What Is Loss Aversion?

Losses attract more attention than comparable gains.

Posted Mar 08, 2018

By Tomwsulcer (Own work) [CC0], via Wikimedia Commons
Source: By Tomwsulcer (Own work) [CC0], via Wikimedia Commons

We don’t like to lose things that we own. We tend to become extremely attracted to objects in our possession, and feel anxious to give them up. Ironically, the more we have, the more vulnerable we are. Having accumulated wealth implies that we have more to lose than to gain. However, emotion regulation, such as taking a different perspective, can reduce loss aversion and help people overcome potentially disadvantageous decision biases.

Why are we so afraid of losing? Our aversion to loss is a strong emotion. The aversive response reflects the critical role of negative emotions (anxiety and fear) to losses (Rick, 2011). In other words, loss aversion is an expression of fear. This explains why we tend to focus on setbacks than progress. Negative emotions, such as from receiving criticism, have a stronger impact than good ones, such as from receiving praise. As Charles Darwin once said, “Everyone feels blame more acutely than praise.”

We are more upset about losing $10 than we are happy about finding $10. Roughly speaking, losses hurt about twice as much as gains make you feel good (Khaneman, 2011). This is why in marital interactions it generally takes at least five kind comments to offset for one critical comment (Baumeister et al, 2001).

The idea of loss aversion is shown in consumer behavior. Consumers are more responsive to a price increase than to decrease. For example, from July 1981 to July 1983, a 10 percent increase in the price of eggs led to a 7.8 percent decrease in demand, whereas a 10 percent decrease in the price led to a 3.3 percent increase in demand (Putler, 1992).

In another study, consumers were asked to either build up a basic pizza by adding ingredients like sausage and pepperoni or scale down a fully loaded pizza by removing ingredients. Consistent with loss aversion, consumers in the subtractive condition ended up with pizzas that had significantly more ingredients than those in the additive condition (Levin et al., 2002).

The principle of loss aversion also applies to the emotional pain of scaling back. While we indulge in buying things, such as a larger home or a new car, we think that we can always downsize if we can not afford those purchases. But in reality, downgrading to a smaller home is psychologically painful. Being wealthy doesn’t help. For rich people, the pain of losing their fortune exceeds the emotional gain of getting additional wealth, so the rich often become vulnerable and anxious.

Ownership is not limited to material things—it also applies to ideas. Once we take ownership of an ideology, about politics or sports for example, we tend to value it more than it is worth. And we hate to lose an argument. However, we run the risk of dismissing others’ ideas that might simply be better than ours. As a teacher (and a parent), I have learned that a good strategy to help students adopt a new idea is be to provide opportunities for them to come up with the idea on their own. People generally have positive attitudes toward themselves, and they enhance the value of their choices and devalue the road not taken. They also feel invested in their opinions. They have skin in the game (Taleb, 2018).

Even our views of mate value change the more time we spend together. The longer we spend with our mates, the harder it is to simply let go, regardless of how unhappy we are.

In a nutshell, loss aversion is an important aspect of everyday economic life. The idea suggests that people have a tendency to stick with what they have unless there is a good reason to switch. The loss aversion is a reflection of a general bias in human psychology (status quo bias) that make people resistant to change. So when we think about change we focus more on what we might lose rather than on what we might get.

What is the cure? Being aware of it might help—forewarned is forearmed. For example, suppose you are de-cluttering your home. Using this knowledge, you can view each item as if you were non-owner (not yet owned it) and apply a simple test: If you didn’t have the item, how much would you be willing to pay to buy it? Just by changing your perspective, you can gain clarity to make you less vulnerable.

We can also take a broader perspective. Stoic philosophy teaches that if you have lost someone or something precious, you can try to value that person or object differently by imagining that you never knew that person, or never owned that object (Bakewell, 2011). If you feel tired of everything you possess, pretend that you have lost all these things and are missing them desperately. Doing so will make us value what we already have, and possibly prevent “the grass is always greener” syndrome.

References

Baumeister, R., Bratslavsky, E., Finkenauer, C., & Vohs, K. (2001). Bad is stronger than good. Review of General Psychology, 5, 323–370.

Bakewell, S. (2011). How to Live, or, A life of Montaigne in One Question and Twenty Attempts at an Answer. New York: Other Press.

Kahneman Daniel (2011) Thinking, Fast and Slow, New York: Farrar, Straus and Giroux

Levin, Irwin P., Judy Schreiber, Marco Lauriola, and Gary J. Gaeth (2002), “A Tale of Two Pizzas: Building Up from a Basic Product Versus Scaling Down from a Fully-Loaded Product,” Marketing Letters , 13 (4), 335-344.

Putler, Daniel S. 1992. “Incorporating Reference Price Effects into a Theory of Consumer Choice.” Marketing Science11 (3): 287–309.

Rick, S. (2011). Losses, gains, and brains: neuroeconomics can help to answer open questions about loss aversion. J. Consum. Psychol. 21, 453–463.

Taleb, NM (2018) Skin in the game, New York: Random House.