Cognitive Biases: Endowment Effect and Loss Aversion

Another good real-world example of cognitive biases was present in the January 16th edition of The Economist. This time, it’s two similar biases, the “endowment effect” and “loss aversion”:

A man may say he would not pay more than $5 for a coffee mug. But if he is told that the mug is his, and asked immediately afterwards how much he would be willing to sell it for, he typically holds out for more. Possession, it appears, lends things an added allure. […]

At the beginning of the week, some groups of workers were told that they would receive a bonus of 80 yuan ($12) at the end of the week if they met a given production target. Other groups were told that they had “provisionally” been awarded the same bonus, also due at the end of the week, but that they would “lose” it if their productivity fell short of the same threshold.

Objectively these are two ways of describing the same scheme. But under a theory of loss aversion, the second way of presenting the bonus should work better. Workers would think of the provisional bonus as theirs, and work harder to prevent it from being taken away.

This is just what the economists found. The fear of loss was a better motivator than the prospect of gain (which worked too, but less well). And the difference persisted over time: the results were not simply a consequence of workers’ misunderstanding of the system. (source)

The fact that it kept working over time, even if the workers understood what was being done, shows how powerful these biases are. The reason for that is almost certainly because they helped our ancestors survive and reproduce; in a very dangerous environment, it is better to be risk-averse and live to see another day than to take a chance and die, and over-valuing what you already have probably made sense in an environment where acquiring desirable things was much harder than it is now.

For more on these biases, see:

See also: Rationality Resources

One Response to “Cognitive Biases: Endowment Effect and Loss Aversion”

  1. purplesapho Says:

    Awesome! thanks for posting these.

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