What if everything economists thought about money was wrong?

For decades, smart people believed something simple: if you think about money in a straight-line way—like adding $1 always feels the same, no matter what—then you'd never want to buy insurance. Why would you pay someone to protect you from risks? With a straight-line view of money, you shouldn't care either way.

But a new study says that belief is busted.

Lahiri

A common argument against linear utility function for monetary returns is, that an agent with such a utility function would have no incentive to insure himself against possible 'loss'. However, this argument seems to collapse if the linear utility function for monetary returns is state dependent and the 'probability of the gain or loss' is spelled out as the 'probability of the state of nature (SON) in which there is the gain or loss' with the constant marginal utility of monetary returns in the 'worse' state being more than the constant marginal utility of money in the 'better' state.

The Core Discovery

An economist named S. Lahiri from PD Energy University in India discovered that this whole idea falls apart if you think about money depending on what's happening in your life. His paper, published in November 2024, flips the script on a puzzle that has confused economists since the 1970s.

The Big Idea: the same dollar feels different when you're already hurting

The Bicycle Analogy

Imagine you only have one bicycle, and it's your only way to get to school. If someone stole it, you'd be devastated. But that same $100 you might get from an insurance company would feel ==super valuable==—like finding water in a desert.

Now imagine you're rich and own five bikes. Losing one? Eh, no big deal. That $100 feels almost useless.

That's what economists call "state-dependent" thinking. Your state—good or bad—changes how much you value money. And when bad states make money feel more valuable, suddenly you do want insurance.

The Perfect Policy Paradox

The study even shows how an insurance company—a single, powerful one, called a =="monopolist"==—could sell you a perfect policy with zero deductible (meaning you pay nothing when something goes wrong) and still make money.

They'd charge a little more than what's technically "fair," and because you really, really want protection when things are bad, you'd happily pay it.

The Caveats

What the math can't tell us:

This is all math—no real people were tested. Scientists still need to see if actual humans act this way.
The equations work perfectly on paper, but people are messy.
The math gets more complicated when there are more than three possible scenarios.

Why This Discovery Matters: It bridges a famous gap between how we feel about losing money (really, really bad) and how economists traditionally modeled our money thoughts. Now those two worlds finally fit together.

Reference: Lahiri, S. (2024). Loss Aversion and State-Dependent Linear Utility Functions for Monetary Returns. PD Energy University, Gandhinagar, India. https://doi.org/10.20944/preprints202411.0287.v1