Do you know

**the difference between tax evasion and financial (tax) consulting?**The only difference is the point of view. … or at least what the joke says.
Many retailers that have both “brick
and mortar” and on-line stores offer

**a discount for purchases done on-line… however, if we change the point of view when purchasing from a “brick and mortar” shop we are surcharged.**The difference is again just the point of view.
Another example is the “classic”
label that says

**“90% fat free”**. If we change the point of view the same information can be communicated as**“10% fat”**.
The interesting thing is that

**exactly the same information framed in different ways is perceived very differently.**Holding on to the example of “90% fat free” vs. “10% fat” you have to admit that the first message is much more appealing than the second.
In order to better understand
these differences in perception we have to remember one basic learning of
prospect theory, namely that

**any outcome is perceived as a gain or as a loss in relation with a reference point.**At the same time, the reference point can be manipulated. But before explaining more on this, I would like to present you with a classic example for framing effects, namely**“The Asian disease problem”**.
“The Asian disease problem” goes
like this: a dangerous disease is expected to hit a city and scientific
estimates are that 600 people will die from this disease. The government can
adopt one of two programs to fight this epidemic.

To half of the participants in
the study the two programs were presented like this:

Program A: 200 people will be
saved for sure.

Program B: there is 1/3
probability that all 600 people will be saved and 2/3 probability that no-one
will be saved.

The results were that 72% of
people chose Program A and 28% chose Program B.

To the other half of participants
in the study the two programs were presented like this:

Program A: 400 people will die
for sure.

Program B: there is 1/3
probability no one will die and 2/3 probability that all 600 people will die.

The results were that 22% of
people chose Program A and 78% chose Program B.

If we look carefully, we see that

**in both scenarios programs A and B have the same objective expected value.**From the perspective of normative economics there should be indifference between choices or in other words a 50-50 preference. But this is not what is most interesting.
If we look at

**how the problem was presented to the two groups, we that the two “problems” are identical.**In the first problem if program A is adopted for sure 200 people will be saved which by logic implies that the remainder 400 die. In the second problem if program A is adopted for sure 400 people will die which by logic means that 200 people will be saved.
Similarly for program B, if we compare the two
problems we see that program B is in essence the same. In the first problem 1/3
probability that all 600 are saved is the same thing with 1/3 probability that
no one will die and 2/3 probability that no-one will be saved is exactly the
same thing as 2/3 probability that all 600 people will die.

**What explain the differences in the choices of participants in the study?**The answer is

**the way in which the information is framed.**In more detail,

**by manipulating the reference point the outcomes are presented as gains or losses.**We know that loss aversion is very powerful and makes people risk seeking rather than risk avoiding.

In the first problem by
describing program A as “saving” 200 people it is implied that the reference
point is all 600 not being saved (dyeing). Thus saving 200 people is perceived
as a gain. We already know that in the area of gains people are risk averse (we
prefer a sure (smaller) gain than a (larger) risky gain). This means that (most)
people will go for the sure thing, thus the 72% preference for program A.

In the second problem by
describing program A as “400 people will die for sure” it is implied that the
reference point is all 600 not dyeing (being saved). Thus “400 people dyeing”
is perceived as a loss. As we know when it comes to loses people are risk
seeking (see Loss aversion and its implications). This explains the 78% preference for program B.

Coming back to “90% fat free” being
more appealing than “10% fat” the key is the manipulation of the reference
point. In the first framing of “90% fat free” the implied (manipulated)
reference point is 100% fat. In the second framing of “10% fat” the implied
reference point is 0% fat.

Similarly for the X% discount for
buying on-line the reference point implied is the price in the “brick and
mortar” store. But if we take as a reference point the price in the on-line
store then the price in the “brick and mortar” store is Y% higher.

**The framing of outcomes**(as it is called in scientific terms)

**has numerous implications for decision design and behavior in general.**By manipulating the reference point the same outcome can be presented (framed) as a gain or a loss.

**We know that people would put in more effort to avoid a loss than they would to obtain a gain.**This has numerous implications.

**One example is traffic violation penalties.**Many countries have a penalty point system which in essence means that when a certain number of violations correlated with their severity are done the driver loses his or her license.

**In**my home country

**Romania penalty points are “given”.**This means that a clean driver starts with zero points and as he or she commits traffic violations (and is caught) there are points added. In our southern neighbor country Bulgaria things are a bit different. If you don’t know the difference between Romania and Bulgaria it is OK, just know that they are two distinct countries that share many similarities.

**In Bulgaria**, a clean driver starts with a number of points (let’s say 20) and as he or she commits traffic violations

**points are subtracted**.

Apparently there is no “real”
difference since the basic principle is the same, namely that traffic
violations are quantified in penalty points. However, this is not entirely true
since subtracting points is perceived as a loss, while adding points is perceived
as a gain. Since we know that people would put in more effort to avoid a loss
than they would to obtain a gain, I believe that the model applied in Bulgaria
is better.

**Another implication of framing effects based on loss aversion is that people are more willing to forgo a gain (discount) than they are willing to accept an equivalent loss.**Coming back to the “Brick and mortar” and on-line shops, by framing the smaller price in the on-line shop is a “discount” males people more willing to buy from a “brick and mortar” shop because this way they don’t suffer a loss, but forgo a discount. If the “reference” price would be the one in the on-line shop and “brick and mortar” shops would surcharge, then people would be less willing to shop in the later because the surcharge would be perceived as a loss.

**To sum up, the same information (on an outcome) can be framed as a gain or as a loss and this has significant implications for decisions and behavior. The “mechanism” behind the framings is the manipulation of the reference point against which the outcome is compared. The rationale behind difference in choices and behaviors due to framing effects is loss aversion.**

Note: This post is documented
from Tversky, A. and D. Kahneman (1981). “The framing of decisions and the
psychology of choice.” Science. 211, 453-458.

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