Post No.: 0345
‘Loss aversion’, which has been briefly mentioned a few times before, is when the negative utility of giving an item up feels greater than the positive utility of acquiring that exact same item.
For example, the displeasure of losing €1 feels greater than the pleasure of gaining €1, or giving €1 away feels worse than not receiving €1 – even though the magnitude of the values are identical. In other words, if we were rational, the joy of finding €1 (or some other fungible thing) should feel just as attractive as the sorrow of losing €1 would feel unattractive. Instead, we tend to find losing €1 more unattractive than finding €1 is attractive, hence a disproportionate aversion to loss.
Welfare benefits and tax breaks are two sides of the same coin. From the perspective of a citizen, not paying some due tax has logically the same effect as receiving some due benefit i.e. mathematically, minus minus 1 = plus 1. And from the perspective of the treasury, not receiving some due tax has logically the same effect as paying some due benefit i.e. mathematically, minus plus 1 = minus 1. This logically means that a rich person dodging government taxes has the same effect on the public finances as a poor person claiming government benefits by an equal amount. Thus if that rich person is (legally or otherwise) dodging €50,000 in taxes per year and the poor person is (legally or otherwise) claiming €5,000 in benefits per year – if one is angry about the poor person then one should rationally be 10x angrier with the rich person than the poor person for taking advantage of the public! But irrationally, due to loss aversion (and perhaps some other reasons too), most people will judge the ‘benefit scrounger’ more harshly than the ‘tax dodger’.
Certain individuals, groups, corporations or industries receiving special tax breaks/reliefs when others don’t (e.g. extra tax allowances for the married) directly affects the public coffers in the same way as certain individuals, groups, corporations or industries receiving special state grants/benefits when others don’t (e.g. welfare credits for the unemployed). Not surrendering tax owed is equivalent to stealing the same amount from everyone in the country, or being denied an eligible benefit is equivalent to having the same amount being stolen from an individual, when we look at the overall pot and compare everybody’s relative positions at the end of the day. You could say that all this follows on from Post No.: 0307 and the subject of irrational attitudes and behaviours when it comes to money.
In a sports league, awarding one team 1 bonus point would be equivalent to all other teams being docked 1 point instead, but most people will find it more palatable for the former to happen than the latter. It has the same effect in the end though.
Where possible, loss aversion means that it’s more persuasive to state how much people will lose if they don’t sign up to some product than to state how much they’ll save if they sign up to the same thing. Pressing home the fear of some kind of loss is therefore a highly common marketing tactic.
People will tend to go for a guaranteed win of €10 than take a bet for €20 or nothing on a 50:50 probability coin toss, even though they rationally have the same expected value (1 x 10 = 10 versus (0.5 x 20) + (0.5 x 0) = 10). The perception of risk and the potential gains and losses seem different but the actual expected values are the same in this example. Most people won’t even take on a bet that has a 50% chance of winning €150 and a 50% chance of losing €100, even though the expected value is positive ((0.5 x 150) + (0.5 x –100) = 25)!
‘Prospect theory’ modifies classical utility value theory to also take into account a reference state from which any gains or losses are compared against. For example, losing €500 from a starting reference point of €1,000 will feel worse than gaining €500 from a starting reference point of €0, even though in both cases one will end up with €500. This scenario crops up on some quiz shows when a sum of money is accumulated in earlier rounds for use in the final round, and then during this final round this sum of money trickles away the longer the contestant takes to complete this final round – the contestant must remember though that he/she actually came in with nothing so going home with anything at the end of the day will be a gain rather than a loss (not accounting for any opportunity costs e.g. taking unpaid time off work just to appear on the show and the cost of travelling to and from the studios).
Another possible example of loss aversion is, if one spends an hour writing something but then the work gets scrapped because it’s deemed rubbish, then fortuitously gaining an hour elsewhere won’t feel like it makes up for this loss. For the effort expended, it also feels much more annoying than the equivalent loss of one hour wasted doing nothing. (I know these feelings very well. Woof!)
So when directly compared or weighed against each other – losses loom larger than corresponding gains. Treating threats more urgently than opportunities overall improves an organism’s survival until reproduction, hence loss aversion has become an automatic function of ‘system one’. If a doctor tells a patient that a painkiller that they’ve been taking for years to deal with chronic pain might not be actually doing anything for them, the patient might still be reluctant to reduce their dosage because of the concern that the pain will feel worse, and this potential loss isn’t worth the potential gain.
We tend to try desperately to not come off worse than we currently are and need a lot of incentive to change our habits – thus stability is favoured over change. There’s considerable loss aversion even when the amount at risk is miniscule relative to one’s total wealth. This could result in turning down some very favourable opportunities.
You can figure out the extent of your own loss aversion by answering what’s the smallest value that you’ll need to stand to gain in order to balance an equal chance to lose a value? For most people, they’ll need to stand to gain €200 before they’ll risk standing to lose €100 in fair coin toss. The loss aversion ratio usually averages from 1.5:1 to 2.5:1 and will be affected by the context and amount – so this coefficient will tend to increase as the stakes rise (e.g. a person may be happy to risk €50 for the chance to win €75, but will only be happy to risk €500 for the chance to win €1,000, in a fair coin toss). In rare cases however, people can be risk-neutral or even risk-seeking (e.g. they’ll risk €10 for the chance to win €9). Of course, although most things have their price, some bets will be unacceptable regardless of the amount one stands to gain (e.g. if the loss would threaten someone’s lifestyle).
Loss aversion and anchoring, or something like them, are probably a couple of reasons why the reputations of generally good guys can fall fast, and the reputations of generally bad guys can rise fast. So if a person is good 99% of the time, that other 1% can cost them dearly because the only way they can realistically go is down; and if a person is bad 99% of the time, that other 1% can fool others because the only way they could realistically go was up (depending on the severity of the bad for both). A ruthless common thug beating up a person is somehow not as newsworthy as an otherwise-upstanding judge beating up a person in an identical manner – the former won’t likely receive media coverage whilst the latter will likely attract the national headlines, even though they both did the exact same thing.
More otherwise-upstanding people are always ‘anchored’ (unfairly) to higher standards, thus good reputations are far easier to destroy than to build. In other words, expectations bias our judgements, and we think in relative rather than absolute terms. We don’t experience the world objectively or therefore fairly – our present expectations shape our experiences massively so that the higher the expectations, the higher the result must be to even feel satisfactory, and therefore the higher the potential for disappointment, and vice-versa.
Therefore ‘promise less and deliver more’ than what was promised! ‘A pessimist is never disappointed’ as some say. A good person doing good is taken for granted and has the greatest distance to fall, whereas a bad person doing good is considered an unexpected and lovely bonus. But taking a step back from it all for a moment and thinking with our rational heads instead of our emotional hearts (and be self-respecting to understand that we deserve to be treated well) – would you rather be with someone who is good to you 67% of the time or be with a ‘bad boy/rude girl’ who is only good to you 33% of the time? It’s up to us to not fall for these biases of judgement and to try our best to look at things more objectively. Likewise, don’t take the good things in your life in general for granted.
However, politicians and advertisers typically over-promise in order to attract votes or sales in the first place – we may complain about this but if it didn’t work on enough of us then they’d stop doing it. More reasons to get wiser then, such as by educating ourselves so that we’ll know what claims are realistic or backed up by sufficient independent science.
Those who stand to lose will fight harder than those who stand to gain – so when territory is contested during a conflict, the current incumbent tends to eventually win most of the time (although there may be other factors that additionally give the home players a home advantage, as it were). In business, current stakeholders are often protected from losses, whilst any new/future members will have to bear any cuts.
Loss aversion is a powerful conservative force that favours minimal changes from the current status quo, as opposed to radical reforms, for both institutions and individuals. It overall helps keep relationships, jobs and communities, for instance, stable – if we miss out on a gain then nothing changes, but if we lose then something’s going to change. For most of us, avoiding a pain is a greater priority than seeking a pleasure. So it holds life together near the reference point. Yet sometimes, radical change is what’s required…