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Chapter 1 provides an overview of loss aversion. After a historical account, it describes the experimental and empirical findings that demonstrate loss aversion and elucidate its relationships to more specific phenomena, such as the status quo bias and omission bias, endowment effect, escalation of commitment, and bounded ethicality. The chapter also reviews studies of the relationship between loss aversion and emotions; the neural basis of loss aversion; and hypotheses about its evolutionary roots. It examines what happens when competing and multiple reference points exist, and highlights the generality of reference-dependence in people’s perceptions and judgments. It also examines the effect of professional experience and group decision-making on loss aversion, and reviews attempts to “debias” loss aversion. It mentions other theories that share the notion that losses loom larger than gains, and discusses critiques of prospect theory. Finally, it points to the impact that loss aversion has had on several disciplines.

In this chapter, we argue that applying evolutionary psychology to economics can explain observed ‘anomalies’ in decision-making. We provide an analysis of the relationships between economics and the evolutionary and biological origin of economic choice, focusing on some selected topics that are of special interest to us. These are: (1) rationality and biases, especially as related to the endowment effect, (2) the extent to which individuals are selfish or pro-social, (3) individuality versus heterogeneity, and (4) perceptions of economics. We discuss examples of how evolutionary psychology can explain anomalous behaviour including violations to rational choice, such as the status quo bias. Evolved mechanisms can also explain the curious persistence of pro-social behaviour in one-shot anonymous interactions, and the observed heterogeneity of agent types. Finally, we argue that the perception of economics is also affected by evolved mechanisms from pre-modern times. We believe that more explicit attention to the evolutionary bases of economic behaviour would lead to real advances in economic theory.

This chapter addresses the psychological significance of ownership and possession and explores how people perceive them. It shows that an individual’s notion of possession is not necessarily physical but may extend to intangible entitlements and expectations. This state of affairs may support a broadening of the law’s understanding of possession. In addition, the chapter analyzes the relative strength of ownership and possession, which is highly relevant to conflicts between owners and possessors, including the doctrines of first possession and adverse possession. The chapter also employs psychological insights to justify seemingly paradoxical legal rules, according to which owners have more freedom to use their property intensively than to refrain from using it at all, more freedom to restrict the transfer of property totally than to subject it to conditions, and more freedom to destroy the property than to modify or change it.

This chapter analyzes monopoly and duopoly pricing when consumers display loss aversion. It assumes that consumers’ reference point is determined by their expectations. First, the model is applied to capture the idea that consumers are antagonized by unexpected price increases, and the implications of this idea for price rigidity and uniformity. Second, the model is applied to capture an “attachment effect” (a variant on the endowment effect) and the implications of this idea for the use of sales.

This chapter discusses one of the most fundamental issues that every legal system must address: the form of protection that should be given to legal entitlements, including property rights. The chapter summarizes the debate regarding the choice between property rules and liability rules, and its underlying assumptions. It then shows how behavioral studies offer important considerations that should influence the legal discussion. Generally speaking, psychological studies invite more optimism about people's ability to reach mutual agreement under property rules and suggest that miscalculations of damages under liability rules may be a graver danger than presently realized. These studies caution us against increasing the use of liability rules and lend additional support to the use of property rules when transaction costs are low.

This chapter discusses key aspects of takings law from a behavioral perspective and employs psychological insights to critically analyze existing legal rules and theories. The chapter highlights various factors that affect the perceived legitimacy of the taking and its adverse impact on property owners. In addition, the chapter addresses two central topics from a behavioral perspective: (1) When should compensation be paid? and (2) what constitutes just compensation? It shows that current compensation rules unjustifiably distinguish between different types of injuries to property, and that the risk of systematic undercompensation of property owners is more severe than commonly realized. These phenomena may have detrimental effects in terms of both efficiency and fairness.

Chapter 5 analyzes the contribution of loss aversion to our understanding of how legal norms affect human perceptions and behavior—that is, how loss aversion is sometimes the output of legal norms. One prime example of this is the powerful “default effect” of legal norms on human behavior in contexts such as posthumous organ donation. Similarly, the chapter argues that the burden of proof in civil litigation is much more than a tiebreaker for cases of evidentiary tie—it sets the baseline against which judges assess the evidence presented to them. Finally, the chapter discusses the use of temporary legislation as a means of overcoming objections to legal reforms—legislation that in turn changes people’s reference point and hence tends to become permanent.

This chapter explores what the reasons for deviating from modified universalism in practice may be. To do so, it draws on behavioural international law and economics. The chapter argues that certain decision-making biases may play a role in cross-border insolvency and can explain both negative inclinations and instances of lack of cooperation, as well as the relative success of modified universalism. The key argument here is that instead of yielding to territorial inclinations, cross-border insolvency law has a debiasing role to play. It should attempt to align choices with optimal solutions, overcoming biases, and should also close gaps in the cross-border insolvency system in line with modified universalism.

This chapter focuses on the exploitation of consumers’ loss aversion by suppliers. One example is the effect of different framings of price and other attributes on consumer decisions (for example, cash discounts versus surcharges for credit). The chapter also examines how the limited availability of goods influences purchase decisions. It argues that escalation of commitment is one explanation for consumers’ failure to read standard-form contracts, and for the effectiveness of “low ball” and “bait-and-switch” marketing techniques. It explains why liberal return policies are a double-edged sword, given customers’ endowment effect. Finally, it draws attention to how suppliers exploit consumers’ status quo and omission biases to the suppliers’ advantage.

People cannot be counted upon to make all of their decisions in a fully rational manner—and sometimes the law should take the possibility of such lapses into account. For instance, contracts that appear to be wildly unfair need not be enforced by a court, under the doctrine of “unconscionability.” The Coase Theorem itself, one of the mainstays of Law and Economics analysis, presents a less optimistic picture in the face of “endowment effects,” where mere ownership of an asset raises the owner’s valuation of the asset. (Ironically, excessive optimism is a common departure from full rationality.) We might need to rethink the proper location of the Parthenon Marbles, the best way to compensate kidney donors, and desirable paths to re-legalizing currently illegal drugs, when rationality shortfalls are rife. Happiness and efficiency are not equivalent, so there will be situations when efficient laws do not promote hedonic well-being.

One might object that the teleological account overemphasizes rationalizability and thereby ties agency too closely to rationality. This chapter clarifies and defends the teleological account by responding to this sort of worry. First, rationality should not be identified with being a coldly logical person who fights off emotions, feelings, and impulses. Sometimes the most reasonable thing to do is to follow one’s heart rather than one’s head. Second, the teleological view has ample room for agents who occasionally do stupid things. Third, even the sort of ‘systematic irrationality’ to which agents are said to be prone is not a problem for the view: for example, those who regularly buy lottery tickets or who are subject to the endowment effect as described by Kahneman and his colleagues are not as systematically irrational as sometimes portrayed.