Prospect Theory — How We Think About Loss
“Prospect theory assumes that losses and gains are valued differently, and thus individuals make decisions based on perceived gains instead of perceived losses. Also known as the “loss-aversion” theory, the general concept is that if two choices are put before an individual, both equal, with one presented in terms of potential gains and the other in terms of possible losses, the former option will be chosen.”
~Investopedia
Prospect Theory says that the pain of losing $1000 would hurt significantly more than the gain of $1000 would help. This imbalanced perception, can give insights into working with people.
“Daniel Kahneman, who won the 2002 Nobel Memorial Prize in Economics for his work developing prospect theory” ~ Wikipedia
Application of Prospect Theory
Say you run a business and have a client to whom you provide a custom service. Then suppose they have the option of paying you $500 to solve an issue that is costing them $1000 every month, or $500 to add a new business optimization that would increase their revenue by $1000 per month. Prospect theory says they will tend towards the former most times as a result of “Loss Aversion”.
Understanding this can provide insight into both how we can communicate more effectively, as well as how we can understand the way our proposals are received from a psychological perspective. Knowing that people tend to give more weight to mitigating losses than they do to achieving wins might be a deciding factor in the success of our business relationships.
