The Certainty Equivalent by Jared Dillian, Mauldin Economics One of my students met me in my office the other day. He is a ROTC cadet; that’s Reserve Officer Training Corps, in case you don’t know. He knows I have military experience, and he wanted to pick my brain about how he could use his MBA while working for the government. “Uh, you can’t, really,” I said. So he asks me, “Should I stay in the government or get out?” At this point I drew him a graph. The x-axis is your ability, competence, IQ, whatever. The y-axis is how much you get paid. So the government path is indicated by the dashed line. If you’re very smart, you can get paid a little more, but generally everyone gets paid the same no matter how competent or incompetent they are. That’s the government. But it’s a lot more than what you would get paid in the private sector—unless, unless you are one of those savants like Zuckerberg or the Google Inc (NASDAQ:GOOG) guys or even a smart businessman or talented trader, in which case you can make a lot more in the private sector than working for the government. But for 9 out of 10 people, no, you should not work in the private sector. You should work for the government. So I asked him, “Are you one out of those 10 people?” He said, “I think I am going to keep working for the government.” Decision Theory If you’ve ever taken a decision theory class (I have, and it was awesome), this is the first thing you learn. You have a 50/50 chance of winning $10,000. You have P = 0.5 of getting $10,000 and P = 0.5 of getting 0. Or you can choose not to play the game and get $3,000. What do you do? The answer is: it depends on who you are and what your risk preferences are. Rationally, the number to get you to walk away should be $5,000. But most people will walk away for less. Sometimes much less. Sometimes people will walk away for $500 or $1,000. After all, it’s money they didn’t have before. Anyone who accepts... More