One of the most robust findings in the study of human economic behavior has to do with the seemingly irrational way in which people make economic decisions. The classic case is called loss aversion.
Imagine this scenario. You work for the National Institutes of Health (NIH), and you are in charge of making budget allocations for the development of drugs to prevent the flu. Your research staff has just presented a report that this year’s flu is predicted to kill as many as 600 citizens. They have also presented you with two options for addressing this threat.
If option A is adopted, 200 people will be saved. If option B is adopted, there is a one-third probability that all 600 people will be saved and a two-thirds probability that no people will be saved.
Which of the two programs would you adopt?
Most people, even physicians (overwhelmingly) choose option A. The reason for this is that B sounds risky (everyone could die), and we don’t like the idea of risking the loss of lives (or money), even though option A predicts the demise of 400 people. We choose the certain (small) savings over the uncertain (possibly large) loss.
Consider a separate set of options, C and D. If program C is adopted, 400 people will die. If program D is adopted, there is a one-third probability that nobody will die and a two-thirds probability that 600 people will die.
Now which of the two programs would you choose? Chances are that this time, you liked option D better than option C. Interestingly, option A and C are equivalent choices mathematically (as are B and D), but in the second scenario, you are presented with the option of gambling to avoid a loss rather than to save lives.
The bottom line is that human beings are wired to be cautious about taking risks for gains, but to throw caution to the wind in order to prevent losses. This phenomenon can be seen in many areas of human life. For instance, we are nearly all content, if not happy, to pay tens or hundreds of thousands of dollars for insurance against losses of various kinds, but mostly unwilling to gamble the same amount of money to secure potential gains.
Why are we loss-averse?
For many years, economists have assumed that this was simply an irrational fact of human nature. Recently, however, evolutionary psychologists have been contending that this demonstrates a sort of “deep rationality,” because in our evolutionary past, losing anything—from food to the few possessions our forebearers might have had (tools, clothes, kin)— would have been potentially catastrophic.
The exception that proves this rule.
Often, it is when rules are broken that we see their value, and such is this case with loss aversion. Psychologists Jessica Li, Doug Kenrick, and Steve Neuberg at Arizona State University recently demonstrated that we are not all loss-averse all the time, as economists had thought. Instead, there are specific situations that can eliminate and reverse loss aversion, but only, so far, in men.
When men are primed (reminded of, made to think) with the thought of mating opportunities—sex—and then asked to make choices like the ones above, loss aversion is wiped out and even reversed. In other words, when men are thinking about opportunities to mate, risks become much more attractive.
These findings, at least in part, explain the often-risky behavior of young men. They also suggest that the state or frame of mind in which we find ourselves on a day-to-day basis may drastically alter the kinds of decisions we make—economic and otherwise. Perhaps it would be well to consider your surroundings the next time you take on an important decision involving potential gains or losses. And consider also the context in which companies present their opportunities for your potential gains or losses. Keep a lookout for subtle “primes” that might affect how you make decisions.
For a quick and entertaining overview of these findings by the authors of the study, see: Loss Aversion
Beyond The Purchase is a website dedicated to understanding the psychology behind spending decisions and the relationship between money and happiness. We study how factors like your values and personality interact with spending decisions to affect your happiness. At Beyond The Purchase you can take quizzes that help you understand what motivates your spending decisions, and you’ll get personalized feedback and tips. For example:
How do you score on the five fundamental dimensions of personality? Take our Big Five personality test and find out.
How do you feel about your past, present, and future? Take the Time Attitudes Survey and learn about your relation with time.
How happy are your Facebook updates? We can analyze your last 25 Facebook status updates and determine how happy you have been.
How happy is your subconscious? Take our Happiness IAT and find out.
With these insights, you can better understand the ways in which your financial decisions affect your happiness. To read more about the connection between money and happiness, go to the Beyond the Purchase blog.