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I am coming to consider Thinking, Fast and Slow by Daniel Kahneman to be a critical read for anyone. I found this chapter particularly worth sharing.
A little background. In the previous chapter they improve upon Bernoulli's utility curve and introduce the concept of loss aversion. Basically that relative to what you consider the neutral point, steps back are twice as bad as equivalent steps forward. Much earlier in the book, they establish the two-systems model of the mind. System one is a massive association network that works quickly and automatically to spit out the quickest conclusion it can jump to, System two is the you you consider yourself which is lazy but capable of checking and correcting the results of the first system. It delivers the awesome observation that What You See Is All There Is or that you have a very hard time considering stuff you're unaware of.
'The concept of loss aversion is certainly the most significant contribution of psychology to behavioral economics. This is odd, because the idea that people evaluate many outcomes as gains and losses, and that losses loom larger than gains, surprises no one. Amos and I often joked that we were engaged in studying a subject about which our grandmothers knew a great deal. In fact, however, we know more than our grandmothers did and can now embed loss aversion in the context of a broader two-systems model of the mind, and specifically a biological and psychological view in which negativity and escape dominate positivity and approach. We can also trace the consequences of loss aversion in surprisingly diverse observations: only out-of-pocket losses are compensated when goods are lost in transport; attempts at large-scale reforms very often fail; and professional golfers putt more accurately for par than for a birdie. Clever as she was, my grandmother would have been surprised by the specific predictions from a general idea she considered obvious.
(Two black pictures with the whites of eyes.)
Your heartbeat accelerated when you looked at the left-hand figure. It accelerated even before you could label what is so eerie about the picture. After some time you may have recognized the eyes of a terrified person. The eyes on the right, narrowed by the raised cheeks of a smile, express happiness - and they are not nearly as exciting. The two pictures were presented to people lying in a brain scanner. Each picture was shown for less than 2/100 of a second and immediately masked by "visual noise," a random display of dark and bright squares. None of the observers ever consciously knew that he had seen pictures of eyes, but one part of their brain evidently knew: the amygdala, which has a primary role as the "threat center" of the brain, although it is also activated in other emotional states. Images of the brain showed an intense response of the amygdala to a threatening picture that the viewer did not recognize. The information about the threat probably traveled via a superfast neural channel that feeds directly into a part of the brain that processes emotions, bypassing the visual cortex that supports the conscious experience of "seeing." The same circuit also causes schematic angry faces (a potential threat) to be processed faster and more efficiently than schematic happy faces. Some experimenters have reported that an angry face "pops out" of a crowd of happy faces, but a single happy face does not stand out in an angry crowd. The brains of humans and other animals contain a mechanism that is designed to give priority to bad news. By shaving a few hundredths of a second from the time needed to detect a predator, this circuit improves the animal's odds of living long enough to procreate. The automatic operations of System 1 reflect this evolutionary history. No comparably rapid mechanism for recognizing good news has been detected. Of course, we and our animal cousins are quickly alerted to signs of opportunities to mate or to feed, and advertisers design billboards accordingly. Still, threats are privileged about opportunities, as they should be.
The brain responds quickly even to purely symbolic threats. Emotionally loaded words quickly attract attention, and bad words (war, crime) attract attention faster than do happy words (peace, love). There is no real threat, but the mere reminder of a bad event is treated in System 1 as threatening. As we saw earlier, with the word vomit, the symbolic representation associatively evokes in attenuated form many of the reactions to the real thing, including physiological indices of emotion and even fractional tendencies to avoid or approach, recoil or lean forward. The sensitivity to threats extends to the processing of statements of opinions with which we strongly disagree. For example, depending on your attitude on euthanasia, it would take your brain less than a quarter of a second to register the "threat" in a sentence that starts with "I think euthanasia is an acceptable/unacceptable..."
The psychologist Paul Rozin, an expert on disgust, observed that a single cockroach will completely wreck the appeal of a bowl of cherries, but a cherry will do nothing at all for a bowl of cockroaches. As he points out, the negative trumps the positive in many ways, and loss aversion is one of many manifestations of a broad negativity dominance. Other scholars, in a paper titled "Bad is Stronger Than Good," summarized the evidence as follows: "Bad emotions, bad parents, and bad feedback have more impact than good ones, and bad information is processed more thoroughly than good. The self is more motivated to avoid bad self-definitions than to pursue good ones. Bad impressions and bad stereotypes are quicker to form and more resistant to disconfirmation than good ones." They cite John Gottman, the well-known expert in martial relations, who observed that the long-term success of a relationship depends far more on avoiding the negative than on seeking the positive. Gottman estimated that a stable relationship requires that good interactions outnumber bad interactions by at least 5 to 1. Other asymmetries in the social domain are even more striking. We all know that a friendship that may take years to develop can be ruined by a single action.
Some distinctions between good and bad are hardwired into out biology. Infants enter the world ready to respond to pain as bad and sweet to (up to a point) as good. In many situations, however, the boundary between good and bad is a reference point that changes over time and depends on the immediate circumstances. Imagine that you are out in the country on a cold night, inadequately dressed for the torrential rain, your clothes soaked. A stringing cold wind completes your misery. As you wander around, you find a large rock that provides some shelter from the fury of the elements. The biologist Michel Cabanac would call the experience of that moment intensely pleasurable because it functions, as pleasure normally does, to indicate the direction of a biologically significant improvement of circumstances. The pleasant relief will not last very long, of course, and you will soon be shivering behind the rock again, driven by your renewed suffering to seek better shelter.
Goals are Reference Points
Loss aversion refers to the relative strength of two motives: we are driven more strongly to avoid losses than to achieve gains. A reference point is sometimes the status quo, but it can also be a goal in the future: not achieving a goal is a loss, exceeding the goal is a gain. As we might expect from negativity dominance, the two motives are not equally powerful. The aversion to the failure of not reaching a goal is much stronger than the desire to exceed it.
People often adopt short-term goals that they strive to achieve but not necessarily to exceed. They are likely to reduce their efforts when they have reached an immediate goal, with results that sometimes violate economic logic. New York cabdrivers, for example, may have a target income for the month or year, but the goal that controls their effort is typically a daily target of earnings. Of course, the daily goal is much easier to achieve (and exceed) on some days that on others. On rainy days, a NY cab never remains free for long, and the driver quickly achieves his target; not so in pleasant weather, when cabs often waste time cruising the streets looking for fares. Economic logic implies that cabdrivers should work many hours on rainy days and treat themselves to some leisure on mild days, when they can "buy" leisure at a lower price. The logic of loss aversion suggests the opposite: drivers who have a fixed daily target will work many more hours when the pickings are slim and go home early when rain-drenched customers are begging to be taken somewhere.
Pope and Schwietzer study a huge sample size of golfers who out perform themselves for par than birdie. I ain't typing it.
Defending the Status Quo
If you are set to look for it, the asymmetric intensity of the motives to avoid losses and to achieve gains shows up almost everywhere. It is an ever-present feature of negotiations, especially of renegotiations of an existing contract, the typical situation in labor negotiations and in international discussions of trade or arms limitations. The existing terms define reference points, and a proposed change in any aspect of the agreement is inevitably viewed as a concession that one side makes to the other. Loss aversion creates an asymmetry that makes agreements difficult to reach. The concessions you make to me are my gains, but they are your losses; they cause you much more pain than they give me pleasure. Inevitably, you will place a higher value on them that I do. The same is true, of course, of the very painful concessions you demand from me, which you do not appear to value sufficiently! Negotiations over a shrinking pie are especially difficult, because they require an allocation of losses. People tend to be much more easygoing when they bargain over an expanding pie.
Some stuff on negotiation tactics that imma skip.
Animals, including people, fight harder to prevent losses than to achieve gains. In the world of territorial animals, this principle explains the success of defenders. A biologist observed that "when a territory holder is challenged by a rival, the owner almost always wins the contest - usually within a matter of seconds." In human affairs, the same simple rule explains much of what happens when institutions attempt to reform themselves, in "reoganizations" and "resturcturing" of companies, and in efforts to rationalize a bureaucracy, simplify the tax code, or reduce medical costs. As initially conceived, plans for reform almost always produce many winners and some losers while achieving an overall improvement. If the affected parties have any political influence, however, potential losers will be more active and determined than potential winners; the outcome will be biased in their favor and inevitably more expensive and less effective than initially planned. Reforms commonly include grandfather clauses that protect current stake-holders - for example, when the existing workforce is reduced by attrition rather than by dismissals, or when cuts in salaries and benefits apply only to future workers. ..."
The chapter goes on to talk about loss aversion and how it affects perceptions of fairness that is a direct echo of the conversation on price gouging we had in this thread. But I'm done typing for now.
Buy the book.
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