Thinking, Fast and Slow

Loss aversion has a biological and psychological root in which negativity dominates positivity. Kahneman shows pictures of two sets of eyes—one wide and frightened, the other calmer. We are drawn to the first set because the brain contains a mechanism that gives priority to bad news. The brain responds even to symbolic threats: words like “war” and “crime” attract more attention than “peace” and “love.” Loss aversion is part of a broad negativity dominance: bad information has more impact and is processed more thoroughly. Bad impressions and bad stereotypes are quicker to from than good ones.

The aversion to failure to reach a goal is much stronger than the desire to exceed it. Golf provides a good example of this. Each hole has a par—a number of strokes associated with it. A birdie (one stroke under par) is a gain, and a bogey (one stroke over par) is a loss. The difference in the rate of success when going for par or for a birdie was 3.6%. For a player like Tiger Woods, this would improve his average tournament score by one stroke and his earnings by almost $1 million per season.

Loss aversion shows up in negotiations, and particularly in renegotiations of an existing contract. It creates an asymmetry that makes agreements difficult to reach: concessions that you make are gains for me, but losses for you. They will cause you more pain than pleasure for me. Loss aversion thus favors minimal changes from the status quo.

Thaler, Knetsch, and Kahneman next designed a survey to examine people’s view of fairness in economic transactions. One question described a hardware store that sells snow shovels for $15, but the morning after a snowstorm, raises the prices to $20. Even though the store acts according to the standard economic model, 82% of people rate this action as Unfair or Very Unfair.

In another example (written in 1984), people viewed it as unfair if a small shop reduced the wage of its only employee from $9 to $7 an hour, even if other competitive shops hired workers at the lower rate. But people did not consider it unfair if the current employee left and the shop hired a new employee at $7 an hour. People do not like firms that exploit their power and believe that the first employee is entitled to a given rate, but also understand that the firm wants to maintain its current profit. Employers who violate rules of fairness are punished by loss of both productivity and sales.

The influence of loss aversion and entitlements extends into justice. A merchant whose goods were lost in transit may be compensated for costs (which people view as losses) but is unlikely to be compensated for lost profits (which people view as foregone gains).