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RECOMMENDED READING

Akerlof, G. A., and R. J. Shiller (2009). Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism. Princeton: Princeton University Press.

Edelman, G. (2004). Wider Than the Sky: The Phenomenal Gift of Consciousness. New Haven, CT: Yale University Press.

Hayek, F. A. (1952). The Sensory Order: An Inquiry into the Foundations of Theoretical Psychology. Chicago: University of Chicago Press.

Kelso, J.A.S. (1995). Dynamic Patterns: The Self-Organization of Brain and Behavior. Cambridge, MA: MIT Press.

Oullier, O., A. P. Kirman, J.A.S. Kelso, eds. (2010). The State of Mind in Economics. Cambridge: Cambridge University Press.

Schrödinger, E. (1974). What Is Life? Mind and Matter—Autobiographical Sketches. Cambridge: Cambridge University Press.

PART THREE

INDIVIDUAL DECISIONS IN A DANGEROUS AND UNCERTAIN WORLD

IN PARTS ONE AND TWO we learned a great deal about how our behavior, even in common situations, often deviates from models of rationality used by economists. We also learned why having the necessary tools is essential for making the right decisions when we are faced with risk and uncertainty.

In Part Three, we confront a world that is not only uncertain but dangerous. The first three chapters in this section (11, 12, and 14) address the question of how humans behave when faced with the possibility of truly catastrophic risks. How do we react in situations involving risk and ambiguity? In what ways are those reactions likely to change depending on how much experience we have? And is it rational that we feel less threatened by events that will take place far in the future?

Whether ambiguous or not, dreadful possibilities stimulate strong emotional responses, such as fear and anxiety. In such instances, many people focus on the emotionally perceived severity of the outcome rather than on its likelihood: Probabilities are neglected. Knowing this, we should not be surprised that public figures and activists often describe tragic outcomes. Rarely do we hear them quote probabilities. The latter, even if reasonably large, would have little resonance in the public debate.

Part Three ends with three chapters (15 to 17) in which knowledge of decision sciences is applied specifically to the case of natural disasters. Why is it that people fail to learn from disasters, only to make the same mistakes again and again? And why, when it comes to insuring against such catastrophes, does our behavior, as individuals or politicians, rarely follow the path of what the “economic man” (described in the introduction of the book) would do? As these chapters demonstrate vividly, the reason is that other things matter more to us. Unfortunately, this propensity is of great consequence to society in that it leads us to collectively mismanage disasters (a hint of what’s to come in Part Four).

But a question remains before we close this introduction to Part Three: Have you noticed something unusual in the chapter numbering? Yes, you are right; there is no Chapter 13. Well, given what we learned about superstition in Part One, we decided not to take that risk. One never knows.

11

Virgin Versus Experienced Risks

CAROLYN KOUSKY, JOHN PRATT, AND RICHARD ZECKHAUSER

INTRODUCTION

Every day we face a multitude of risks. Some we have experienced before; some we have not. Some we have contemplated; others have never crossed our minds. We define four types of risk based on these two dichotomies, as shown in Figure 11.1: virgin risks, contemplated risks, experienced risks, and neglected risks. Individual, institutional, and societal responses to these four types of risk vary in predictable ways.

FIGURE 11.1 Typology of Risks

Virgin risks are those we have neither experienced nor considered. For an individual, a car crashing into her living room is surely a virgin risk. For society, the meltdown in securities markets of 2008-2009, and its aftermath, was similarly a virgin risk. Of course, if risks are unlikely enough to