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Hang 'em with probability zero: Why does it not work?

By Sanjit Dhami and Ali al-Nowaihi


Last updated 11/2006A celebrated result in the economics of crime, which we call the Becker proposition\ud (BP), states that it is optimal to impose the severest possible punishment\ud (to maintain effective deterrence) at the lowest possible probability (to economize\ud on enforcement costs). Several other applications, some unrelated to the economics\ud of crime, arise when an economic agent faces punishments/ rewards with very low\ud probabilities. For instance, insurance against low probability events, principal-agent\ud contracts that impose punitive fines, seat belt usage and the usage of mobile phones\ud among drivers etc. However, the BP, and the other applications mentioned above,\ud are at variance with the evidence. The BP has largely been considered within an\ud expected utility framework (EU). We re-examine the BP under rank dependent expected\ud utility (RDU) and prospect theory (PT). We find that the BP always holds\ud under RDU. However, under plausible scenarios within PT it does not hold, in line\ud with the evidence

Topics: Behavioral economics, Illegal activity, Expected utility theory, Rankdependent expected utility, Prospect theory, Prelec and higher order Prelec probability
Publisher: Dept. of Economics, University of Leicester
Year: 2006
OAI identifier:

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