Engineer's Finance

Please Read Part I before starting the second part.

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Let me give you another set of options:

Case B:

Let’s say you own a motorbike which you really love. There is a 25% chance that your motorbike will meet an accident and will require repair cost of 200 Rs, while there is a 75% chance that the motorbike will not suffer any accident. So here are your two choices:

1. Pay Insurance premium of Rs. 50 to avoid paying repair cost of your motorbike
2. Suffer 200 Rs. loss to your motorbike repair cost (25% chance) or Zero Loss to your motorbike (75% chance)

Which one will you choose?

Again, as in the previous case explained in the beginning of this article, majority (98%) of the individuals choose to take option 1. Hardly a few will select option 2. The fact is both these options again value to the same price.

Now comes the most interesting part: Compare option 1 of Case A and Case B – are the 2 options any different? Option 1 of Case A mentions a sure loss of 50 Rs. while that of case 2 mentions paying an insurance premium. Are they two different? No – they are exactly the same. Similarly, option2 of case A and B are also exactly the same. Yet majority of individuals (including me) end up selecting option 2 for case A and option 1 for case B. The only difference in case A and case B is about the presentation. The same concept is presented in 2 different forms so we end up making 2 different choices. This shows how wrong we are in our perception.