Mad Cows, Terrorism and Junk Food: Should Public Policy Reflect Subjective or Objective Risks?

Empirical evidence suggests that people’s risk-perceptions are often systematically biased. This paper develops a simple framework to analyse public policy when this is the case. Expected utility (well-being) is shown to depend on both objective and subjective risks. The latter are important because of the mental suffering associated with the risk and as a basis for corrective taxation and second-best adjustments. Optimality rules for public provision of riskreducing investments, “internality-correcting” taxation and provision of (costly) information to reduce people’s risk-perception bias are presented.

Introduction: Public policies concerning health care, education, transportation, energy, agriculture, national security and military defence, the environment, and virtually all public policy areas in a modern society have to deal with risks. For example, how should we deal with natural catastrophes, genetically engineered food, terrorism, airplane safety, gun control and toxic substances in food? While risk has been incorporated into mainstream economic theory for a long time, there are many problems with applying the conventional approach in practice.

Author: Olof Johansson-Stenman

Source: Göteborg University

Download URL 2: Visit Now