1 00:00:00,777 --> 00:00:08,325 One of the most interesting findings in behavioral economics, and definitely in 2 00:00:08,325 --> 00:00:14,580 one of the earliest finding, has been this idea of loss of aversion. 3 00:00:14,580 --> 00:00:20,894 And loss of aversion is the idea that we get happy when we make money. 4 00:00:20,894 --> 00:00:27,067 But, we really suffer when we lose money. So, for example, ask yourself, if I flip 5 00:00:27,067 --> 00:00:32,108 the coin and you got the $150. If it fell on tails and you lost a $100, 6 00:00:32,108 --> 00:00:35,398 if it fell on heads would you take this bet? 7 00:00:35,398 --> 00:00:38,970 The expected value is positive, but would you take it? 8 00:00:38,970 --> 00:00:42,675 Most people would say no. And if you say yes to that one, what about 9 00:00:42,675 --> 00:00:47,570 if the positive was 125 and the negative was minus 100, will you take that? 10 00:00:47,570 --> 00:00:52,662 At some point, most people say I would not take it even though the expected value, 11 00:00:52,662 --> 00:00:55,791 the average of those two outcomes is positive. 12 00:00:55,792 --> 00:01:00,181 Also, if you've invested in the stock market, you probably realize that on days 13 00:01:00,181 --> 00:01:04,521 when you make 2%, you're happy. But on days that you lose 2%, you're 14 00:01:04,521 --> 00:01:08,594 really miserable. And this asymmetry around the neutral 15 00:01:08,594 --> 00:01:13,290 point has become very important, and this be calling Loss Aversion. 16 00:01:13,290 --> 00:01:18,972 Gains make us happy, but losses make us really miserable. 17 00:01:18,973 --> 00:01:24,447 And there are all kind of consequences of this idea of, of loss aversion. 18 00:01:24,447 --> 00:01:30,560 For example, it's important to realize that the losses are not just around the 19 00:01:30,560 --> 00:01:35,659 zero, it's around where you are. So, for example, imagine that all of a 20 00:01:35,659 --> 00:01:39,882 sudden I give you some salary. I give you maybe $50,000 a year as a 21 00:01:39,882 --> 00:01:43,034 salary. Once I gave you that amount of money, what 22 00:01:43,034 --> 00:01:46,419 do you think about the reduction of your salary? 23 00:01:46,420 --> 00:01:49,065 Are you looking at compared to zero? No. 24 00:01:49,065 --> 00:01:52,664 You look at it from this new point of making $50,000. 25 00:01:52,664 --> 00:01:58,502 And if I try to take something away from you, it's becoming incredibly unpleasant. 26 00:01:58,503 --> 00:02:02,120 So, how might we use this idea of loss aversion? 27 00:02:02,120 --> 00:02:05,040 First of all, let's think about the following example. 28 00:02:05,040 --> 00:02:09,380 Imagine that you're working for me, you're a sales person and you're selling TVs for 29 00:02:09,380 --> 00:02:13,290 example. And you're selling TV A and TVs B's. 30 00:02:13,290 --> 00:02:17,192 And both of those companies pay commission. 31 00:02:17,192 --> 00:02:22,408 Company A pays you when you sell a TV A's, and company B sell you gives you 32 00:02:22,408 --> 00:02:28,386 commission when you sell TV B. How could these companies get you to sell 33 00:02:28,386 --> 00:02:32,360 more of their TVs? Of course, they could increase their 34 00:02:32,360 --> 00:02:35,116 commission. If you got more commission from one TV, 35 00:02:35,116 --> 00:02:38,341 you would sell that more. If you got more commission from the other 36 00:02:38,341 --> 00:02:42,037 TV, you would sell that more. But can we use loss aversion? 37 00:02:42,038 --> 00:02:46,227 So, imagine what would happen if one of the companies prepaid you. 38 00:02:46,228 --> 00:02:51,322 They, they said look, we think that this year you're going to sell 300 TVs from our 39 00:02:51,322 --> 00:02:55,062 TVs and we're going to give you all the commission up front. 40 00:02:55,062 --> 00:03:01,057 And then, every TV you don't sell that is ours, you have to give us the money back. 41 00:03:01,058 --> 00:03:05,362 So, we run many experiments like this. And we get people to be in the position of 42 00:03:05,362 --> 00:03:08,698 the salesperson. And for one type of TV they sell, they get 43 00:03:08,698 --> 00:03:13,686 commission after the fact. And for the other type of TV, they get the 44 00:03:13,686 --> 00:03:17,544 comission in advance as if they always sold just this TV. 45 00:03:17,544 --> 00:03:22,807 And then, they can, if they don't sell the TV, they have to give the money back. 46 00:03:22,808 --> 00:03:27,394 So, imagine for example, that I am the salesperson. 47 00:03:27,394 --> 00:03:31,611 And if I sell one of the TVs, TV B, I make $12. 48 00:03:31,611 --> 00:03:34,050 But then, if I, and if I sell TV A, I make $10. 49 00:03:34,050 --> 00:03:39,072 But if TV A prepays me, it means that if I sell, if I sell TV B I get $12 and I have 50 00:03:39,072 --> 00:03:45,007 to pay back $10. Now, it's still a good deal for me because 51 00:03:45,007 --> 00:03:50,895 I get more money and have to get rid of less, right? 52 00:03:50,895 --> 00:03:55,860 If I sell TV A, I'm, I'm, I've gotten $10 and nothing happened. 53 00:03:55,860 --> 00:04:00,570 If I sell TV B, I have to give back $10 but I actually made more money. 54 00:04:00,570 --> 00:04:05,855 What happened in the experiment? People oversell the TV that's prepaid. 55 00:04:05,855 --> 00:04:09,542 Even when it's irrational, even when they lose money. 56 00:04:09,542 --> 00:04:14,624 Which suggests that once you give people money, they value that money to a higher 57 00:04:14,624 --> 00:04:19,905 degree, they don't want to give it up. And because of that, they are redirecting 58 00:04:19,905 --> 00:04:22,992 their efforts. Here's another way to think about how 59 00:04:22,992 --> 00:04:26,269 these effects might work. So, imagine you work for a company. 60 00:04:26,270 --> 00:04:30,376 And every month you can save money in your retirement plan. 61 00:04:30,376 --> 00:04:35,290 And the way it usually works is that you put some money in, let's say 5% of your 62 00:04:35,290 --> 00:04:38,670 salary, and the company matches 5% of your salary. 63 00:04:38,670 --> 00:04:43,290 And those 5%, and 5% go into your long-term savings account. 64 00:04:43,290 --> 00:04:46,677 Now, what if your company actually matches up to 10%? 65 00:04:46,677 --> 00:04:51,760 If you're putting 5 and they're putting 5, you're leaving some money on the table but 66 00:04:51,760 --> 00:04:55,660 you don't see it being left on the table. One of the things that we predict would 67 00:04:55,660 --> 00:05:00,703 happen is the following. What if the company gave 10% up front and 68 00:05:00,703 --> 00:05:05,224 then you matched it? But you only put 5%. 69 00:05:05,224 --> 00:05:09,942 And then, they take those other 5% that you did not match, and they take it back. 70 00:05:09,943 --> 00:05:13,561 Now, we have the principal of loss aversion working, right? 71 00:05:13,562 --> 00:05:17,523 Now, you see money going into your long-term savings. 72 00:05:17,524 --> 00:05:21,290 You see that you are not matching all of it, and you see some of it going away. 73 00:05:21,290 --> 00:05:25,524 And the idea is that money that we don't get, it's a shame. 74 00:05:25,525 --> 00:05:29,240 But money that goes away have a lot of psychological impact. 75 00:05:29,240 --> 00:05:35,136 And because of the prediction is that under those conditions, people would save 76 00:05:35,136 --> 00:05:38,116 more money. There's another implication for loss 77 00:05:38,116 --> 00:05:42,743 aversion which is very interesting, which is something called the endowment effect. 78 00:05:42,743 --> 00:05:47,549 And again, the idea is once we get something, we get used to owning it. 79 00:05:47,550 --> 00:05:52,202 And from that starting point, we think about gaining from that perspective, or 80 00:05:52,202 --> 00:05:56,408 losing from that perspective. But we've adjusted to this new level of 81 00:05:56,408 --> 00:05:59,230 ownership, right? We get the salary, we get the house. 82 00:05:59,230 --> 00:06:03,130 Whatever it is. The initial experiments on the endowment 83 00:06:03,130 --> 00:06:07,190 effect were done with mugs. They took a big group of students. 84 00:06:07,190 --> 00:06:11,377 They gave half of them mugs and they gave half of them candy. 85 00:06:11,378 --> 00:06:17,022 And then they said, look, the people who have the mugs, how much would you sell 86 00:06:17,022 --> 00:06:20,010 your mug for? And then they told them, and how much 87 00:06:20,010 --> 00:06:23,350 would you pay for candy? And the people who had the candy, the 88 00:06:23,350 --> 00:06:26,062 chocolate bar, they say, how much would you sell? 89 00:06:26,062 --> 00:06:29,170 You can be, bar four, and how much would you buy a mug for? 90 00:06:29,170 --> 00:06:33,726 Now, because you assigned the mugs and the candies randomly, 50% of the people got 91 00:06:33,726 --> 00:06:38,198 those, 50% of the people got those. You would expect that for 50%, they would 92 00:06:38,198 --> 00:06:41,769 prefer the other good. But what happens when you do it? 93 00:06:41,770 --> 00:06:46,579 Almost nobody switches. The people who owned mugs say, oh my 94 00:06:46,579 --> 00:06:49,927 goodness, mugs are wonderful. I don't want to give them up. 95 00:06:49,927 --> 00:06:52,467 Let me keep them. I'm not willing to give them up. 96 00:06:52,468 --> 00:06:56,080 People who owned the candy bars say, oh, candy bars are just fantastic. 97 00:06:56,080 --> 00:07:01,691 I'm not willing to give up the candy. So, what happen is the moment you give 98 00:07:01,691 --> 00:07:04,800 people mugs, they get used to mugs. They think mugs are great. 99 00:07:04,800 --> 00:07:08,297 And they want a high price for giving up these mugs. 100 00:07:08,298 --> 00:07:11,520 The people who get candy, all of a sudden, want a high price for candy. 101 00:07:11,520 --> 00:07:15,379 And because of that, there's no switching in this marketplace. 102 00:07:15,380 --> 00:07:19,671 We did these experiments with Duke basketball tickets. 103 00:07:19,671 --> 00:07:23,260 I teach at Duke. At Duke, there's a huge basketball team. 104 00:07:23,260 --> 00:07:26,047 It's really important for the students. It's something very central. 105 00:07:26,047 --> 00:07:30,271 And toward the end of the season, if the team is doing very well, there's some 106 00:07:30,271 --> 00:07:34,426 really important games. And the students are camping in order to 107 00:07:34,426 --> 00:07:37,963 get tickets for these games. But in that particular year, there were 108 00:07:37,963 --> 00:07:40,642 not going to be enough tickets for all the students. 109 00:07:40,642 --> 00:07:43,820 So, the students camped out in order to be in line for the tickets. 110 00:07:43,820 --> 00:07:47,288 They camped for many days. And at the end of those many days, they 111 00:07:47,288 --> 00:07:49,828 had a lottery. And they said, well, all of you camped, 112 00:07:49,828 --> 00:07:52,962 all of you deserve tickets. But, we don't have tickets for all of you. 113 00:07:52,962 --> 00:07:57,395 So, we're going to have a lottery and some of you are going to get the tickets and 114 00:07:57,395 --> 00:08:00,650 some of you are not. So, we had the group that all had high 115 00:08:00,650 --> 00:08:05,411 interest in those tickets and they were randomly assigned by the lottery to people 116 00:08:05,411 --> 00:08:08,883 who are ticket owners and people who are not ticket owners. 117 00:08:08,883 --> 00:08:11,656 So, together we achieve common, we called up these people. 118 00:08:11,656 --> 00:08:16,418 We found out what the lottery outcome was. And we knew who was the ticket owner and 119 00:08:16,418 --> 00:08:21,228 who was not, and we called them up and we said, hey, if you're a ticket owner, can 120 00:08:21,228 --> 00:08:24,980 we tempt you to sell us the tickets? And if you were not a ticket owner, we 121 00:08:24,980 --> 00:08:27,990 said, hey, we might get a ticket for you. How much would you pay for it? 122 00:08:27,990 --> 00:08:32,386 What happened? The people who were ticket owners wanted 123 00:08:32,386 --> 00:08:36,350 about $2,000 to give up their tickets. Lots of money. 124 00:08:36,350 --> 00:08:41,036 The people who did not have tickets were willing to buy one for a hundred and some 125 00:08:41,036 --> 00:08:45,210 dollars but not more than that. What happened is the moment people became 126 00:08:45,210 --> 00:08:49,498 ticket owners, they value it to a higher degree, and giving it up became much more 127 00:08:49,498 --> 00:08:52,909 important. The people who did not own the ticket did 128 00:08:52,909 --> 00:08:55,555 not value it as much. Now, not only that. 129 00:08:55,555 --> 00:09:00,594 But when we asked them to explain their reasons, the reasons were very different. 130 00:09:00,594 --> 00:09:03,650 Now, these two people are on two sides of the transaction. 131 00:09:03,650 --> 00:09:06,874 They have reasons for switching to the other side and they have reasons for 132 00:09:06,874 --> 00:09:09,864 keeping where they are. If you have a ticket, you have a reason to 133 00:09:09,864 --> 00:09:13,640 try and sell the ticket to get money, and you have your reasons to go to the game. 134 00:09:13,640 --> 00:09:17,174 If you don't have a ticket, you have reasons to go to the game, and to keep the 135 00:09:17,174 --> 00:09:20,920 money or not to spend the money. But what we heard from people when we 136 00:09:20,920 --> 00:09:25,380 asked them why, were reasons only about their side of the transaction. 137 00:09:25,380 --> 00:09:31,030 People who had this ticket said, going to his game is going to be my defining moment 138 00:09:31,030 --> 00:09:33,622 to do. It's going to be incredibly important, 139 00:09:33,622 --> 00:09:36,881 it's something that would be the capstone of my experience. 140 00:09:36,881 --> 00:09:39,450 I will tell my children about it and my grandchildren about it. 141 00:09:39,450 --> 00:09:41,710 I'll keep on remember it. I'll think about it. 142 00:09:41,710 --> 00:09:46,940 It'll be a huge part of my experience. The people who did not have the ticket, 143 00:09:46,940 --> 00:09:51,011 could also give us this reason. They could say, I want to go to the game 144 00:09:51,011 --> 00:09:55,555 because it will be apart of my life, telling my children, but no, those people 145 00:09:55,555 --> 00:09:59,192 thought about the money. They said, well, I don't want to spend so 146 00:09:59,192 --> 00:10:02,370 much money on a ticket. I can go to a bar, I could see the game 147 00:10:02,370 --> 00:10:06,859 for free, and maybe buy some drinks, and that would actually be more interesting 148 00:10:06,859 --> 00:10:10,190 for me. So, what happens is the moment you move on 149 00:10:10,190 --> 00:10:15,527 the ownership curve, you start to evaluate things from that perspective. 150 00:10:15,528 --> 00:10:19,390 And you think very differently about what you're going to lose and what you're going 151 00:10:19,390 --> 00:10:22,016 to gain. And in that particular case, when you're 152 00:10:22,016 --> 00:10:26,368 thinking about selling a ticket, you're thinking about what you're going to give 153 00:10:26,368 --> 00:10:28,520 up, the ticket. And that's what you focus on. 154 00:10:28,520 --> 00:10:31,308 And that's what you think about the experiences. 155 00:10:31,308 --> 00:10:33,500 If you have money but no ticket, what are you thinking? 156 00:10:33,500 --> 00:10:37,382 You're thinking about giving up the money. You're thinking about that side of the 157 00:10:37,382 --> 00:10:40,693 transaction. So, it seems that loss of aversion is a 158 00:10:40,693 --> 00:10:45,200 very general way for us to think about what we have and what we own. 159 00:10:45,200 --> 00:10:50,678 And the moment you own something, you think about your changes in terms of gains 160 00:10:50,678 --> 00:10:56,073 and losses, and then losses are more salient and prominent, and actually more 161 00:10:56,073 --> 00:11:00,308 important in our decision. As a final thing, you can think about what 162 00:11:00,308 --> 00:11:03,677 does 30 day money back guarantee basically provide. 163 00:11:03,677 --> 00:11:08,679 It basically says, yeah, look. Why don't you buy a sofa, take it home, 164 00:11:08,679 --> 00:11:12,595 see how it is, and you could always bring it back, right? 165 00:11:12,595 --> 00:11:15,450 And from you as a consumer, it says, okay, I have no risk. 166 00:11:15,450 --> 00:11:20,845 I can take this sofa home, I can try it, I can get, I can get see how it works for 167 00:11:20,845 --> 00:11:22,726 me. What you don't probably appreciate is loss 168 00:11:22,726 --> 00:11:26,767 aversion, the endowment affect. Probably what you don't appreciate is by 169 00:11:26,767 --> 00:11:33,332 the time you bring the sofa home, and you use it for a few days, you become to like 170 00:11:33,332 --> 00:11:38,800 it to a slightly higher degree. All of a sudden, it's yours, and giving it 171 00:11:38,800 --> 00:11:42,126 up is more difficult. So, while you initially value the 172 00:11:42,126 --> 00:11:46,481 transaction and saying, oh, that's not a big deal, let me just take it home and I 173 00:11:46,481 --> 00:11:50,250 will evaluate how it works. Once you take it home, you get used to it. 174 00:11:50,250 --> 00:11:55,050 You change your position to think of yourself as an owner of that sofa. 175 00:11:55,050 --> 00:11:58,371 Now, all of a sudden, giving it up is tougher. 176 00:11:58,372 --> 00:12:01,669 So, in summary, loss of aversion is really interesting. 177 00:12:01,669 --> 00:12:05,630 It's one of the first important findings in behavioral economics. 178 00:12:05,630 --> 00:12:07,487 And if you think about it, it's everywhere. 179 00:12:07,487 --> 00:12:12,734 And you can also think about how to introduce it in places where people could 180 00:12:12,734 --> 00:12:17,833 actually be prompted by it, like in financial savings, to behave better.