That is, people don't choose what is actually more beneficial to them, but rather what they believe in their hearts is more beneficial to them. This mental belief is the scale, and this scale is a bit inaccurate when calculating gains and losses.
Suppose you are the lucky person selected. I have two mystery boxes: one has a 100% chance of winning a prize of 100, while the other has a 51% chance of winning 200 and a 49% chance of winning nothing. Which one would you choose? Most people would choose the first one because they can easily get 100 for free. Faced with a certain gain, people are unwilling to take risks. This is called the certainty effect.
But if you were the one giving away the mystery box, one option would cause you to lose 100, while the other would give you a 51% chance of losing 200 but a 49% chance of losing nothing—and you have to give one away. Which one would you give me? Most people would choose the second one because when faced with a certain loss, people choose to take a gamble. This is called the reflection effect.
You just lost 100 while shopping. Although I later gave you a mystery box worth 100, you would still be troubled by the 100 you lost. This is called loss aversion. Later, you think about it and decide to use that 100 to buy a few lottery tickets for fun, thinking you might even win a big prize or something. Even though you know you are extremely unlikely to win, many people, just like you, are still very keen on buying lottery tickets. This is called fascination with small probabilities.
Back at work, you receive a notice that the company will give everyone a raise, and you feel happy. Your monthly salary was 8,000, while his was 7,000—not bad. After the raise, yours is 9,000 and his is 10,000. Although you are earning more than before, you are still unhappy because you earn 1,000 less than he does. This is called reference dependence.
These are all effects influenced by prospect theory. Although they are different reactions under different conditions, they all stem from the inaccurate scale in your mind.
Fear of loss, fear of risk, and desire for profit are the three weights on this scale, but their actual weights are not the same,
The certainty effect means that when faced with a certain gain, we fear uncertain risk more. In other words, fear of risk outweighs the desire for profit.
The reflection effect means that when faced with a certain loss, we are more willing to take a chance and make a gamble. In other words, fear of loss outweighs fear of risk.
Loss aversion means that compared with gaining an advantage, we dislike suffering a disadvantage more. In other words, fear of loss outweighs the desire for profit.
If that is the case, then the fascination with small probabilities would not make sense. If people are afraid of losses, why do so many still spend money buying lottery tickets? Wouldn’t simply not buying one avoid the loss? The reason is that people put small amounts of money spent on things like lottery tickets into their mental account for daily expenses. They assume that if they do not spend that money here, they will spend it somewhere else. It is a fixed loss, so when faced with a certain loss, we are more willing to take a chance and buy a lottery ticket. This is still because fear of loss outweighs fear of risk. The fascination with small probabilities is more like a special case of the reflection effect.
Then why are we unhappy when our salary does not increase more than our colleague’s? I am indeed 1,000 richer than I was before, but being surpassed by a colleague is another kind of disadvantage. The benefit of my salary increasing by 1,000 is not as great as the harm of my colleague earning 1,000 more than I do. This is still because fear of loss outweighs the desire for profit. Therefore, reference dependence can be regarded as a derivative of loss aversion.
When there are gains to be had, everyone is a miser. When faced with losses, everyone becomes a risk-taker. People are always driven by the instincts to pursue benefits and avoid harm. The value of avoiding harm is always greater than that of pursuing benefits, because pursuing benefits helps you live better, while avoiding harm determines whether you survive at all. Only by surviving first do you get a chance.