Gains and Losses

The last two weeks have been a whirlwind. I moved to Boston to start a new role as a research assistant and am also taking classes along the way. One of the classes that I’m taking is Behavioral Economics. One of the readings (and there are so many!) is an interesting paper by Richard Thaler called Mental Accounting and Consumer Choice.

In particular, he builds on Daniel Kahneman and Amos Tversky’s model of loss aversion, which says that people strongly prefer avoiding losses to acquiring gains. We feel a loss approximately twice as badly as we feel a gain, so the magnitude from losing $2 is as strong as gaining $1.

Thaler took this model and said, okay, so is it better to combine the losses/gains together in one go or separate them? You can go through the different thought experiments: would you want to pay a fine a little at a time, or a lump-sum? Would you want to get a small piece of chocolate at a time, or a whole bar?

He found that people are happier (“get more utility”) by separating the gains, and aggregating the losses. You see plenty of examples in businesses where they’ll “separate the gain” by selling you items one-by-one and telling you all the benefits of each item so that you feel the happiness little by little. Or “aggregate the losses” when you pay for an insurance package that is all-inclusive instead of having to feel pain for an additional item you pick.

In the spirit of this blog, here are some examples of how you can apply it to your ever day life –

  1. Increase in gain should be separated – if you’re giving someone a gift, it’s better to buy many small gifts, than to have one big gift, given the same amount of budget.
  2. Increase in loss should be combined – if you’re telling your boss you didn’t complete a few tasks, you should deliver it all at once because separating it is just prolonging the torture.
  3. Gain and then losses – if you’re going to deliver bad news after establishing good news, do it at once. This is when you set the expectation high, and then cannot deliver. In this situation, it is better to tell them the disappointment in one sitting.

Hope you’ll be able to find ways to use this in your day-to-day! I’m thinking that purchasing one item at 10 stores will make me happier than purchasing 10 items in one store! 😉

Happy weekend xx

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