Why you hate loss more than you love gain

When doctors wanted to motivate a group of people to exercise, they offered them $42 upfront for a 30-day period, equivalent to $1.40 per day. Anyone who did not exercise was penalized $1.40 per day.

The doctors promised another group of people $1.40 per day that they exercised.

Same exercise, same payment. Guess which group did better?

The group that got the money upfront worked harder to retain their money than the people who could earn their money every day.

This human tendency is called loss aversion and we need to recognize it while formulating public policy.

Now an established concept in economic theory, loss aversion has its roots in behavioral economics. Basically, people value something they have more than the same thing which may be available to them.

For example, if your home has a nice view, you will fight hard to retain if there is a threat that the view will vanish due to someone else’s actions. On the other hand, if your home does not have a nice view, you may not make the same effort to get it. The prospect of the loss is more important than the prospect of a gain.

Formally, you may accept some compensation if your neighbor destroys your view. This compensation is what economists call Willingness to Accept (WTA). It is the compensation that would make you give up something you have.

Then there is a concept called Willingness to Pay (WTP), which is what you would be willing to pay get something.

In conventional economic theory, we have

Willingness to Accept (WTA) = Willingness to Pay (WTP)

which means that what you will accept as compensation when you are deprived of something is the same as what you will pay to get that same thing.

But, in the real world, we often find that

Willingness to Accept (WTA) > Willingness to Pay (WTP)

which means that there is loss aversion. The loss of something you have is seen as more valuable than the gain from getting it if you don’t have it.

Loss aversion also explains why voters would choose a candidate who promises not to do away with a favorable policy, instead of going for a candidate closer to their political beliefs.

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