Certainty Equivalence and Inequivalence for Prices

Abstract

A basis for the analysis of economic behaviour under uncertainty has existed ever since Daniel Bernoulli’s famous paper (1738). Indeed, Bernoulli applied his expected-utility theory to explaining the de mand for marine insurance—the problem, of course, being to explain positive demand for a risk with negative expected value. Bernoulli saw clearly that both the Gedanken evidence of the St Petersburg paradox and the real-world purchase of insurance were simply state ments that the certainty-equivalent of a risk was not its expected value; his clear analysis led him to the synthesis of an alternative theory of behaviour.

This work was supported by Office of Naval Research Grant N00014-86-K-0216 at the Institute for Mathematical Studies in the Social Sciences, Stanford University, Stanford, California.