Question

Suppose that Ike is loss averse. In the morning, Ike’s stockbroker calls to tell him that he has gained $1000 on his stock portfolio. In the evening, his accountant calls to tell him that he owes an extra $1000 in taxes. At the end of the day, does Ike feel emotionally neutral since the dollar value of the gain in his stock portfolio exactly offsets the amount of extra taxes he has to pay? Explain.

Answer 1

Step-by-step explanation:

Since Ike is loss averse, the loss will be felt by him than the gain. The principle of loss aversion is prominent in the domain of economics, and people with loss aversion always prefer to avoid losses than to acquire equivalent gain.

This means that the increase in taxes of $1,000 that Ike experienced, will make him to have a very high disutility than the $1,000 gain from his stock portfolio.

As a loss averse Ike is, the $1,000 loss as a result of the tax have impact in 2.5times more than the $1,000 gain if we're to be handled theoretically.