Fairness

. Linked with gains and losses is the concept of fairness and unfairness (this goes against the economic theory that states behaviour is ruled by self interest). It is considered unfair for organisations to reduce existing wages and/or increase prices, rents, etc. Even though an organisation may change its prices, etc as a reflection of changing demand and supply, there is a moral component, ie the exploitation of market power that imposes losses on others in order to increase profit is unacceptable. Employers who violate rules of fairness are punished by reduced productivity, and merchants following unfair pricing practices can expect to lose sales, eg a buyer who purchases something that is later reduced in price will decrease future purchases by around 15% (Daniel Kahneman 2012), ie the buyer's reference point is the lower price and they perceive they have sustained a loss by paying more than appropriate.

"...Unfairly imposing losses on people can be risky if the victims are in a position to retaliate..."

Daniel Kahneman 2012

. Altruistic punishment - strangers who witness unfair behaviour often join in the punishment; this is accompanied by increased activity in the "pleasure centres"of the brain

"...It appears that maintaining the social order and rules of fairness in this fashion has its own reward. Altruistic punishment could be the glue that holds societies together..."

Daniel Kahneman 2012

. Our brains are not designed to reward generosity as reliably as they punish meanness; there is a marked asymmetry between losses and gains

. The influence of loss aversion and entitlements impacts on many aspects of our lives, such as in the administration of justice, financial transactions, etc. A firm whose goods were lost in transit may be compensated for costs actually incurred but is unlikely to be compensated for lost profit, ie the distinction is drawn in the law between restoring losses and for compensating for gains.

. Choices are not evaluated separately and independently

. The past and current situations are important as they provide valuable reference points

. The preference for status quo is a consequence of loss aversion. Also tastes are not fixed: they vary with the reference point; the disadvantage of a change looms larger than its advantages, which induces a bias in favour of the status quo

. Expectation principle = assigning weights (probabilities) to outcomes. This assumes decision-makers are rational, which we know they are not

. Possibility effect = involves a highly unlikely outcome being weighted disproportionally more than it deserves, eg buying a lottery ticket (has a very small chance of winning a large prize). We tend to downplay small risks and are willing to pay far more than expected value to eliminate them altogether

. Certainty effect = outcomes that are almost certain are given less weight than their probability justifies, ie over-weighting of small probabilities increases the attractiveness of, for example, gambling and insurance policies

. Both possibility and certainty have a powerful impact on the domain of losses, ie

"...The decision weights that people assigned to outcomes are not identical to the probability of these outcomes. Contrary to the expectation.....outcomes are overweight - this is the possibility effect. Outcomes that are almost certain are underweight relative to actual certainty......any weighing of uncertain outcomes that is not strictly proportional to probability lead to inconsistencies and other disasters..."

Daniel Kahneman 2012

"...People values to gains and losses rather than to wealth, and the decision weights that they assigned to outcomes are different from probabilities..."

Daniel Kahneman 2012

 

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