To explain loss aversion, behavioral economists rely on a model, developed in 1979, called prospect theory. Kahneman & Tversky's (1979) prospect theory identified loss aversion as way to explain how people assess decisions under uncertainty. An economist would describe loss aversion as the case when an individual's utility is concave over gains and convex over losses. In layman's terms, it means that a gain contributes less to utility/happiness than an equal dollar loss subtracts from utility/happiness.
Let's consider an example. Suppose you are called into your supervisor's office and he tells you that you are going to get a raise of $500 per month. How happy would you be on a scale of 1 to 10? Would you rate your happiness a 5? 6? 7? Now consider instead that your supervisor calls you into his office and tells you that you are going to get a pay cut of $500 per month. How upset would you be on a scale of 1 to 10? Would you rate your anger more than a 10? For most people, the negative feelings that come from the pay cut would be much stronger than the positive feelings that come from the pay raise. Graphically, figures 1 and 2 compare sample utility functions of a loss-averse individual and a non-loss-averse individual. These figures demonstrate that for loss-averse individuals, the pain of the pay cut is more intense than the joy of the pay raise.