Gambling’s Economic Mysteries : Casinos should not be allowed to exist according to conventional economic rules. Because conventional economic rules assume humans are rational, this is the case. According to conventional economic rules, if someone offered you a deal in which you gave 100 dollars and received 94.80 dollars in return, you would not take it, but for some strange reason, perfectly intelligent people go to the roulette table every day and, in essence, take that exact deal.
Take a look at an American roulette table, which has 38 numbers, including double-zero, zero, and one to 36. The red, black, even, and odd boxes have the best odds on the table. If you put a $5 chip in the red box, for example, and the ball lands on the red number, you will double your money. You gain $5, but the ball could also land on zero or double zero, which are neither red nor black and, for these purposes, neither even nor odd. It would make perfect sense if the zero and double zero were not present when playing roulette.
If you start with $100 and play indefinitely, you’ll end up with $100 because you’ll have a 50% chance of doubling your money each time. Because of the zeros, the odds of doubling your money are actually 47.4 percent. This means that for every dollar you play, you can expect to lose 5.2 cents, but for some reason, people continue to do it, despite the fact that the small difference between fair odds and the odds offered by casinos and other gambling institutions earns them close to half a trillion dollars per year worldwide.
But consider this: just as gambling shouldn’t work, insurance shouldn’t either. Insurance is the polar opposite of gambling. Insurance companies are essentially gambling companies, but the roles are reversed: you are the casino and the insurance companies are the gamblers. If you pay a car insurance company $1500 a year to insure your vehicle, they are betting that you will not cause more than $1500 in coverable damage in a year. Of course, insurance companies need to make money, so they need a margin.
ANOTHER MAGICAL ECONOMIC : Gambling’s Economic Mysteries
For example, MetLife, one of the largest insurance companies, collects $37.2 billion from people who have insurance policies with them. However, they only pay out 36.35 billion dollars in insurance claims. Of course, there are other sources of revenue and expenses at MetLife, but the odds are pretty good compared to the roulette wheel when looking at the balance between what comes in and what goes out for insurance. You give back 97.7% of every dollar, but you’re still losing money.
Insurance companies, according to the same conventional economic rules that say casinos shouldn’t exist. Shouldn’t exist as a concept because people get back less than they put in, but here’s why they do.
Consider this: would you prefer to receive $5 with 100% certainty or have an 80% chance of receiving $6? 25 dollar. Feel free to think that to yourself for a moment, but chances are you said you’d rather have the sure 5 dollar than the 80 5 chances of 6. 25 dollar.
But here’s the strange thing: these two options are worth exactly the same amount. If you took the 80 percent gamble an infinite number of times, you’d get $5 on average each time. Because 80 percent of $6.25 equals $5.
People should, in theory, have no preference between these two options because they are both worth the same amount. But here’s the thing: most people despise losing a specific amount of money. They enjoy it when they win. That is, the negative effect of losing $5 is greater than the positive effect of winning $5, for example.
Because the second option carries the risk of loss, which is a more powerful negative experience. The positive experience of almost certainly gaining $5. It is worth less overall, even if it is worth the same in dollar terms.
Insurance is a worthwhile gamble for the insurance company. Because the odds are in their favor and they profit, while the gamble is worthwhile for you. Because the monetary amount you receive plus the absence of the monetary makes the deal worth more than the total amount you put in.