Thinking, Fast and Slow

by Daniel Kahneman

Loss aversion creates an asymmetry that makes agreements difficult to reach.

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.

Many of the messages that negotiators exchange in the course of bargaining are attempts to communicate a reference point and provide an anchor to the other side.

Because negotiators are influenced by a norm of reciprocity, a concession that is presented as painful calls for an equally painful (and perhaps equally inauthentic) concession from the other side.

Loss aversion is a powerful conservative force that favors minimal changes from the status quo

This conservatism helps keep us stable in our neighborhood, our marriage, and our job; it is the gravitational force that holds our life together near the reference point.

the only constraint was that the questionnaire should include at least one mention of fish, to make it pertinent to the mission of the department. This went on for many months, and we treated ourselves to an orgy of data collection.

Maybe i should try this in business?

We also found that the moral rules by which the public evaluates what firms may or may not do draw a crucial distinction between losses and gains.

The basic principle is that the existing wage, price, or rent sets a reference point, which has the nature of an entitlement that must not be infringed.

It is considered unfair for the firm to impose losses on its customers or workers relative to the reference transaction, unless it must...

Unfair

viewed the pre-blizzard price as a reference point

raised price as a loss

must but simply becau...

A basic rule of fairness, we found, is that the exploitation of market power to impose losses...

the current employee leaves, and the owner decides to pay a replacement $7 an hour.

It appears that the employer does

not have a moral obligation to pay $9 an hour.

The replacement worker has no entitlement to the previous worker’s reference wage, and the employer is therefore allowed to reduce pay without the risk of being branded unfair.

We also relied on the evidence of survey responses, for which economists generally have little respect. However, the editor of the journal sent our article for evaluation to two economists who were not bound by those conventions

Employers who violate rules of fairness are punished by reduced productivity, and merchants who follow unfair pricing policies can expect to lose sales. People who learned from a new catalog that the merchant was now charging less for a product that they had recently bought at a higher price reduced their future purchases from that supplier by 15%, an average loss of $90 per customer.

Remarkably, altruistic punishment is accompanied by increased activity in the “pleasure centers” of the brain. It appears that maintaining the social order and the rules of fairness in this fashion is its own reward. Altruistic punishment could well be the glue that holds societies together.

However, our brains are not designed to reward generosity as reliably as they punish meanness.

Here again, we find a marked asymmetry between l...

Increasing the chances from 0 to 5% transforms the situation,

creating a possibility that did not exist earlier, a hope of winning the prize. It is a qualitative change, where 5 10% is only a quantitative improvement. The change from 5% to 10% doubles the probability of winning, but there is general agreement that the psychological value of the prospect does not double.

The large impact of 0 5% illustrates the poss...

The improvement from 95% to 100% is another qualitative change that has a large impact, the certainty effect.

If such an event actually happens in your life, you should know that a large industry of “structured settlements” exists to provide certainty at a hefty price, by taking advantage of the certainty effect.

The conclusion is straightforward: the decision weights that people assign to outcomes are not identical to the probabilities of these outcomes, contrary to the expectation principle.

The expectation principle, by which values are weighted by their probability, is poor psychology.

In problem A, almost everybody prefers the left-hand urn, although it has fewer winning red marbles, because the difference in the size of the prize is more impressive than the difference in the chances of winning.

In problem B, a large majority chooses the urn that guarantees a gain of $500,000.

the certainty effect is at work. The 2% difference between a 100% and a 98% chance to win in problem B is vastly more impressive than the same difference between 63% and 61% in problem A.

When you pay attention to a threat, you worry—and the decision weights reflect how much you worry.

The parents were willing to pay an additional $2.38, on average, to reduce the risks by two-thirds from 15 per 10,000 bottles to 5. They were willing to pay $8.09, more than three times as much, to eliminate it completely.

This premium is compatible with the psychology of worry but not with the rational model.

two conclusions:

people attach values to gains and losses rather than to wealth,

the decision weights that they assign to outcomes are different...

“Am I willing to take even a small chance of getting nothing at all? Even 90% of the claim is a great deal of money, and I can walk away with it now.”

Two emotions are evoked, both driving in the same direction: the attraction of a sure (and substantial) gain and the fear of intense disappointment and regret if you reject a settlement and lose in court.

Here again, two emotions are involved: the sure loss is repugnant and the possibility of winning in court is highly attractive. A defendant with a weak case is likely to be risk seeking, prepared to gamble rather than accept a very unfavorable settlement. In the face-off between a risk-averse plaintiff and a risk-seeking defendant, the defendant holds the stronger hand.

The superior bargaining position of the defendant should be reflected in negotiated settlements, with the plaintiff settling for less than the statistically expected outcome of the trial.

When you take the long view of many similar decisions, you can see that paying a premium to avoid a small risk of a large loss is costly.

Buying a ticket is immediately rewarded by pleasant fantasies, just as avoiding a bus was immediately rewarded by relief from fear. In both cases, the actual probability is inconsequential; only possibility matters.

Overweighting of unlikely outcomes is rooted in System 1 features that are familiar by now.

Emotion and vividness influence fluency, availability, and judgments of probability—and thus account for our excessive response to the few rare events that we do not ignore.

The two questions are different but obviously related. The first asks you to assess the probability of an unlikely event.

The second invites you to put a decision weight on the same event, by placing a bet on it.