Imagine two people in the same general financial situation. One loses $50; the second finds $50. The first person should lose about as much satisfaction as the second person gains, right? Actually, it doesn't quite work out like that, thanks to a phenomenon known as loss aversion. First discovered by Daniel Kahneman and his associates, loss aversion is the human tendency to strongly prefer avoiding a loss to receiving a gain. This particular cognitive bias consistently explains why so many of us make the same irrational decisions over and over, in the realm of economics and elsewhere. Psychologist Laurie Santos has even observed economic behavior in capuchin monkeys that displays loss aversion much like that of humans.
Loss aversion neatly explains the phenomenon known as the endowment effect, the tendency for people to place a higher value on something they own than on an identical thing that they do not own. In 1990, Kahneman and others ran an experiment giving one third of the participants mugs, one third chocolates, and one third neither a mug nor chocolate. The participants then had the option of trading their mug for a chocolate (or vice versa); those with neither item were asked to choose which one they wanted. 86 percent of those who had started with mugs chose mugs, while ten percent of those who had started with chocolate chose mugs. However, only about half of those who had started with nothing chose mugs. Examining these numbers, it becomes obvious that starting out with the mug makes it seem extra desirable to the person who has it—that's the endowment effect.
Loss aversion also explains why despite deciding you'll hate a movie ten minutes in, you'll stick it out for the whole two hours in misery. You've already paid for the ticket, so you don't want to waste money by not seeing the movie. But you won't get that money back if you stay, so why do you feel like you have to? The reason we’re inclined to throw good money after bad (which economists call the sunk cost fallacy) is a perfect example of loss aversion in action. If we've spent resources on something—whether it's as small as a ticket to a bad movie or as large as the billions of dollars spent in a war or social program that's not working out—we're inclined to stay the course so as not to waste what we've already spent. In other words, we want to avoid feeling the loss of what's been spent, so we stick with our plan, hoping for a gain, even when sometimes that just leads to a bigger loss in the long run.
Why are we so averse to loss? Like many cognitive biases, it conferred a big evolutionary advantage. All organisms survive by maximizing opportunities and minimizing threats. Because a loss of precious resources reads as a threat to our very survival, we're hardwired to try to hold on to what we have. In the terms of natural selection, it makes sense to try to avoid loss at all costs. But, of course, our ancestors didn't have to contend with the many complicated economic problems we find ourselves with now, which is why the loss aversion that helped us in the past often hurts us today.
photo by sara robertson