Tuesday, January 13, 2009

could gambling be rational?

This post was inspired by a comment Plonkee left on one of my previous posts. In my post I was commenting on the fact that the Casinos in Lake Tahoe where I was vacationing were doing OK, in spite of the poor economic situation, to which Plonkee replied that:
"I'd expect gambling to go up in a recession. Who wouldn't want to win lots of money for very little outlay?"
That got me thinking. What if gambling is a very rational thing to do. I am going to resort to a little economics 101 here, so bear with me. 

In economics there is a concept called decreasing marginal utility. To understand what it is, consider the following example: if you are hungry, the first few bites of your food are very important to you. These bites give you the fuel that you need to live. As you keep eating however, you get less and less benefit from the food, until eventually you are stuffed and want no more. This is the decreasing marginal utility: as you get more of something, the extra that you get is of less value to you.

The same can be said for money. If you are making very little, every little bit of extra cash means a lot. However, if you are a billionaire, making a few more thousands of dollars should matter very little to you. It's not that this additional money you earn has less value objectively, only that it is less important to you personally. This little additional money doesn't do much for you.

Back to our gambling discussion. Could it be, that gambling is an opposite case? A case of increasing marginal utility? Consider a person who makes enough money to live on and stash a few more dollars in a savings account every month. That person can use this additional money, but he knows that those few extra dollars will not dramatically change his life. However, if he uses a dollar or two to buy a lottery ticket, and he happens to win, his life will change completely over night. Now, it's true that on average playing the lottery is a losing proposition for this person - his expected payoff is negative, he needs to spend more money than he can expect to win - however, perhaps the microscopic chance of winning, combined with the dramatic impact of such a win, is worth more than the money he is giving up by playing. 

In that sense, is it possible that gamblers are being completely rational in the economic sense of the word? Personally, I think they just like the thrill of the game, but who knows?

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Ren said...

I think there's a big difference between classic gambling and playing the lottery. In the first, your potential winnings are proportional to your risk. Nobody is going to be set for life after a trip to a casino*.

I've always said that only the first dollar spent on a lottery ticket (for a given drawing) is worthwhile, is it moves your odds up from zero. Of course, there are so many separate drawings now, that playing every one is actually a fair amount of money -- an amount worth saving, probably.

Combine that with the common examples of how poorly people handle the money after they win, and I see that theory of rational gambling is quite unlikely to pan out.

* Progressive payouts and the like at casinos are more akin to the lottery than classic gambling.

plonkee said...

Yes, it's possible that gamblers are being completely rational.

Most people I know play the lottery and treat it as an entertainment expense; they don't think they are actually going to win the jackpot. But, I guess the whole *in it to win it* is economic rationalism.