1) You win a contest and the prize is a choice between two options — to either receive a guaranteed payout of $900, or to take a 90 percent chance of getting a $1,000 payout albeit with a 10 percent chance of getting nothing.
2) You are fined and given a choice between two options — to either pay $900 outright, or to take a 10 percent chance of paying nothing but with a 90 percent chance of having to pay $1,000.
Which of these two options above would you choose?
According to loss aversion theory, the vast majority of people will choose to receive the guaranteed $900 as outlined in scenario one and they will gamble for a chance to pay nil in scenario two. This is inconsistent (and therefore irrational) behavior: for the same $900 payout, people refuse the gamble in the domain of gains but accept it in the domain of losses.
If the affected parties have any political influence, however, potential losers will be more active and determined than potential winners; the outcome will be biased in their favor and inevitably more expensive and less effective than initially planned.
When Richard Thaler, Jack Knetsch and I studied public perceptions of what constitutes unfair behavior on the part of merchants, employers and landlords, we found that the moral rules by which the public evaluates what companies may or may not do draw a crucial distinction between losses and gains. The basic principle is that the existing wage, price or rent sets a reference point, which has the nature of an entitlement that must not be infringed. It is considered unfair for the company to impose losses on its customers or workers relative to the reference transaction, unless it must do so to protect its own entitlement. Consider this example:
A hardware store has been selling snow shovels for $15. The morning after a large snowstorm, the store raises the price to $20. Eighty-two percent of participants in the survey rated the action unfair, though the hardware store was behaving appropriately, according to the standard economic model.
Regulatory focus. In this case a distinction is made between prevention and promotion focus. The former are more concerned with negative outcomes while the latter is concerned with the presence or absence of positive results. Those who focus on negative outcomes are thus more sensitive to losses than those who are promotion-focused. People who make decisions for others tend to be more focused on promotion, while people who decide for themselves tend to think more about the possibilities of negative outcomes: as a result people who make decisions for others are less loss averse when considering regulatory focus.
Searching for Information. When making decisions for others, people tend to search for more information relative to making the decision for oneself. One of the benefits of acquiring lots of information is that it shows less loss aversion. Think of stockholders who have a diversified number of stocks. They will be less loss averse in comparison with those who have only a limited number of stocks. Thus also regarding information seeking, deciding for others leads to relatively less loss aversion.
Omission Bias. Omission bias is the tendency to consider harmful actions as worse than equally harmful omissions, because actions are more obvious than omissions. Making decisions oneself is more biased to omissions, mainly because people want to avoid the feeling of being responsible for potential losses.
- Purchase Timing
Individual A decides to make the purchase early, then finds out the same product was offered on better terms later.
Individual B decides to wait for a better deal, then finds out that the earlier (missed) opportunity turns out to be more attractive than later options.
In this case, individual A may feel that it was not possible to predict the better sale and, therefore that she/he is not responsible for the outcome. However, individual B is expected to feel greater regret and be more upset with the purchase-timing decision than individual A because deciding to wait may be more of a gamble and reflect a deliberate strategy on the part of the consumer for getting a better deal than what is currently available.
- Choosing Between Brand Name and Price
If the consumer selected the more expensive alternative and it failed, then the responsibility for the failure would rest on the manufacturer rather than on the decision of the consumer. But, if the consumer chose the cheaper alternative and it failed, then the consumer might feel responsible for the failure and regret the decision.
The conclusion from this study is that the considerations of decision errors tends to increase the preference for earlier purchases and better-known brands.
- Regret vs. Responsibility
*It was assumed that regret and responsibility were highly positively correlated, with a higher sense of responsibility leading to greater regret. However, selections of better-known brands were associated with less responsibility and greater regret. Thus, regret and responsibility should be regarded differently.
- Purchase Timing
Individual A decides to make the purchase early, then finds out the same product was offered on better terms later.
Individual B decides to wait for a better deal, then finds out that the earlier (missed) opportunity turns out to be more attractive than later options.
In this case, individual A may feel that it was not possible to predict the better sale and, therefore that she/he is not responsible for the outcome. However, individual B is expected to feel greater regret and be more upset with the purchase-timing decision than individual A because deciding to wait may be more of a gamble and reflect a deliberate strategy on the part of the consumer for getting a better deal than what is currently available.
- Choosing Between Brand Name and Price
If the consumer selected the more expensive alternative and it failed, then the responsibility for the failure would rest on the manufacturer rather than on the decision of the consumer. But, if the consumer chose the cheaper alternative and it failed, then the consumer might feel responsible for the failure and regret the decision.
The conclusion from this study is that the considerations of decision errors tends to increase the preference for earlier purchases and better-known brands.
- Regret vs. Responsibility
*It was assumed that regret and responsibility were highly positively correlated, with a higher sense of responsibility leading to greater regret. However, selections of better-known brands were associated with less responsibility and greater regret. Thus, regret and responsibility should be regarded differently.
Power. People with more power experience less loss aversion. Furthermore, people that make decisions for others tend to think they have power over others. They feel they can control others by making decisions for them. Therefore, decision makers for others seem to be relatively less loss averse.
Nobody likes to lose, and most people will go out of their way to avoid loss. Even if it is something that they never wanted in the first place, people will still go to great lengths to avoid losing it. This antipathy against loss is so strong, people can go to extraordinary lengths to hold on to things that previously they had absolutely no interest in, mainly because there’s the feeling that once something is a loss, the opportunity to own it again may never arise.
The Magic Trick
Phrase your offers so they make your customers feel that they may be missing out on something. Everyone has had an email saying “Hurry now, 50% off offer ends tomorrow!” at some time. What are the odds that a certain percentage who received that email clicked on the vendor’s website, just in case they were genuinely missing out on the half price offer. They may end up being persuaded to make that purchase they’ve always been considering.
Nobody likes to lose, and most people will go out of their way to avoid loss. Even if it is something that they never wanted in the first place, people will still go to great lengths to avoid losing it. This antipathy against loss is so strong, people can go to extraordinary lengths to hold on to things that previously they had absolutely no interest in, mainly because there’s the feeling that once something is a loss, the opportunity to own it again may never arise.
The Magic Trick
Phrase your offers so they make your customers feel that they may be missing out on something. Everyone has had an email saying “Hurry now, 50% off offer ends tomorrow!” at some time. What are the odds that a certain percentage who received that email clicked on the vendor’s website, just in case they were genuinely missing out on the half price offer. They may end up being persuaded to make that purchase they’ve always been considering.
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