The Magic Economics of Gambling

The only thing about gambling my statistics teacher ever said was "the longer you play, the more your winnings tend to negative infinity. If you win something, get up and leave"

I gambled once in my life. My dad gave me $50 to gamble as a "lesson" to show its a waste of money. I was down to $10 and feeling bad about it and then I won $394. Im never gambling again.

People picked the 100% chance to win a $5 option because you left out the part about an infinite number of tries.

The only reason I have car insurance is I am legally required to have it for liability.

When it comes to the 100%/$5 vs 80%/$6.25 choice, the question kind of implies that you only get one roll of the dice, which is why most people take the sure thing. When you pose the question, you don't say "given infinite rolls, which would you pick?"

The point of insurance is not that the loss hits us more emotionally than the gain. The point of insurance is to get rid of a significant risk, and replace it with a monthly, predictable payment, we can plan for. Also the point of insurance is that the loss when it happens can drive us into bankruptcy, so it actually has way bigger effect on our life than a comparable gain. And the third point is that we are also spreading risk not just over time, but across the population as well, so the unlucky ones actually gain on insurance, on the expense of the lucky ones. Three reasons why insurance is good, and all three are reasonable, regardless of emotions.

On may 5th, I woke up at 5 am. I had been dreaming of the number 5 all night. I had the 5 dollar special at the diner for breakfast. I filled my car up with gas, it topped off at exactly 5 dollars. I said I have to go to the race track, it was 5 miles away. I got there at 5pm, just in time for the 5th race. I bet 5 thousand on the #5 horse. Sure enough, she came in 5th.

One concept you left out is risk of ruin. If you went to a 100% payback perfectly random roulette wheel with $100 and bet $5 each spin for an infinite number of spins you would walk away with $0 every time, because at some point during that infinite number of spins you will go on a run where you are down $100. This is another way casinos make money. It is not just that they have the edge. It is also that they have virtually unlimited bankroll in relation to most players.

The point of buying insurance is so the government doesn't put me in jail and impound my car.

As someone who develops cost-benefit analyses incorporating behavioral economics, I'm ecstatic that you are shedding light on this topic. Perceived risks, loss aversion, transaction costs, and the interplay with psychology, cognitive science, and evolutionary biology are fascinating. I will note, however, that the foundation for insurance is more than just fear of loss. There is a distinct difference between insurance for things that you can do more than once (e.g. buy a new phone with extended warranty) vs. one-time things (e.g. life insurance) or large ticket items (e.g. home or car insurance). One cannot play the "gambling" game buying an infinite number of houses and skipping on insurance. Losing a house to fire is likely to be a financially crippling event that you cannot recover from without insurance. Similarly, you only have one life. And so you are paying to avoid loss for these infrequent, large, or one-time transactions. On the other hand, most people can probably recover from breaking a $200 phone, and will go through several phones in their lifetime. What you described in the video related to insurance is really more applicable to buying extended warranty for these kinds of smaller, repeated transactions.

The oversimplification in this video results in some weird hypotheses. For instance, the reason people buy insurance is to pay, let's say $10 a month, so that when they get a $50.000 claim, they do not go bankrupt. Also, the reason it works, is because everybody chips in, and hereby the risk gets spread equally over all people. The real question should be, would you rather pay $10 a month, and get $50.000 when needed, or pay $0 per month, and pay $50.000 when needed. That's why people buy insurance ;)

The first time I ever went to a casino I had $150 I'd decided ahead of time I was ok with losing. I first went to the blackjack table and lost $100 in three hands. Then I took my remaining $50 and went to the slots, where I promptly lost the rest in about 5-10 minutes. I remember feeling very unlucky, especially since my dad was famous in the family for being "lucky"; he always seemed to leave Vegas at least a few hundred bucks richer was the story we all grew up with. It wasn't until later in life that I realized I was the lucky one. Because my initial experience with gambling was so negative, I lost all my money before I could even enjoy one of those (at the time) free drinks that you got while gambling, I was turned off and bored and found the whole thing stupid. Consequently I've never gambled, never bought lottery tickets, and gotten to keep most of my money. My dad and my brother both had success early, which allowed them to develop a taste for the process. In the end, however, neither of them was particularly lucky in the long run as they both lost thousands of dollars over the years, with my dad nearly losing his house because of it, to say nothing of the thousands of dollars they both lost in lottery tickets. They both passed kind of young and when I was cleaning their cars for sale I found hundreds of Powerball tickets discarded on the floor of their cars. Eventually I made the connection that first experiences tend to count the most with things like that. It sets the bar of your expectations, often just about no matter what happens later. I've since won thousands from lottery tickets without ever buying a single ticket, I had several jobs where managers would buy tickets as small prizes for performance and won several times, but to this day I'm not even the slightest bit tempted to ever actually buy tickets or gamble when I go to Vegas, because emotionally I still feel what I felt the first time. More than once I've had the thought that parents should create sham casinos for their kids where the games are rigged for them to lose so that their kids first experience with gambling is negative to try and deter them from getting a taste for that life experience, but I have no idea how that would work lol.

I'm a behavioral economics professor. I disagree with the wording on a few things here. 1) $5 for sure and an 80% chance of winning $6.25 are not "worth the exact same amount." They have the same EXPECTED VALUE. That's not the same thing; 2) you seem to be saying loss aversion explains why people buy insurance. Loss aversion helps potentially explain it for sure, but risk aversion is enough to explain it. One need not also be loss averse. Indeed, if loss aversion applies to the big loss you are insuring against, why doesn't it apply to the insurance premium you pay for sure?; 3) risk-seeking behavior or the utility value of gambling could explain why people like roulette quite easily as well - it's not obviously totally irrational.

We got a CGP Grey video earlier, and now we're getting a Wendover Productions video... MAXIMUM EDUCATION

You don't make $20 on a savings account that pays 1% on a $2000 investment. You lose $40 of spending power because inflation went up by 3%.

As an insurance underwriter with 5 years of experience, I can safely say that insurance IS legal gambling. You're just given tools to "read the cards" (loss history, construction type, inspections, applications (that are legally binding), historical lost trend data, and our favorite "law of large numbers". With that said, the government does regulate insurers, so if we are profiting too much we are legally obligated to reduce our rates. The rate increases you see each year is due to inflation and the local experience of all risks in your local area.

I’m a regular in a few casinos and from what I’ve observed the “odds of winning” are irrelevant for most gamblers, they seek excitement, thrills and a reason to celebrate until dawn. To feel like the “stars have aligned just for them”, that the forces beyond our perception and control are on their side i.e to feel significant even if it’s only for a night or two. This euphoria is what hooks people and of all the addicts I personally know, not one of them are driven by a greed for wealth (though occasionally motivated by a desire to pay back taxes and to avoid prison) and now that I think deeper about it they’re basically adrenaline junkies that are unfortunately used to living “fast” and well beyond their financial means. Living every weekend like it’s literally their last one, something I don’t recommend for anyone. It’s a disease tbh that’s caused by nihilism, intense fear with a touch of insanity. But, we all gotta go sometime so why not go whilst doing the things you love to do? This is what I’m told, and I cannot find any fault in their logic lol

"Gambling is fun! You're exchanging money for fun or the possibility of more money. It's a win-win situation!" -every casino owner ever

While I would never say this to my friends who play the lottery, I love the old line: the lottery is a tax on people who don't understand math!

In Portugal, there is an institution called "Holly house of Mercy", wich holds the monopoly of loteries in Portugal for 200 years. Its an huge charity that runs child care, eldery care, orphanages, food banks, etc... So, playing in the lotery can be considered charity and you dont feel guilty about spending money in it.