Loss aversion
Loss aversion is a psychological and economic concept that describes how individuals prefer to avoid losses rather than pursue equivalent gains. Research indicates that the emotional pain associated with losing is typically felt more intensely than the pleasure of winning, often quantified as being twice as impactful. For example, a person would rather secure a certain win of $50 than gamble for a potential gain of $100, due to the greater fear of losing. This bias is a key component of prospect theory, developed by psychologists Amos Tversky and Daniel Kahneman, which explores how people make decisions under risk.
Loss aversion significantly influences behavior in various contexts, including marketing and consumer behavior. Advertisers often leverage this bias by emphasizing potential losses to persuade consumers, such as highlighting the negative consequences of not purchasing a product. Additionally, decision-making scenarios can be framed in ways that either amplify the perception of loss or highlight gains, affecting choices even when the actual outcomes are the same. Overall, understanding loss aversion can provide insight into human behavior in economics, marketing, and everyday decision-making.
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Subject Terms
Loss aversion
Loss aversion is an economic term used to describe a person's preference in avoiding losses compared to acquiring equal gains. For example, people would rather not risk losing $100 over winning $100. Losses have more of a psychological impact on a person than gains do, so the amount to be won would have to be larger (in most cases, double) for many people to accept the risk. Psychologists Amos Tversky and Daniel Kahneman developed prospect theory to explain how people weigh risks. Loss aversion is a cognitive bias of prospect theory. Kahneman later won a Nobel Prize in economics for his work on the theory. Many advertising and marketing campaigns use loss aversion to persuade consumers to purchase items by convincing them they will lose out if they do not seek "last chance" deals.
Background
In loss aversion, people view losses and gains differently, and they put more stock on losses than gains. This means that people are more likely to make decisions based on the amount of the loss over the chance to win—even if the gain is more. For example, most people would rather win $50 on a definite bet rather than take a more risky bet in which they could win $100. The prospect of the gain outweighs the prospect of the loss even though the gain is worth more.
Prospect theory is a behavioral theory first proposed by psychologists Amos Tversky and Daniel Kahneman. According to the theory, people rely on several biases when making decisions. These biases can be used to convince people to make a particular decision.
The three biases people use when making decisions are certainty, isolation effect, and loss aversion. Certainty explains how individuals put more weight on options that are more certain over ones that are less certain. People would rather win a smaller sum on a sure thing than take a risk to win a larger amount but risk winning nothing. For example, if individuals have a 100 percent chance to win $100 or a 90 percent chance to win $200, studies have shown that about 80 percent of individuals will choose the first option since a 10 percent chance to win nothing exists with the second option. Most people would rather avoid the risk and take the certain winnings. However, in cases of certain losses, most people would take a risk to avoid a loss.
The second bias is isolation effect. This explains a person's ability to remember or focus on something that appears differently or stands out from other items. For example, if a person is presented with a list of words in which all of the words are the same color, font, and size except for one of the words, chances are the person will remember the word that appears differently from the others. German psychologist Hedwig von Restorff first proposed the isolation effect in 1933. Because it is too difficult to remember all of the details for each option, the brain focuses on only the differences. Tversky and Kahneman determined that people are affected by the isolation effect when taking risks. People do not react to risks according to rational assessments, but how risks are framed, or presented. If the risk is presented in a way that highlights the gain over the loss, people are more apt to take the risk to avoid the loss.
Overview
The third bias is loss aversion, which is the preference of avoiding losses to receive equal gains even when the possibility of losing is very small. The pain threshold of losing is higher than the thrill of winning. Psychologists and behavioral economists determined that people feel twice as bad over a loss than a gain. This is why people tend to guard against losses more than pursuing similar gains. They would rather see a sure gain—even if miniscule—than experience a loss.
If a person wins $75 and then loses $50, the person will feel the loss of $50 more than the gain of $25. However, the order of losses and gains matters. If this scenario is reversed and a person loses $50 and then wins $75, the framing of the situation changes. The person feels a greater gain than loss even though the gain was only $25.
Loss aversion affects a person's ability to sometimes make logical choices. While many people know it is better to win than lose, this type of cognitive bias interferes with a person's ability to rationalize this. In the example above, a person comes out ahead by $25 in both cases; however, a person feels worse about the loss than the gain even when no real difference actually exists.
Kahneman also determined that the amount of the gain influences a person's decision. No matter the total, most people said they would need double the winnings to take a risk. For example, if a coin is tossed and lands on heads, a person loses $25. If it lands on tails, the person wins $25. Many people would not take this wager. However, if the gain was doubled to $50, and the loss remained $25, more people would take the wager. The gain outweighs the loss.
Companies regularly use loss aversion tactics in their marketing and advertising campaigns to persuade consumers to purchase their products or services. For example, an insurance company may list negative consequences that people might encounter without having insurance. Consumers see the items on this list as losses. They perceive the event of one of these negative consequences occurring as greater than the actual probability of them happening. To avoid these losses and risk a larger expense, people agree to the smaller loss of purchasing insurance.
Another example is surveys. Surveys are a useful marketing tool, but sometimes it is difficult to convince people to give up their time to take a survey. In this example, a person might be told how long the survey takes and be offered a reward for taking the survey; however, the reward has to be weighted more than the loss of time for a person to accept the gain over the loss.
Bibliography
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