The Psychology of Everyday Life: Motivation and the Search For Happiness

The Psychology of Money

What is loss aversion?

This concept, introduced by Daniel Kahneman and Amos Twersky as far back as the 1970s, refers to our emotional reaction to cues of immediate loss. Emotionally, we are primed to hold onto what we have and to strenuously try to avoid loss. Consequently, we tend to avoid a choice that will lose us money in the short run, even if it will make us more money in the long run. It is important to remember that this tendency is stimulus bound. So we are not responding to the actual possibility of loss as much as the cue that signals the possibility of loss. In the absence of such loss cues, we can be sideswiped by reward cues, as happens when we overspend on our credit cards. Because of this, manipulation of cues will strongly influence our behavior.

The deMartino experiment on the framing effect described above supports our tendency toward loss aversion. Another experiment reported by Jonah Lehrer in his book on decision making shows the effect of loss aversion. A group of physicians was given a scenario involving an outbreak of a lethal disease. In the first condition, two options were described in terms of the number of people that would live. In option 1, 200 (of a group of 600) people would survive. In option 2, there was a one-third chance that 600 people would be saved and a two-thirds chance that no one would be saved. Only 28 percent of the physicians chose the second, riskier strategy. When the same options were described in terms of the number of people that would die, 78 percent of the physicians chose the risky strategy. Here we see how emotional biases affect the decisions even of highly trained people in responsible positions.


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