Saturday, May 16, 2015

Smoking and Loss Aversion

There are still more than 40 million Americans who smoke cigarettes.  If you asked them, just about every single one would tell you that he or she wants to quit.

In fact, as many as 50 million already have stopped smoking.  They have used nicotine gum, hypnosis, support groups or sheer, gritty willpower to do it.  And if you asked them, they would say that quitting was possibly the most difficult thing they ever did.

An interesting publication in the New England Journal of Medicine last week reported the results of a small study that offered smokers financial incentives to give up cigarettes. Surprisingly, of the two groups in the study, the more successful one was the one that was paid less money for quitting.

Loss Aversion and Modern Economics

For hundreds of years, economists assumed that human beings were rational economic actors who depended on logic, not emotions or impulses, to make decisions.  But in the last 50 years this notion has been turned on its head.

One example is smoking.  Why would any rational person smoke?  A report from the U.S. Surgeon General in 1964 made clear that smoking could cause heart disease, lung cancer, cancers of the mouth and throat, and emphysema.  It said that smoking could kill you. 

There followed 30 years of warnings on cigarette packages, public health hectoring and banning of cigarettes from many public places.  Even after all that, almost 25 percent of American adults were smokers in 1994. 

Economists realized that there exists the potential for irrationality in every human.  They began to study this, often with the help of psychologists.

One prominent economist, Daniel Kahneman, summarized much of what he and his colleagues had learned in his book, Thinking, Fast and Slow, published in 2011.

A key discovery that Kahneman repeated again and again was that people worry more about the chance of a small loss than they value the chance of a large gain.  After many experiments, this was his conclusion:

     "You can measure the extent of your aversion to losses by asking yourself
      a question:  What is the smallest gain that I need to balance an equal chance 
      to lose $100?  For many people, the answer is about $200, twice as much as
      the loss.  The 'loss aversion ratio' has been estimated in several experiments
      and is usually in the range of 1.5 to 2.5."

Money and Quitting Smoking

So here is what happened in the smoking/money incentive study.

A group of smokers was divided into two groups;

     -- Each member of one group was offered a reward of $800 after
         ceasing smoking for six months.

     -- Each member of the other group was required to deposit $150
         with the study organizers; if the smoker stopped smoking for 
         six months, he or she would receive the deposit money back
         plus another $650.

When the conditions were explained, 90 percent of those offered the potential $800 reward signed up.

Only 17.1 percent of smokers agreed to participate when faced with the $150 deposit/$650 reward alternative.

The variation in signups is significant.  The first group would lose no money if they were unable to quit smoking.  The second group would be out $150 if they did not quit.  

Obviously, the potential to lose money caused most of the second group to drop out of the experiment.  That's loss aversion at work.

But what is more significant is how results differed between the two groups.

     -- Only 17.1 percent of the no loss/$800 win group managed to stop smoking
         for the full six months. 

     -- Of the other group, 52.3 percent did quit smoking for six months. They got their
         $150 back, plus another $650.  And they'd quit smoking! 

Apparently having some skin in the game increased smokers' motivation.  As Kahneman said, people are motivated more by the fear of a smaller loss than the chance of an even larger gain.

Note:  Actually, anyone in the study could have made even more money by acting individually.  If the cost of a package of cigarettes is $5 (a low estimate in most states), a pack-a-day smoker who quit would save $900 by the end of six months.

More proof, if proof is needed, that smokers are like most humans and are not rational economic actors.

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