Lecture 2: Gambling and Problem Gambling
ECOS3997 Stream 1, Semester Two 2023
ECOS3997 | Dr Stephen L. Cheung
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What is Gambling?
Gambling is a branch of the entertainment industry, where patrons stake money on a
risky or uncertain event, in the hope of winning a larger prize. It includes:
Casino gambling, Electronic gaming machines (“pokies”);
State lotteries (Lotto, Powerball, etc.);
Racing, Sports betting.
Gambling is conceptually distinct from investment, where people also bear risk in the
hope of a better return. Why?
In its commercial form, the expected value of gambling is negative (“the house always
wins”). This means that continued gambling leads to mounting expected losses.
ECOS3997 | Dr Stephen L. Cheung
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Gambling in Australia
In 2018, roughly 35% of Australian adults (around 6.5 million people) spent money on
gambling in a typical month.
It’s estimated Australians lost around $25 billion on legal forms of gambling in
2018-19, the largest per-capita losses in the world!
More than half of these losses are accounted for by pokie machines alone.
Source: Australian Institute of Health and Welfare (2021).
ECOS3997 | Dr Stephen L. Cheung
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Gambling in Australia
Amount Wagered ($m) Net Losses ($m) Net Loss per capita
Racing 26,965 3,509 179
Casino 26,237 4,857 248
Gaming Machines 153,565 12,717 649
Lotteries 7,799 2,932 144
Sports Betting 11,113 961 49
TOTAL 225,755 25,009 1,277
Source: Australian Gambling Statistics, 2018-19.
ECOS3997 | Dr Stephen L. Cheung
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Source: The Economist (2017). 5
What is “Problem Gambling”?
For a minority of individuals, gambling can have significant negative consequences
(e.g., divorce, job loss, debt or bankruptcy, illegal activity).
The Diagnostic and Statistical Manual of Mental Disorders (DSM) is the standard
classification of mental disorders published by the American Psychiatric Association.
“Pathological Gambling” was first included in DSM-III in 1980, when it was classified
as an “Impulse Control Disorder”, alongside the likes of kleptomania, pyromania, and
trichotillomania.
“Gambling Disorder” was reclassified as an Addiction in the DSM-5 in 2013, making it
the first (and only) recognised behavioural addiction.
ECOS3997 | Dr Stephen L. Cheung
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Diagnosis of Gambling Disorder requires at least four of the following in the past year:
Need to gamble increasing amounts to achieve the desired excitement (tolerance).
Restless or irritable when trying to cut down or stop gambling (withdrawal).
Repeated unsuccessful efforts to control, cut back on or stop gambling.
Frequent thoughts about gambling (cravings).
Often gambling when feeling distressed.
After losing money gambling, often returning to get even (loss chasing).
Lying to hide gambling activity.
Risking or losing a close relationship, job, or other opportunity due to gambling.
Relying on others to help with money problems caused by gambling.
Source: American Psychiatric Association.
ECOS3997 | Dr Stephen L. Cheung
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What is “Problem Gambling”?
The prevalence of full DSM-diagnosed gambling disorder is around 1%, but another 3
to 5% display subclinical features that put them “at risk” of gambling-related problems.
The Problem Gambling Severity Index is a standard measure of at-risk behaviours in
gambling. It is designed for use in general populations (not only in clinical settings),
and to identify at-risk individuals below the threshold of problem gambling.
In Australia, it was included in the HILDA survey in 2015 and 2018.
The index is scored from 0 to 27, and respondents are classified as non-problem (0),
low-risk (1-2), moderate-risk (3-7), or problem gambling (8+).
ECOS3997 | Dr Stephen L. Cheung
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Comparable Figures from the UK ...
Source: UK Behavioural Insights Team (2018).
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Take-Aways
In countries where reliable data exist, the prevalence of true problem gambling is at
most ~1%. Strictly speaking, “problem gambling” refers to a clinical diagnosis.
When you see larger numbers cited in media and policy discussions, this includes
also the “at-risk” groups.
If you see numbers as high as 8-10%, this includes even the “low-risk” group who
score 1 or 2 out of 27 on the PGSI.
The vast majority of people (>90%) experience no or negligible harms from gambling,
either because they do not participate, or because they gamble responsibly.
ECOS3997 | Dr Stephen L. Cheung
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However ...
The minority of problem gamblers are responsible for a disproportionate share of
expenditures, losses, and social harms from gambling.
They also account for a disproportionate share of operators’ profits. Unscrupulous
operators who abuse their “social license” may be tempted to exploit them, or to
lead other “at-risk” groups down the path to addiction, e.g., using “dark nudges”.
More generally:
Problem gambling is important to the study of addictions, as it is not confounded
by any direct effects psychoactive substances upon the brain.
Even recreational gambling may be challenging for economists to explain as rational
behaviour. This makes it a prime topic for behavioural economics.
ECOS3997 | Dr Stephen L. Cheung
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Source: Australian Gambling Research Centre (2017). 13
Gambling in Standard Economics
ECOS3997 | Dr Stephen L. Cheung
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Monetary Motivations for Gambling
A handful of professional gamblers are able to successfully profit from gambling.
To do so, they need both a strategy to “beat the odds” and resources to place large
volumes of bets. These operations come to resemble financial investments.
But the majority of gamblers face negative expected returns, yet they persist – rationally
or otherwise – despite understanding (at least on a cognitive level) that this is the case.
Assuming purely monetary motives, an expected utility maximiser will accept a gamble
with negative expected value only if they are risk seeking (the opposite of risk averse).
But is this a plausible explanation?
ECOS3997 | Dr Stephen L. Cheung
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Expected Utility and Gambling
Expected utility theory (EUT) struggles to explain why someone who gambles would at
the same time buy insurance for their home, car, or health. In each case the product is
worse than a fair bet, because the insurer / gambling operator needs to take its cut.
In insurance, one pays a price (in the form of negative expected value) to reduce
the amount of risk they bear. Under EUT this implies a concave utility function.
In gambling, one pays a price (in the form of negative expected value) to increase
the amount of risk they bear. Under EUT this implies a convex utility function.
In short, how can someone be risk averse and risk seeking at the same time?
ECOS3997 | Dr Stephen L. Cheung
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Expected Utility and Gambling
Friedman and Savage (1948) famously explained simultaneous insurance and gambling
within EUT by proposing a very particular shape for the utility function.
On the previous slide, suppose that initial wealth is at .
If uninsured, there is a small chance that wealth is reduced to . Since utility is
concave to the left of , the decision maker is willing to pay to avoid this risk.
By gambling, there is a small chance that wealth is increased to . Since utility is
convex to the right of , the decision maker is willing to pay to take on this risk.
For future reference, note that this is the exact opposite shape of the utility function to
what is assumed in Prospect Theory (in Lecture 3).
ECOS3997 | Dr Stephen L. Cheung
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Expected Utility and Gambling
In short, Friedman and Savage reconcile gambling with insurance by resorting to special
wiggles in the utility function.
These wiggles need to be just the right size, and in just the right place, to produce
the required behaviour.
They need to be able to fit gambles of different sizes, by people of different wealth
levels. This all seems like too much of a stretch.
In particular, it’s the (horizontal) inflection around initial wealth that makes the small
price paid for both insurance and gambling less painful.
By contrast in Prospect Theory, it’s overweighting of the small probability of losing
(in insurance) or winning (in gambling) that drives both behaviours.
ECOS3997 | Dr Stephen L. Cheung
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Portfolio Theory and Gambling
A more elaborate (and possibly not entirely serious) explanation for gambling appeals
to the Capital Asset Pricing Model (CAPM) in Finance.
The point is that people should care about the overall riskiness of their entire portfolio
(of investments, gambles, etc.), as opposed to the specific risk of any single asset.
When evaluating the riskiness of any asset, they should consider how it interacts
(correlates) with the returns on the other assets they already hold.
If an asset is very negatively correlated (its “beta” is sufficiently negative), it is attractive
as a hedge. Even risk averse investors would accept negative expected returns on such
an asset, because it serves to reduce overall portfolio risk.
ECOS3997 | Dr Stephen L. Cheung
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Portfolio Theory and Gambling
While undoubtedly witty, there are at least two problems with this explanation ...
First, the outcomes of most gambles are uncorrelated, not negatively correlated, with
returns on financial assets. Then, according to the CAPM, their expected return should
equal the risk-free rate, which is not typically negative.
So CAPM still cannot explain gambling by risk averse “investors”.
Second, while risk seekers might be willing to gamble despite negative returns, CAPM
suggests they should not have to, as they would be better off buying risky investments.
In equilibrium, more risky assets are rewarded with higher positive expected returns.
So CAPM actually does not really explain gambling by risk seekers either.
ECOS3997 | Dr Stephen L. Cheung
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Gambling as Consumption
So standard economics (and finance) struggle to explain gambling when the motive is
purely monetary. This approach essentially treats gambles as (bad) investments.
But gambling may still be rational if it is motivated at least in part by its consumption
(or entertainment) value (thrill of playing, pleasure of daydreaming of a big win, etc.).
As argued by Paul Samuelson in 1952:
gambling and risk taking will never significantly be discernible in terms of money
prizes alone, as distinct from elements of suspense and gamesmanship.
ECOS3997 | Dr Stephen L. Cheung
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Gambling as Consumption
According to the consumption view, expected losses from gambling represent a price
paid for the enjoyment of gambling (like paying to go to a concert or sporting event).
Then gambling need not be any more irrational than these other activities.
But unless the gambler sets strict limits ex ante, she does not know how much she
will actually pay until she has finished.
If she later regrets her losses, she has inconsistent preferences which are not rational.
Similarly if she misjudges her chances of winning, then her beliefs are not rational.
So gambling for consumption can be rational, but not if it is motivated by irrational
preferences, beliefs, or decision-making processes.
That’s where behavioural economics comes in.
ECOS3997 | Dr Stephen L. Cheung
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Communication: The Economist Style Guide
Here is the famous Introduction to The Economist's style guide, taken from the online
excerpt to the twelfth edition (2018).
ECOS3997 | Dr Stephen L. Cheung
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Communication: The Economist Style Guide
On only two scores can The Economist hope to outdo its rivals consistently. One is the
quality of its analysis; the other is the quality of its writing. ...
The first requirement of The Economist is that it should be readily understandable.
Clarity of writing usually follows clarity of thought. So think what you want to say, then
say it as simply as possible. Keep in mind George Orwell’s six elementary rules:
1. Never use a metaphor, simile or other figure of speech which you are used to
seeing in print.
2. Never use a long word where a short one will do.
3. If it is possible to cut out a word, always cut it out.
ECOS3997 | Dr Stephen L. Cheung
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Communication: The Economist Style Guide
4. Never use the passive where you can use the active.
5. Never use a foreign phrase, a scientific word or a jargon word if you can think of an
everyday English equivalent.
6. Break any of these rules sooner than say anything outright barbarous.
Readers are primarily interested in what you have to say. By the way in which you say it,
you may encourage them either to read on or to give up. If you want them to read on:
Catch the attention of the reader and then get straight into the article. Do not spend
several sentences clearing your throat, setting the scene or sketching the background.
Introduce the facts as you tell the story and hold the reader by the way you unfold the
tale and by a fresh but unpretentious use of language. ...
ECOS3997 | Dr Stephen L. Cheung
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Communication: The Economist Style Guide
[I]t is up to you to provide the ideas, analysis and argument that bind ... the article
together. That is the hard part. Once you have them, you need only plain, straight-
forward words to express them. Do not imagine that you can disguise the absence of
thought with long words, stale metaphors or the empty jargon of academics. ...
Read through your writing several times. ... Cut out anything superfluous. ... hold your
reader’s attention by keeping the story moving. If the tale begins to flag, or arguments
seem less than convincing, you can rescue it only by the sharpness of your mind. ...
Do not be stuffy. ... Use the language of everyday speech, not that of spokesmen,
lawyers or bureaucrats ... Pomposity and long-windedness tend to obscure meaning, or
reveal the lack of it: strip them away in favour of plain words.
ECOS3997 | Dr Stephen L. Cheung
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Communication: The Economist Style Guide
Do not be hectoring or arrogant. ... When you express opinions, do not simply make
assertions. The aim is not just to tell readers what you think, but to persuade them; if
you use arguments, reasoning and evidence, you may succeed. ...
Do not be too pleased with yourself. Don’t boast of your own cleverness ... You are
more likely to bore or irritate [readers] than to impress them.
Do not be too chatty. Surprise, surprise is more irritating than informative. So is Ho, ho
and, in the middle of a sentence, wait for it, etc.
Do not be too didactic. If too many sentences begin Compare, Consider, Expect,
Imagine, Look at, Note, ... readers will think they are reading a textbook ...
ECOS3997 | Dr Stephen L. Cheung
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Communication: The Economist Style Guide
Do your best to be lucid. (“I see but one rule: to be clear”, Stendhal.) Simple sentences
help. Keep complicated constructions and gimmicks to a minimum, if necessary by re-
membering the New Yorker’s comment: “Backward ran sentences until reeled the mind.”
... “The paragraph”, according to Fowler, “is essentially a unit of thought, not of length;
it must be homogeneous in subject matter and sequential in treatment.” One-sentence
paragraphs should be used only occasionally.
“A scrupulous writer”, observed Orwell, “... will ask himself at least four questions, thus:
What am I trying to say? What words will express it? What image or idiom will make it
clearer? Is this image fresh enough to have an effect? And he will probably ask himself
two more: Could I put it more shortly? Have I said anything that is avoidably ugly?”
ECOS3997 | Dr Stephen L. Cheung
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Next Week’s Tutorial
Before your next tutorial, please read the following two articles (each 10 pages):
Eadington (1988), “Economic perceptions of gambling behavior”, Journal of
Gambling Behavior, 3(4), 264-273.
Gainsbury et al. (2017), “Behavioral economics and gambling: A new paradigm for
approaching harm-minimization”, Gaming Law Review, 22(10), 608-617.
Please consider the arguments in these two articles in conjunction with the relevant
material in Lectures 1 and 2 (for example, Lecture 1, slide 20).
You will be asked to write about the economic justification for public policy interven-
tion in gambling, and the forms that such interventions might take.
ECOS3997 | Dr Stephen L. Cheung