Decisions Have An Opportunity Cost That Require Tradeoffs

Behavioral Economics: When Do We Minimize Risk?

by Elaine Schwartz    •    Nov 12, 2012

With Election Economics having concluded, for the next 4 weeks, Monday posts will focus on topics that relate to behavioral economics.

Let’s start with Hurricane Sandy and my own NJ neighborhood. Really though, we will be looking at how many of us manage risk.

After August 2011 Hurricane Irene, I lost power for 8 days and assumed it would never happen again. Less than 2 months later, with the October 2011 snowstorm, I again lost power for 8 days. After the second storm, my perception of the risk of losing power had changed and I soon decided to purchase a residential generator.

Economics Nobel Laureate, psychologist Daniel Kahneman explained my behavior. First of all, displaying “availability bias,” I began to overestimate the probability of an event because I could recall and therefore imagine it much more clearly.

And then I became a part of an “availability cascade” through which a public reaction conveys growing alarm about a future unpredictable event. Last year, I participated in “availability cascade” within my own neighborhood. Seeing an increasing number of neighbors purchase generators, I believed a generator was necessary. Had I looked at the probability of such an event during a longer time frame, I might have concluded it was not as likely.

Now, after Hurricane Sandy, many more of us might be reacting to an “availability bias” and “availability cascade.”

Describing the businesses that benefit from disasters, a lead article in the NY Times Sunday Business section reported that residential generator sales are soaring. At Wisconsin based Generac Power Systems, they are running 3 shifts 6 days a week to meet the change in demand from Sandy. One NJ contractor says he is booked through January 8 and has 4 or 5 neighbors appear when he arrives to give an estimate at a home. Are we observing examples of post-Hurricane Sandy availability bias–overestimating future probability–and availability cascade–emotional public reaction that spreads?

And a final fact: Availability bias and cascade worked in my favor. For Hurricane Sandy, I had a generator back-up when we lost power for 12 days. After other natural and manmade disasters though, they have resulted in a misallocation of public and private resources.

Sources and Resources: You can read the NY Times article, “The Mad Max Economy,” here while my behavioral economics analysis is based on sections of the Daniel Kahneman book, Thinking Fast and Slow.

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