Last week we discussed the anchoring bias (i.e., when we are faced with making a decision, we tend to become stuck on the first price we see). Today I want to discuss the endowment effect. First, try this one at home: give your friend a quarter and see how much it costs you to buy it back.
The endowment effect is our inclination to value what we already have more highly than it is worth. For example, if people are given (endowed with) a dime, in order to sell the dime, people want more than 10 cents. Give someone a coffee mug with a price tag of $5.00 on it and they are not likely to part with it for a mere $5.00.
The endowment effect is one of the most robust findings in behavioral economics; however many researchers believe it is a special case of loss aversion (i.e., we’ll take risks to prevent a loss, but not to realize a gain). So, isn’t the endowment effect the same thing as loss aversion? A series of clever experiments demonstrated that there is a difference.
Researchers set up a trading market in which participants were buyers and sellers of coffee mugs. Crucially, some of the buyers and sellers were not selling the mug they owned, but mugs just like the ones they owned. As it turned out, when people owned a mug identical to what they were trading they demanded higher prices as sellers and were willing to pay more as buyers. That is, just owning a mug made the rest of the mugs they were trading more valuable (even though people were not trading their own mug).
Because the participants were buying and selling mugs that were not their own, and they were not losing anything in the trades, loss aversion was not driving the price up. Hence, the endowment effect is not the same as loss aversion.
What can we learn from this? When considering whether it is worth hanging on to that stock, or whether you should accept an offer for your used car, try to step back and consider the transaction more objectively. Ask yourself how you would establish the value of that item if you encountered it for the first time.
At BeyondThePurchase.Org, we are researching the connection between people’s spending habits, happiness, and values. To find out more about how your personality and values influence how you relate to money and spending, we encourage you to first Login or Register with Beyond The Purchase and then take our Sucker Rumination Scale and the Tightwad/Spendthrift Scale. We think you may learn a lot about how you and why you spend your money the way you do.