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AN INVESTIGATION OF RISK-TAKING, LOSS AVERSION AND STATUS QUO BIAS IN SINGAPOREAN YOUTHS ACROSS DIFFERENT INCOME LEVELS

LEE SI YUAN

M15606

Research Paper in part fulfilment for the NUS High Diploma (Major in Economics) presented to the Department of Humanities, NUS High School of Mathematics and Science 2014/2015

EC6111 Humanities Research Paper Economics An investigation of risk-taking, loss aversion and status quo bias in Singaporean youths across different income levels

ABSTRACT

Despite assumptions of rationality (gain-maximization) in classical economic theory, people often make less-than-ideal decisions, due to widespread prevalence of well-documented “irrationalities” like status-quo bias, loss- aversion and risk-taking. This causes significant deviations from expected market behaviour. Several parameters affect the incidence of these irrationalities, but the focus here is on income levels. This survey-based investigation targeted late-adolescents to young adults aged 17-21 with tertiary education, separated into different sections to investigate different irrationalities highlighted. The survey was disseminated physically and through Google forms. Collated data then underwent chi-square association tests, which showcased a clear association between Loss & Gain Attitude and income levels, where all options showcased low probabilities of gaining relatively large amounts (with overall small net gain). Scenarios entailing slight net loss overall (mirroring gambling and investment) also warrant further study, using larger sample sizes with more equal gender-ratios, before making conclusive remarks about their association with income levels.

LEE SI YUAN

M15606

EC6111 Humanities Research Paper Economics An investigation of risk-taking, loss aversion and status quo bias in Singaporean youths across different income levels

Introduction

Classical economy theory is based on the assumption of economic rationality amongst individuals, to maximize gain and minimize loss. Theoretically, this should mean that

individuals rarely engage in activities where net losses in the long run are presented, and have few qualms switching to better alternatives, assuming low transaction costs

or additional time needed. However, this is not the case, due to certain irrationalities

in our decisions made, which have psychological origins.

Three such phenomena will be defined. Loss aversion is when the potential losses

from a decision made looms larger than potential gain of the same value. Even larger potential gains can be outweighed by the prospects of a small loss. Often, it is the result of exaggeration of opportunity costs. This means that decisions made do not maximize one’ economic welfare. Loss aversion is often confounded with risk-taking,

of

which it appears to share an inverse relation with. Risk-taking is informally known

as

the willingness to make losses, in presence of a greater potential gain. Last but not

least, status quo bias is the unwillingness to move on to more beneficial alternatives,

where little additional time or effort is needed. This need not be economical in nature, however the phenomenon is also used to analyse why some political parties remain

in power legitimately for prolonged durations, despite rising discontent with the

government (as seen in Japan, where the Liberal Democratic Party continues to dominate despite many unpopular decisions made).

Whilst studies have been studied on forms of economic irrationality, much of it focuses

on loss aversion and risk-taking, not so much for status-quo bias. In addition, age and

ethnic group appears to be the main parameters studied. Focusing on income level as

a parameter could benefit government policymakers and marketing agents in

investigating “sticky prices” for certain goods baskets, and identify investment or lottery schemes which are most attractive to different income groups. In scenarios where significant loss of welfare was identified, it will then be easier to pinpoint specific forms

of risk-partaking activities to regulate.

Identifying sources of welfare loss is especially important in the lower-income groups. Since they already earn comparatively little, saving even small amounts of money that were not well-spent (due to the above forms of irrationality) could go quite a long way in increasing their living standards.

Evaluative Conclusion

In scenarios presenting net gain (in low possibilities but large amounts) without

possibility of loss, there exists a clear association between Loss & Gain attitude and

Income Group. Income Group D with the highest income overwhelmingly chose the option with lowest possibility of winning the largest amount. Income Group A with the lowest income chose the “moderate” option, which increasingly shifted to the option with highest (though still low) possibility of winning the smallest amount as income level increased, up to upper-middle income in Group C. This can find application in

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EC6111 Humanities Research Paper Economics An investigation of risk-taking, loss aversion and status quo bias in Singaporean youths across different income levels

improving promotional offers by companies in non-price competition products/services targeted at high-income consumers would find “lottery” offers more attractive, in contrast to middle-income groups who may prefer spinning a wheel for prizes. It is worth noting here that there exists no clear association between prize selected (and its equivalence in money) with income group, which is tested later on in the “reality-based” status-quo bias test. However, a significant proportion picked the good (pencils), believing it to have greater value than its equivalence in money despite being otherwise specified. This irrationality was somewhat alarming.

The possible associations between Risk-Taking Attitude and Income Group should be further studied with larger sample sizes and more equal gender ratios, before clear conclusions can be made. For the scenario entailing high chance of small loss but small chance of large gain (small net loss overall) mirroring a typical lottery, higher income groups seemed more prone to make losses though this is typically not of major concern, in view of their better financial position to make occasional small losses without compromising material living standards (compared to if this happened in lower- income groups). The importance in determination of above-mentioned associations can be attributed to the widespread nature of investment and gambling schemes in reality, which may cause welfare loss as a whole if not carefully monitored.

Uppermost Income Group D showcased the lowest incidence of status-quo bias in both economic and non-economic scenarios. This potentially identifies them to have the highest price-elasticity of demand for products/services, indicating that it may not be worthwhile in developing forms of non-price competition like brand loyalty to cater to this income group. They may also constitute a significant proportion of “swing- voters”, assuming they have little vested interest in any particular group.

Inconsistency of results for non-economic and economic status-quo bias in the other Income Groups prompted the need for an additional of status-quo bias tests using items of actual economic value in reality. Results show that lower and lower-middle income groups A and B exhibit lower status-quo bias when goods are low-cost, but all 3 groups have equally low status-quo bias when the value of the good was significantly increased.

This may hint at lower price elasticity of consumption for Income Group C with regards to products/services at low cost, owing to their disregard to differences to small differences in welfare compared to lower income groups. Where applicable, this can be exploited in non-price competition, for instance through brand loyalty programs. This may also hint at greater price elasticity of products/services for lower income groups, indicating that companies targeting them should engage more extensively in price competition to increase revenue.

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