Does Loss Aversion Invalidate the Cost-Benefit Principle?

Numerous studies have found that people’s reservation prices for selling things they possess are roughly twice what others who don’t possess those things would be willing to pay to acquire them. This finding, which behavioral economists call loss aversion, prompts an important policy question: If losses weigh twice as heavily as gains, should the cost-benefit principle be modified to recommend taking only those actions whose benefits are at least twice as large as their costs? Here, I argue that this would be misguided. Although losses do indeed loom disproportionately large, both in prospect and in the immediate aftermath of having experienced them, people generally adapt to them much more quickly and completely than they had anticipated. Once people take an action, its benefits quickly become part of their endowments, causing its perceived value to rise accordingly. But adaptation affects the costs of the action in the opposite direction. Even costs that seemed genuinely daunting in prospect are generally seen as much less so once people have had an opportunity to adapt to them. To say that loss aversion creates a powerful status-quo bias is thus descriptive but, by all indications, maladaptive.