Loss Aversion

The loss-aversion theory says that people value gains and losses differently and, as such, will base decisions on perceived gains rather than perceived losses. Thus, if a person were given two equal choices, one expressed in terms of possible gains and the other in possible losses, people would choose the former.

For instance, a lot of people have been interested in giving teachers an economic incentive to improve their students’ achievements. Unfortunately, many of these efforts just haven’t worked. Is it possible to tweak them to make them more effective? In an ingenious study, teachers were given money in advance and told that if their students did not show real improvements, they would have to give it back. The result? A big improvement in teacher quality, as measured by a significant increase in students’ math scores.

Loss aversion helps to explain a lot of things, including investment behavior (the prospect of losses, even if unlikely, can discourage people from making pretty good investments), advertising, educational campaigns, and the power of default rules (if people are automatically enrolled in some plan, they might not opt out, partly because they don’t want to lose what they have).

It is very related with The Endowment Effect: Once I own something, not having it becomes more painful, because it is a loss. If I don’t yet own it, then acquiring it is less important because it is a gain.

Summing-up: People are more motivated by to avoid a loss than to acquire a similar gain. We feel the pain of loss more acutely than we feel the pleasure of gain. In other words, we may like to win, but we hate to lose.

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