Due to the recent coronavirus pandemic, numerous countries are starting to suffer in the sudden loss of stock due to stockpiling. People are suddenly hoarding piles of products to be kept for future potential reserves, in fear that the prices of the products will rise or will run out. This behaviour is now commonly called “panic buying.” Panic buying has been around since epidemics such as the Spanish flu in 1918. It is one of the ways where humans try their best to cope with uncertainty. So why does this happen?
Amos Tversky and Daniel Kanheman, two psychologists who won a Nobel Prize in Economics for their work in thinking and decision-making, proposed a new theory called Prospect Theory in criticism of the Expected Utility Theory in 1979. During that time, the Expected Utility Theory helped people compute on the predicted utility theory and considered the risk preferences of their individuals: risk-averse, risk-neutral or risk-seeking.
Picture 1: Expected utility theory graphs - risk averse, risk neutral, and risk seeking.
The Prospect theory argues that losses and gains are valued differently. Losses are perceived as very damaging, whilst gains become less rewarding as time goes on.
As you can see in the graph here, when losses are received, the impact of the value in the beginning will be quite harmful, but then its value’s loss impact slows down as the losses increase. As an example, imagine you are paying for dinner. There are situations when you buy 10 dollars of dinner for yourself and want to get the bill, just to find out that the 10% value-added tax (VAT) is originally not included in the menu’s pricing.
If that’s the case, you may frown to think that you will need to pull out an extra $1 to fully pay the bill. However, if you need to treat your group of friends for dinner and prepared $300 for the occasion, an extra 30 dollars won’t seem as frustrating to pull out than the former. This shows how loss can be perceived more negatively when its loss is minimal.
Picture 2: the prospect theory graph
The same happens when people receive gains. Getting a $1 discount voucher from paying for $10 in a supermarket can feel more rewarding than receiving a $50 voucher from paying $500, despite the values being proportional (both are 10% discount). Even though both indeed do reward happiness, the $1 voucher from paying $10 seems to be valued better than hearing that you have to pay $500 to get a $50 voucher discount.
Since losses are generally frowned upon and gains looked forward to, the Prospect Theory also helps in explaining about certain human behaviours in certain situations - one of them includes the event of uncertainty. According to this theory, when uncertainty happens people tend to be loss averse.
“losses loom larger than gains” -Kahneman & Tversky (1979)
Loss aversion assumes that disadvantages or losses influence choices more than gains or bonuses. This means that, if there’s a situation that can potentially put an individual in a disadvantage, they will try to minimize the losses. A study conducted by Kanheman and Tversky asked participants to imagine a scenario where an unusual disease is going to kill 600 people. They were then proposed two programs to deal with this disease.
Program A: 200 people will be saved.
Program B: there is ⅓ chance of 600 people being saved, and ⅔ chance of no one will be saved.
In this, 72% participants picked program A because it was seen as more risk averse, since the program seemed to guarantee a more certain outcome. Program A ensures that 200 people will be saved, but program B might potentially kill everyone therefore people will avoid that potential and take the safer chance instead. Then, participants were given more program choices which were framed using different words:
Program C: 400 people will die.
Program D: there is a ⅓ chance of nobody dying, and ⅔ chance of nobody being saved.
Interestingly, when shown these options, 78% participants voted with program D. People thought that the risky choice is a better option, despite the fact that Program C and D is the same with program A and B - just reworded in different ways. Program C sounded more overwhelming than Program D as the negatives are brought up and mentioned.
From this, Daniel Kahneman and Amos Tversky found that people prefer to avoid loss instead of being risk averse - which leads back to their initial findings that proposes the fact that people tend to avoid one thing that seems more like a loss than another.
There were some considerations that had to be taken into account when implementing this study to real life situations, as we always have to acknowledge that psychology experiments have to be evaluated empirically. One of them being that the study was done in form of a questionnaire, thus may be an unreliable reflection of how people might behave in real situations as the experiment relies on some degree of imagination. Nevertheless, overall people’s behaviour was found to be consistent with what Kahneman and Tversky found.
How this theory relates back to panic buying
Panic buying happens in uncertainty. There is a lot of uncertainty in our current situation— and the only thing we can make sure to cling on to are the essentials: food, toilet papers, masks, medicine and many other potentially important necessities. Most of us are afraid of the worst to come, such as a situation where we won’t be able to buy food needed in the future when they are still available in the supermarkets right now and this is a way loss aversion takes form. To avoid that potential loss, many humans decided to do what everyone thought was the right thing to do: to stockpile food, hoard as many supplies necessary, and many more.
Thus, we learned that panic buying is one of the ways we cope with uncertainty, through loss aversion such as preventing possible loss situations such as having empty stocked supermarkets when needing to buy basic necessities.
side note: loss aversion isn’t the only factor in play. There are other factors such as the herd mentality, the sense of being in control when there’s uncertainty, and fear or panic itself. They all contribute to panic buying, but in this article I simply wanted to explore in depth regarding Prospect Theory and loss aversion, and how that applies in panic buying.
Citations
“Panic Buying Definition and Meaning: Collins English Dictionary.” Panic Buying Definition and Meaning | Collins English Dictionary, HarperCollins Publishers Ltd, www.collinsdictionary.com/dictionary/english/panic-buying.
Photograph by Mario Tama, Getty. Coronavirus Is Spreading Panic. Here’s the Science behind Why. 17 Mar. 2020, https://www.nationalgeographic.com/history/reference/modern-history/why-we-evolved-to-feel-panic-anxiety/.
Tognazzini, Bruce. “Prospect Theory and Loss Aversion: How Users Make Decisions.” Nielsen Norman Group, 19 June 2016, https://www.nngroup.com/articles/prospect-theory/.
Kahneman and Tversky’s Prospect Theory. https://www.sjsu.edu/faculty/watkins/prospect.htm. Accessed 30 Mar. 2020.
Tversky, Amos and Daniel Kahneman. (1991). "Loss Aversion in Riskless Choice: A Reference Dependent Model," QuarterlyJournal of Economics 107(4), 1039-1061.
Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica, 47, 263-291.
This article is quite informative, because it gives a better perspective at what we are seeing right now in the USA.