Kahneman's most ingenious aspects of psychological theory have to do with quantifying psychological gains and losses. These findings were the result of years of careful, clever, imaginative studies.
The mind does not function according to the standard laws of economics. In the mind, losses are weighted more heavily than equivalent gains. This is due to the mind's tendency to form a personal attachment to an object or phenomenon associated with the present state. In a sense, current possession is given extra value in the mind, even if there is no other rationale for it. The value of any change is dependent on the initial baseline (so finding a quarter will seem much luckier if you are just short on bus fare home, compared to a different situation where your wallet is full of bus tickets). We are willing to "pay" disproportionate amounts, psychologically or economically, for certainty, or for possibility. People would "pay" an amount much more than 10% higher to have 100% instead of 90% certainty of safety or gain. This is the basis on which the insurance industry thrives. And people are willing to pay much more than 1% of a potential gain to raise the probability of gain from 0 to 1% (we see this phenomenon every day when people buy lottery tickets).
Psychologically, this means that we may distribute mental time, energy, or attachment irrationally. We may chase irrationally after long shots, or invest an excess of energy into a task--perfectionistically--in a way which is unnecessary and depriving to other goals. And the core mental property of loss aversion may cause us to hold onto aspects of the status quo too tenaciously, and cause us to be unreasonably unwilling to take small risks, if these risks involve letting go of something we currently have.
On the other hand, some of these phenomena could be viewed as intrinsic elements of what "makes us human." While buying lottery tickets or doing other types of gambling activities are on the one hand irrational, they on the other hand could be viewed as game playing. And we are willing to pay to play games. (in the case of gambling, we pay with financial loss and lost time). I think if such activities could be framed as play activities, it might help people to assign fair values to the activities. The act of risk-taking might actually feel enjoyable, particularly if there are other positive cues associated (for the gambler, it might be the glitzy casino), even though the net result of the activity is loss. The problem is, many people who gamble actually frame the activity as a profit-building venture, which is highly irrational and would be expected to lead to financial ruin if pursued to the fullest extent. Also, the mind tends not to frame probabilities accurately, and is prone to see causal patterns in random sets; therefore many a gambler comes to believe that he or she is having some kind of exceptional luckiness that is different from average.
Similarly, insurance purchasing is on the on hand an often inefficient use of money, but on the other hand it could be viewed as the cost of feeling more secure. Or of paying someone else to take on some of your life risks.
The phenomenon of loss aversion is part of what helps us maintain stability in our relationships with people, belongings, and activities.
But sometimes this phenomenon can cause us to irrationally hold onto relationships, behaviours, commitments, or objects which would be healthier to let go of.
Kahneman's research shows us that these phenomena cause extremely strong biases in decision making. While some of these biases may be an intrinsic part of our humanity, I think that at the very least, his work invites us to think much more closely about the rationality of our decisions, when it comes to economic or psychological changes, acquisitions, or losses.
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3 days ago