Probability And The Principle Of Indifference In Applied Economic Reasoning

by Philip Pilkington

Article of the Week from Fixing the Economists

Carola Binder has brought my attention to a very commendable post she did regarding how people perceive their chances of being laid off. The results, from the point of view of the application of probability theory to economics, were very interesting.

department.of.indifference

Here I quote Binder in full:

Prior to answering the question, survey takers are given this brief intro to help them understand probabilities: “Your answers can range from zero to one hundred, where zero means there is absolutely no chance, and one hundred means that it is absolutely certain. For example, when weather forecasters report the chance of rain, a number like 20 percent means ‘a small chance’, a number around 50 percent means ‘a pretty even chance,’ and a number like 80 percent means ‘a very good chance.'" Nonetheless, most people seem to have tremendous difficulty quantifying their probability of job loss. Over half of people choose 0% or 50% as their response.

People intuitively knew when asked this question that they had no idea how to calculate such a probability so many of them just shrugged their shoulders and gave it a 50/50 - this is not because they actually think that there is a 50/50 chance of being laid off but rather that they know they cannot come up with a numerical estimate of such a probability. Binder goes on to connect this with the Principle of Indifference which she lays out as follows:

The Principle of Insufficient Reason, or Principle of Indifferencesays that “if we are ignorant of the ways an event can occur (and therefore have no reason to believe that one way will occur preferentially compared to another), the event will occur equally likely in any way."

She goes on to note that Keynes, in his Treatise on Probability was highly critical of the principle of indifference. This is where I would like to say a few words and show that I think these to be in keeping with Keynes’ thoughts on the matter.

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