It's not surprising if you've talked to human beings ever. But it is irrational, and I'm not sure I understand why we are instinctively that way. Why is losing something more painful than gaining the equivalent thing?
Because you have to reorganize your life and scale back the things you were doing, and deal with the ripples of that. You're taking care of people and there's less money and food, etc. Whereas it's fun to anticipate how to spend more resources.
I saw the example recently that giving people a 5¢ discount for bringing their own bag does very little to change behavior, whereas adding a 5¢ to get a bag from the grocery store changes behavior dramatically -- that seems like a good illustration of the irrationality.
On the other hand, the irrationality in question may not be loss aversion specifically, but rather a tendency to use heuristics ("added charges are bad") rather than weighing the cost-benefit on a case by case basis ("5¢ is negligible and I'd like a plastic bag today.")
Ah, planning/the hedonic treadmill. I hadn't made the connection.
Because you have to reorganize your life...
One of the more annoying characteristics of the neo-liberal "creative destruction!" types is their apparently complete inability to appreciate the negative effects of chronic instability on people's lives.*
A few years ago I moved to a new city for a new job and it was a huge massive draining pain in the ass. And this was a case where the job was a step up.
*Actually I suppose they do appreciate it and just think it's a good thing to keep the proles in a state of constant uncertainty and anxiety.
that seems like a good illustration of the irrationality.
Sure, there is an actual laboratory irrationality, which then also shows up in the grocery store, etc. But it's because we've got a habit of the mind, which is reasonable in most larger circumstances.
People optimize whatever they've got relentlessly. Optimizing takes energy, so a gain has to cover the costs of optimizing to be worth it. If you lose, you have the burden of the loss and the burden of re-optimizing.
I also suspect that the process of optimizing makes people feel as if they have a right to the status quo (because they put labor in). But I see it in water all the time. Whatever people have, that's what they think they deserve as the baseline.
But it is irrational
This is the key, isn't it? Loss aversion isn't counterintuitive at all, unless you're an economist (or have been trained to think like one). It's an important finding of behavioral economics because it challenges traditional economic assumptions of perfect rationality. And it's a strong challenge, because it's easy to demonstrate convincingly that the phenomenon is both real and pervasive.
From the OP:
Loss aversion itself is a clever concept, and I like Kahneman's book, but it's only counterintuitive because it's held up against a backdrop of idiotic game theory bullshit.
Whatever people have, that's what they think they deserve as the baseline.
This makes me think there may be another psychological factor amplifying loss aversion in many cases -- the feeling that it's important to not give up anything in an interaction/negotiation, because doing so sets the precedent for future negotiations to take more.
See, for example, the politics around trying to implement an income tax in WA state -- there's resistance from people who wouldn't pay any tax under the current proposals because they believe (correctly IMO) that the tax would eventually get expanded.
I wasn't disagreeing with that. You just seemed like you were questioning why the theory was noteworthy, since it isn't in any way counterintuitive. It's not meant to be counterintutive; it's meant to be demonstrably irrational.
I once had it explained to me by an economics grad student that loss aversion was the result of decreasing marginal utility. I don't know if this is the standard assumption in rational expectations circles, but it's nonsense.
People optimize whatever they've got relentlessly
You Californians, you act like you are all laid back and stuff, but really you are much more anal than all of us in un-optimized flyover country.
One of the more annoying characteristics of the neo-liberal "creative destruction!" types is their apparently complete inability to appreciate the negative effects of chronic instability on people's lives.*
Its all easier to understand when you remember that they are the ones creating and you are the ones being destroyed. (I guess that's actually the substance of your footnote.)
I do think that the use of "rational" for the mechanical exercise of rules is actively harmful. I think it should be required to be replaced with another term. My candidate is "idiotic rationality" somewhat after "idiot savant" although I realize that that term is now deprecated. "Mechanical rationality" would be a less insulting option.
9 is good.
Possibly related, we got a LOLreassessment about 18 months ago (quadruple our previous assessment, more than any house had ever sold for in our corner of the neighborhood). Long story short, we found out the other day that our appeal was rejected, and we now live in a (nearly) quarter million dollar house. I'm still dubious it's actually worth that, but it's probably close now, close enough that the difference between the assessment and the real # isn't worth arguing over.
Anyway, AB was shell-shocked by this* until I pointed out that we've been underassessed for a dozen years, and by increasingly absurd amounts. That made her feel better, but of course it is true that we were used to paying X, and now we have to pay 2X, and the loss is felt much more than any theoretical benefit from X being too low did.
Of course the real frustration is that we will (basically) never benefit from this appreciation; we plan to die here, so the only upside is more access to credit, hooray!
*They had to redo the millage after the reassessment, but I'm pretty sure our taxes will roughly double
Per 15 you can kick the can down the road a bit by having a model that includes costs for loss adjustment etc. and not just assuming that utility is strictly proportional to your measure of value. Or like any non-moron you accept that your model is limited and signal such by referring to "idiotic rationality."
19: We were well under-assessed for nearly 20 years, and I had a somewhat similar discussion with my wife when went up quite a bit (not as much as you, but still by a significant amount). In part this might have been due to an order of magnitude error on our property square footage, the official record showing it to be a tad smaller than the square footage of the house itself.
I'm still under-assessed, but not by as much as before.
19.4 Living in an improving neighborhood usually means less trash in the streets, fewer breakins, and better beer at the corner store.
Have you looked up Pennsylvania liquor laws lately?
Does loss aversion depend on framing? If so, then
it really is completely irrational and is not at all explained by 2. Wikipedia seems to suggest that people will make a different choice if you phrase something as "Let me give you 10 dollars but I'll take it away if you don't do X" versus "I will give you 10 dollars if you do X."
2 explains why we prefer gains to losses, but that is perfectly consistent with rational actors.
Loss aversion is about why we hate losses more than we love gains of the same magnitude.
2 is talking about the gains/losses of the same magnitude, then.
"Of the same magnitude" is key. Obviously if a loss in salary makes you much less happy, but an equal gain in salary makes you only a little happier, then you would pay to avoid an equal chance of gain or loss.
Loss aversion is about the fact that even when we are talking about changing among the same pair of situations, people are desperate to avoid a "loss" but don't mind passing up a "gain" as much. So that people aren't just evaluating the possible outcomes and including transition costs such as disruptiveness, but instead are additionally averse to an outcome if it involves a "loss."
I had thought 26 was exactly what loss aversion was (and that it is completely different from declining marginal utility of money).
The explanation in the OP of course works perfectly well if you figure that the reframing is simply causing people to regard the "loss" as the type of event that requires painfully readjusting current expectations / planning downward. The perhaps unexpected part is that you can trigger that change in regard through something as simple as the reframing described in 26.
It's simpler than that; cash flow comes before P&L. The quality of "being able to pay incoming bills" is more important than that of "potentially more money". Only clowns, aka economists, would miss this. Kotsko's financial advice to grad students is very strong on this point and he's right.
As a rule, standard economics assumptions include that the actor isn't liquidity constrained, i.e. has enough cash or credit that this isn't an issue. But cash flow management is an issue for Apple and they have *all* the cash.
It seems like it's part of the economics equivalent of physicists dealing with things like friction and hysteresis and transfer efficiencies to get a quantitative handle around entropy and things like that, or chemists going beyond thermodynamics to look at transition states. If you've become used to understanding everything by looking only at measurements taken at very particular types of equilibria, kinetics and state changes that are asymmetric in terms of time/direction are going to be confusing and hard to deal with.
31, 32: While it's fun to call economists clowns, they are aware of this effect, and have been for years. To quote Wikipedia, "Economists have realized significance of precautionary savings long ago." If you just Google "liquidity constraint", you get a billion economic papers.
Can we call game theorists clowns?
I'm afraid of clowns but not the guy who taught the game theory class I took. So, no.
I don't think 2 quite gets it. What "loss aversion" refers to as I understand it is the idea that presenting something as a gain versus presenting the same thing as a loss will affect how people respond it, and that's surprising. E.g., suppose the local gas station charges more if people use a credit card than if they pay cash. People will make different decisions if it's presented as a penalty for card users than if it's presented as a bonus for cash users.
Isn't the easy explanation that people use rules of thumb rather than pure rationality? Start with the explanation in 2, that cutting back consumption sucks more than increasing by the same amount is enjoyable. Then assume, in a manner that seems reasonable to me, that in the day-to-day
world rather than when someone's purposefully manipulating you for research or marketing, that things that look like 'losses' usually do mean cutting back consumption. At tht point, it's not surprising at all that you find people reacting on the basis of whether something looks like a loss rather than whether it's really going to mean cutting back: it's easier, and it usually works pretty well.
But you should have been. So, yes.
Isn't the easy explanation that people use rules of thumb rather than pure rationality?
Right, and this is exactly how Kahneman describes it. Loss aversion is part of the fast thinking system. Its inaccurate and basically automatic, so it leads to all sorts of decisions that seem irrational to the slow thinking system.
Isn't the easy explanation that people use rules of thumb rather than pure rationality?
Wasn't this, essentially, my argument in 3.2? (inspired by this discussion at CT)
35: Actually, I rather like game theory. A lot of interesting stuff*. Just needs the change I suggest in 18 when applied to people's behavior. I'm not really sure who to blame for that.
*For instance it's use in evolution for theories such as evolutionary stable strategies (ESS) for behaviors developed via evolution for organisms not even capable of "thinking."
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