The trouble with Bernoulli 1738

The trouble with Bernoulli 1738

Not all academic fields have a clear starting point, a seminal paper that constitutes the foundation of the entire discipline. But economics does. The paper that defines modern formal economics was written by Daniel Bernoulli in 1738. It introduces expected utility theory. The main thrust of our work is, of course, to replace expected utility theory and instead work with time-average growth rates of wealth. I’ll mention how that works, but the focus of this post will be on something else. Bernoulli’s paper is not only conceptually misleading but also technically flawed in a sneaky way that keeps confusing everyone. Where Bernoulli determines the price to be paid for a risky prospect, he contradicts himself. I wouldn’t make such a fuss about this if the paper wasn’t so absolutely crucial. This basis of economics contains an error that invalidates commonly held beliefs and puts tens of thousands of studies into a different light. I recently encouraged people, using twitter, to read the paper and see for themselves. In this blog post I go through the relevant analysis step by step and address questions that came up in response to the tweet.

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