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Loss AversionThe idea of potential loss plays a large role in human decision making. In fact, people seem to be more motivated by the thought of losing something than by the thought of gaining something of equal value; that is, losses loom larger than gains. This loss aversion is reliable across a wide variety of domains (Kahneman & Tversky, 1979, 1984). For instance, homeowners told how much money they could lose from inadequate insulation are more likely to insulate their homes than those told how much money they could save (Cialdini, 2006). Wilson, Kaplan, and Schneiderman (1987), in another study, found that physicians’ letters to smokers describing the number of years of life that will be lost if they don’t quit are more effective than letters describing the number of years that will be gained if they do quit. In an interesting study Fryer, Levitt, List and Sadoff (2012) looked at teacher incentives in the Chicago area and gave one group of teachers a $4000 bonus at the beginning of the school year and told them it would be reduced by an amount reflecting their K-8 students’ performance—the more the students’ standardized scores increased, the more of the bonus their teacher could keep (the “loss” group in which a deduction is taken for failing to meet a threshold). Another group of teachers were told they would receive a $4,000 bonus paid at the end of the school year if their students improved during the year (the “gain” group in which a bonus is given for meeting a threshold). Consistent with over 30 years of psychological and economic research on the power of loss aversion to motivate behavior, students whose teachers in the “loss” group of the experiment (i.e., teachers who would lose part of their bonus if their student’s performance did not increase) showed statistically significant gains in math—roughly .2 to .3 standard deviations—a pattern that held whether teachers were compensated as a group or as individuals. There was no gain for students when their teachers were offered the bonus in the traditional fashion (i.e., teachers who would get a bonus if their student’s performance increased) at the end of the school year. Thus, communicating a teacher incentive program in terms of losses rather than gains led to improved student outcomes. The impacts observed were large—roughly the same order of magnitude as increasing average teacher quality by more than one standard deviation. Loss frames suggested by Hossain and List (2009) can also have positive effects on effort in a manufacturing setting. Hossain and List studied how Chinese factory workers reacted to two contracts which only differed in their framing. The first was framed in terms of a gain. Workers are told that in addition to a flat wage a bonus would be given for meeting a threshold. A second group was given information framed in terms of a loss. Workers were told that they would get a flat wage and a bonus which would be retracted if they failed to meet a threshold. Employees performed at a significantly higher rate under the loss condition. In both cases, the total compensation was paid out at the end of the month. The loss frame communicates the expectation that achieving a bonus is the default and individuals frequently comply with this expectation (Brooks, Stremitzer, & Tontrup, 2011). These studies suggest that there may be significant potential for exploiting loss aversion in the pursuit of both optimal public policy and the pursuit of profits.ReferencesBrooks, R., Stremitzer, A., & Tontrup, S. (2011). Framing Contracts: Why Loss Framing Increases Effort. Retrieved at economics/documents/Fall2011_Stremitzer.pdf Cialdini, R. B. (2006). Influence: The psychology of persuasion (Rev. ed.). New York: CollinsBusiness Essentials. Fryer, Jr., R. G., Levitt, S. D., List, J., & Sadoff, S. (2012). Enhancing the efficacy of teacher incentives through loss aversion: A field experiment. New York, NY: National Bureau of Economic Research.Hossain, T., & List, J. (2009). The behavioralist visits the factory: Increasing productivity using simple framing manipulations. NBER Working Paper, No. 1562. Retrieved at , D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica, 47, 263-291.Kahneman, D., & Tversky, A. (1984). Choices, values, and frames. American Psychologist, 4, 341-350. Wilson, D. K., Kaplan, R. M., & Schneiderman, L. J. (1987). Framing of decisions and selection of alternatives in health care. Social Behavior, 2, 51-59. ................
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