Loss aversion is the tendency for people to try to avoid losses more than they try to make gains. This can affect the economy as people are reluctant to take financial risks, and can lead to distortions in negotiations. However, loss aversion can be avoided if the acquired item has the same benefits as the traded item. Marketing departments use loss aversion to bring their product into the public consciousness.
Loss aversion is the term applied to the tendency of investors to try to avoid a loss even harder than they try to make a gain. Studies have shown that investors are more likely to sell good stocks to earn profits than bad ones to minimize losses. Psychologically, people tend to feel losses more acutely than wins, and a loss often leads to feelings of regret. Regret can lead people to mistake a negative outcome for a bad decision and, in extreme cases, have widespread effects on their confidence in decision making.
The economy can be affected by people’s natural tendency to be averse to loss, especially in times of economic hardship. It’s one of the reasons people are reluctant to upgrade expensive durable goods and take financial risks. Sellers see the commodity as a loss and price it accordingly. Shoppers see merchandise as a revenue and budget accordingly. Problems occur when the seller and the buyer don’t see the value of the item in a targeted way.
The real-world result of loss aversion on both sides of the negotiating table can lead to distortions of the status quo, which is an inherent preference for things to remain as they are. Nothing is gained, but nothing is lost. When evaluating risk, especially financial, a certain type of individual or company tends to prefer the security of identity to the stress of a bet.
Loss aversion can be avoided if the acquired item has the same benefits as the traded item, even if it has different attributes. For example, buying a car is basically just exchanging a certain amount of money for a car. If the customer feels that the car would serve him just as well as that amount of money, the transaction is completed without reluctance, even though a car and money are two very different things. Studies have shown that focusing on the concrete differences between the two (driving a car versus spending money) can lead to greater loss aversion than focusing on similar benefits (both allow for a level of freedom).
Marketing departments leverage loss aversion to bring their product into the public consciousness. Free trial programs are based on the idea that once a customer tries a product, they are considering what they would pay to avoid missing out on that product, rather than buying it. Delayed payment programs work the same way. Standing in the store watching a television, a consumer may reject the $3,000 price tag. Once the television has been in his home for a few months and enjoyed with his family every night, he’s much more likely to decide it’s worth $3,000 to avoid losing it.
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