Classical economics long assumed that people weigh costs and benefits consistently. Research from the 1970s onward, by Kahneman, Tversky, the economist Richard Thaler and others, showed systematic departures from that ideal, founding the field of behavioral economics.

Loss aversion

In their 1979 paper on prospect theory, Kahneman and Tversky argued that people judge outcomes as gains or losses from a reference point, usually where they are now, and that losses feel larger than gains of the same size. This is loss aversion. Many people turn down a coin toss that wins $150 or loses $100, even though on average it pays. Estimates often suggest that losses weigh roughly twice as much as equal gains, though the figure varies a great deal by person and situation. A related finding, the endowment effect, is that people value an item more once they own it.

Framing

Framing means that the same information described in different words can change choices. In a 1981 study, Tversky and Kahneman asked people to imagine an outbreak of an unusual disease expected to kill 600 people. Offered a program that would save 200 people for sure, or a gamble with a one-third chance of saving all 600 and a two-thirds chance of saving no one, most chose the sure thing. Other participants saw the same options described in terms of deaths: 400 people will die for sure, or a one-third chance that nobody dies and a two-thirds chance that all 600 die. Now most chose the gamble. Only the description had changed, from lives saved to lives lost.

Sunk costs

The sunk cost fallacy is continuing something because of what has already been spent on it, rather than because of what lies ahead. People sit through a bad movie because they paid for the ticket; governments keep funding failing projects because so much has been invested. In a 1985 study by Hal Arkes and Catherine Blumer, many participants chose a more expensive ski trip they expected to enjoy less over a cheaper one they expected to enjoy more, when both were paid for and fell on the same weekend. The rational rule is that past costs cannot be recovered whichever option you choose, so only future costs and benefits should count.

Status quo bias

Status quo bias is a preference for keeping things as they are. One striking result is the power of defaults: many people stick with whatever option is preset. When employers began enrolling workers in retirement savings plans automatically, letting them opt out rather than requiring them to opt in, participation rose sharply.

Overconfidence

People tend to be more confident than accurate. Asked to give a range they are 90 percent sure contains a true value, such as the length of a river, people find that their ranges contain the truth far less often than 90 percent of the time. In a 1981 study, most American students rated themselves as more skillful than the median driver, which cannot be true of most people.

The planning fallacy

The planning fallacy, named by Kahneman and Tversky in 1979, is the tendency to underestimate the time, cost and risk of our own projects, even when we know that similar projects ran over. The Sydney Opera House is a famous case: planned for completion in 1963 at an estimated cost of 7 million Australian dollars, it opened in 1973 at a cost of about 102 million. We plan from the best-case story of our own project and neglect the record of others.

Worked example: should the club keep fixing the van?

A community sports club owns an old van. Over the past year it has spent $3,000 on repairs. Now the mechanic says it needs another $2,000 and should then last about one more year. A reliable used van would cost $6,000 and should last about five years. The board meets to decide.

Sunk cost. One member says, “We've already put $3,000 into this van; we can't throw that away.” But the $3,000 is gone whichever option the club picks. The real choice is between future costs: $2,000 for about one year, or $6,000 for about five.

The arithmetic. Repairing costs about $2,000 per year of use. Replacing costs $6,000 divided by 5, or $1,200 per year. On these figures, replacing is cheaper per year.

The planning fallacy. The board checks the record. Last year the mechanic estimated $2,000 for repairs, and the final bill was $3,000, which is 50 percent more. If this repair runs over by the same proportion, it will cost $3,000, not $2,000. Taking the outside view makes the repair option look even worse.

Framing and loss aversion. “Spending $6,000” sounds painful, a loss. The same choice framed as “saving about $800 a year compared with repairs” sounds like a gain. Stating it both ways shows whether wording is driving the decision.

Status quo bias. Keeping the old van feels like the safe default simply because it is what the club has. A fair comparison asks: if we had no van today, which would we choose?

The used van could have problems too, but the board now argues about the right things.