Loss Aversion: Why Do We Hang on to Things for No Reason?
Why do we hang on to things for no reason?
Posted Aug 31, 2011
It's common knowledge that people are afraid of losing things: They don't want to let go of old sweaters even if they are never worn anymore; they don't want to get out of relationships even when they are no longer happy; they don't even sell their losing stocks on the market. Maybe it is a part of being a social animal that we form attachments to our environment, but the extent and the speed of attachment is unbelievably fast.
One of the first experiments in the "endowment effect" (later also dubbed as the "status-quo bias) was run in the early 80s. Two groups of participants were asked to come to the laboratory. They were asked to sit in two separate rooms. Participants in the first group were endowed with a mug. In other words, the experimenter gave each person a mug, and told them that they now owned the mug. Participants in the second room, however, were just shown the mug. The experimenter in the second room stood in front of the room with the mug in his hands, not giving it to the subjects. Participants, however, were asked to inspect the item. The mug, by the way, had the college's insignia on it.
Participants in both rooms were given decision sheets and were asked to report the value at which they would sell or buy the mug. An endowed subject, with the mug in his hands, would report a "selling" price: I would ask $5 to sell the mug (willingness to accept). The second group would report "buying" prices: I would pay $5 for the mug (i.e. willingness to buy).
Endowment effect is the difference between willingness to accept and willingness to buy. In the initial study, the mean price sellers asked for was $5.78, and the mean price buyers were willing to pay was $2.21.
Why is there a difference, if the mug is an object that can be acquired in the open market? If people who own things are having a difficult time to let go of their possessions, how will we have trade in the economy? Exchange of goods and services would be hard to attain if there is such a discrepancy between willingness to pay and accept.
One of the initial reactions to the endowment effect study I just described came from those who proposed that it must have been the use of a college mug that induced the difference in prices. Experimental subjects who were endowed with the mug, the researchers said, must have formed an attachment to the object beyond what we can simply measure by the market price, since the mug had "sentimental value."
To alleviate the sentimentality issue, researchers ran the same study, this time with pens. Just standard issue pens anyone can purchase at the store. They even put the price stickers on the pens (it said $3.98) so that the two groups of subjects wouldn't have any informational asymmetry as to what the market price would be.
And the endowment effect stayed. The difference got smaller in some treatments, but it was still there. Those who were given pens to begin with, didn't want to part with their pens (in exchange for dollars, of course); and those who didn't start with pens didn't want to pay as much for them.
Further studies varied the experimental design, by eliminating the income effect (in case endowing subjects with mugs increased their wealth in the society and that was the reason why they were okay to keep the goods); by alleviating sentimentality (some tests used simple tokens instead of mugs); by eliminating incomplete information on value (via price stickers); by repeating the game (to see whether there was learning about the market price of goods); and so on and on.
After about a decade of testing, if not more, economists decided that the phenomenon called the endowment effect is indeed robust. And what is the psychology behind it? All the studies point to one explanation: Pain of losing.
Maybe this is the reason why, when we go to a store, sellers want us to hold the product, or they suggest that we just try it on. Maybe this is why there are all those free return deals, because they know that once we feel like we own the product, the attachment will form instantly, and the price we'll need to let go of the product will be slightly higher than the market price. So we'll end up keeping it.
Loss aversion is not rational from an economic point of view; but the "pain of losing" might have negative dollars associated with it. If, when we have to give up a mug, what we're losing is not just the mug but something more, than it makes sense that people would demand higher prices for what they own.
I wonder how the researchers will quantify or measure this "pain of losing". What I also wonder is whether this pain of losing is an artifact of the consumer culture that we've grown up in, and whether societies that don't subsist on "having as many goods and services possible" will exhibit similar characteristics.