Risk Aversion = Marginal Utility of Income

The fact that consumers are risk averse is often taken for granted in economic literature. This assumption is not data-drivenly wrong, and its existence has been shown extensively in the literature. However, what is often missed is the driving force behind why people are risk adverse. I believe that it can be shown, both theoretically, experimentally, and data drivenly that this relationship stems from the fact that the Marginal Utility of Income is negative. Furthermore, these studies and test can be used to approximate a functional form for the Marginal Utility of Income.

The specification, and affirmation of this function will have broad ranging impacts on multiple fields. Economic cost-benefit analysis will now have a theoretical base.

Such a theory should be able to explain:

  • lotteries
  • warranties / insurance
  • Business vs consumer thought

Reading Thought

I’m trying to start working my way through Keynes “The¬†General Theory of Employment, Interest and Money”. I finished Krugman’s introduction, which I thought was very well laid out.

One thing that really stood out to me was Krugman’s emphasis of how thoroughly Keynes understood the modern day school of thinking. I definitely do not feel that I currently understand a lot of the theories that are out there, but the eagerness and urgency to know them was definitely increased.