Let’s assume you would like to sell your house. According to Wired journalist Jonah Lehrer, the price you select might not be optimal. Why? Because we like to avoid losing money. (Of course, you might say, that is obvious. But an economist would suggest that a rational person would grasp the reality of the current housing market.)
People who purchased homes during the housing bubble probably paid much more for them than their current market value. According to Lehrer, these people have a tendency to price their homes much higher than others who made housing purchases after the height of the housing bubble. The reason is “loss aversion”. Only when houses are more realistically priced will the housing market recover.
The Economic Lesson
Loss aversion was first identified by economics Nobel Laureate Daniel Kahneman (a psychologist) and Amos Tversky during the 1970s. In one experiment they gave subjects two sets of alternatives. Worded differently, both actually were identical. However, for the first pair, option “A” said out of 600 people, 200 will be saved. With the second pair, the first option said that out of 600 people, 400 will die. Presented the first pair, people chose “A”. However, for the second pair they rejected that first option. According to Kahneman and Tversky, “losses loom larger than gains” and people are not always the rational decision makers that classical economists cite.
Loss aversion can also explain most investors’ behavior when faced with a losing investment. It also can explain capuchin monkey behavior.