The article by Matthew Rabin and Richard H. Thaler discusses the anomalies in risk aversion, a phenomenon where individuals tend to avoid risky monetary prospects even when they involve a potential gain. While economists typically explain risk aversion through the lens of expected utility maximization, the authors argue that this explanation is not plausible in most cases. They present a theorem that shows how small-scale risk aversion can imply absurdly large-scale risk aversion, leading to conclusions that are inconsistent with observed behavior. For example, a risk-averse individual who turns down a 50-50 gamble of losing $10 or gaining $11 will also turn down a 50-50 gamble of losing $100 or winning a substantial amount. This paradoxical result highlights the limitations of expected utility theory in explaining risk aversion over moderate stakes. The authors further illustrate the problems with expected utility theory by examining experimental economics and real-world contexts. They argue that the theory's inability to explain modest-scale risk aversion leads to misleading interpretations and inferences. For instance, the use of lottery procedures in experiments to infer subjects' beliefs about risk is questioned, as it assumes linearity in probabilities, which may not hold for risk-averse individuals. To better explain risk aversion, the authors propose incorporating two concepts: loss aversion and mental accounting. Loss aversion, as described in prospect theory, suggests that people feel the pain of losses more than the pleasure of gains. Mental accounting refers to the tendency to evaluate financial transactions in isolation rather than in a broader context, which can lead to risk aversion over small-scale risks. The article concludes by emphasizing that expected utility theory is an ex-hypothesis, meaning it is a starting point for economic analysis but not necessarily a descriptive model of human behavior. The authors call for the development of more realistic models of choice under uncertainty to better understand risk aversion.The article by Matthew Rabin and Richard H. Thaler discusses the anomalies in risk aversion, a phenomenon where individuals tend to avoid risky monetary prospects even when they involve a potential gain. While economists typically explain risk aversion through the lens of expected utility maximization, the authors argue that this explanation is not plausible in most cases. They present a theorem that shows how small-scale risk aversion can imply absurdly large-scale risk aversion, leading to conclusions that are inconsistent with observed behavior. For example, a risk-averse individual who turns down a 50-50 gamble of losing $10 or gaining $11 will also turn down a 50-50 gamble of losing $100 or winning a substantial amount. This paradoxical result highlights the limitations of expected utility theory in explaining risk aversion over moderate stakes. The authors further illustrate the problems with expected utility theory by examining experimental economics and real-world contexts. They argue that the theory's inability to explain modest-scale risk aversion leads to misleading interpretations and inferences. For instance, the use of lottery procedures in experiments to infer subjects' beliefs about risk is questioned, as it assumes linearity in probabilities, which may not hold for risk-averse individuals. To better explain risk aversion, the authors propose incorporating two concepts: loss aversion and mental accounting. Loss aversion, as described in prospect theory, suggests that people feel the pain of losses more than the pleasure of gains. Mental accounting refers to the tendency to evaluate financial transactions in isolation rather than in a broader context, which can lead to risk aversion over small-scale risks. The article concludes by emphasizing that expected utility theory is an ex-hypothesis, meaning it is a starting point for economic analysis but not necessarily a descriptive model of human behavior. The authors call for the development of more realistic models of choice under uncertainty to better understand risk aversion.