On the weighting of rare events and the economics of small decisions

Abstract

Experimental research suggests that decision makers tend to overweight low probability (rare) events when they rely on a description of the possible outcomes (e.g., the situations addressed by Kahneman & Tversky [19]), but to underweight low probability events when they rely on personal experience (e.g., Barron & Erev [3]). The current chapter summarizes two lines of research designed to evaluate the implications of this pattern. The first line includes an experimental examination of the two contradicting effects. The results suggest that the two effects do not cancel each other. Rather, it is possible to predict which effect is likely to occur in a particular situation. The second line of research explores if the understanding of the experimental results can be used to derive practical implications. Four examples are presented that demonstrate that the experimental pattern can shed light on the economics of small decisions. © 2007 Springer-Verlag Berlin Heidelberg.