Allais Paradox

Discipline: Economics

Allais Paradox was formulated by French economist Maurice Allais (1911- ) to counter principles of game theory proprounded by other economists and to establish a definition of rationality in risky situations.

Earlier analysis of game theory had suggested that in the following example, the preference of A over B should entail a preference of C over D.

Allais stated, however, that many sensible people who wanted A over B would choose D or C, suggesting a paradox.

For example, do you prefer A over B, where A is the certainty of winning 100, and B is a 10 per cent chance of winning 500; and do you prefer C over D, where C is an 89 per cent chance of winning 100; and D a 1 per cent chance of winning nothing.

Equilibrium is such that an individual's marginal rate of substitution equals the marginal rate of transformation; that is C is an 11 per cent chance of winning 100 (89 per cent chance of winning nothing), or D is a 10 per cent chance of winning 500 (90 per cent chance of winning nothing).

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