteed payoff over a risky gamble with a higher expected value.