Endowment Effect: What It Is And How It Affects Decision Making
Typical situation in every home with babies and children. The boy is playing with his toys except one. We take the toy and he starts pouting. He feels like he is losing something, something that gives him great value for one simple reason: it is his.
This phenomenon can be extrapolated to the world of adults and, especially, in the sale and purchase of products. It’s called the endowment effect, and there’s a lot of psychology and scientific research involved. Let’s discover it below.
The endowment effect is a psychological phenomenon that occurs when people attribute more value to things solely for the fact of possessing them. That is, it is about overvaluing what you already have and fearing, in a more or less rational way, losing it.
Although things have an objective value, the subjective value that we can attribute to them is very variable depending on whether we already possess it or, if not, we want to acquire it. This is very easily understandable keeping in mind situations in which economic transactions are carried out. The seller will give a higher value to the object he wants to sell compared to the buyer, who will want to purchase it at a low price. For this reason, in places without fixed prices such as street markets, haggling is so common.
Based on this, it can be understood that the endowment effect, since it is a bias, means that an objective analysis of the value of a certain good is not carried out. This is why in many economic situations the intervention of a professional, such as an appraiser or manager, is necessary to give the price that the product being sold and bought deserves.
Research on this effect
The endowment effect was originally described by economist Richard Thaler who, along with Nobel Prize-winning economist Daniel Kahneman and his colleague Jack Knetsch They saw how this particular effect developed, in addition to addressing it experimentally. The first thing that made them think about it was the particular case described below.
One person had bought a case of wine in the 1950s. He had purchased each bottle at a price close to $5. Years later, the person who had sold these bottles showed up, preparing to offer the new owner of the wine to buy back the bottles at a price much higher than the original: 100 dollars per bottle, that is, 20 times more than the original value. Despite the succulent offer, which meant earning $95 more for each bottle, the new owner of the bottles refused to resell them.
Faced with this curious case, Thaler’s group set out to experimentally address this effect, this time under laboratory conditions and with cheaper objects: cups and chocolate bars.
In one of the first experiments, the participants, who were students, were divided into three groups. A group of buyers, a group of sellers and a group that had the option to buy or receive money for a certain product.
In the sellers’ group, participants had to sell their mugs for prices between $1 and $9.25. In the group of buyers, they had to purchase the cups offering offers that did not exceed $9.25. The third group had to choose between the cup and the amount of money that was offered to them as an offer.
Differences were seen in the value of the cup depending on the role that the participant had had. On average, sellers sold their mugs at prices close to $7, while buyers wanted to purchase them at prices no higher than $3. Those who had the option of purchasing the cup or a money offer accepted around $3.
In another experiment, instead of putting money in the middle, participants were given one of two things: either a cup or a bar of Swiss chocolate. After giving each participant one of those two objects at random, they were told that they could keep what they had been given and exchange it with other people in case they would have preferred to have the other object. Most of the participants, both those with the cup and those with Swiss chocolate, They chose to stay with what they had been given.
What causes this phenomenon?
It is possible that a certain sentimental attachment to that object has been generated, which makes it difficult to get rid of it, since it is seen as losing a part of oneself. This is very easy to see when we shared a toy in childhood with a sibling or a friend. We were afraid that he would get lost or break it, and we preferred to keep him next to us.
Another way to understand it, from a more adult perspective, is the assessment we make of the value of our house compared to that of others. It is possible that, in terms of quality and quantity of square meters, all these houses are the same, but as a general rule we attribute a higher price to our own house than to others.
This sentimental value can be generated very quickly, and it does not have to be very deep for the endowment effect to occur. In fact, this is demonstrated by research carried out by the Georgia Institute of Technology and the University of Pittsburgh, by Sara Loughran Sommer and Vanitha Swaminathan.
In this experiment the subjects acted as sellers and buyers. The sellers were given a pen that they could sell for values between $0.25 and $10, and they also had the option to buy it. Buyers could buy the pen for a price in that range or keep the money.
Before the study, half of the participants were asked to think about a past romantic relationship that didn’t go well and to write about it with the pen the researchers gave them. The other half were asked to write about something everyday, without much sentimental value.
Sellers who wrote about the romantic relationship tended to put a higher price on the pen from which we can conclude that it is more difficult for us to get rid of an object once a link associated with that object is created.
What does it have to do with loss aversion bias?
Part of not wanting to get rid of something has to do with another cognitive bias, in this case loss aversion. This bias is of great importance in everyday life, given that It is one of the psychological phenomena that most strongly affects all of our daily decision making.
Getting rid of something, even if done voluntarily, can be interpreted as a loss, and no one wants to lose. The human being is an animal that wants to retain all property in its hands for as long as possible. It is for this reason that, although completely consciously, when it comes to deciding to eliminate something from our lives, we try to avoid it, giving it a greater value than it really has, sabotaging a sale or preventing us from sharing it with others.
According to Thaler, the buyer sees acquiring a new object as something pleasurable, a need that, although not real, must be satisfied. Instead, The seller sees getting rid of the object as a loss, something that, despite being compensated with money, he is not willing to feel.
What implications could this have in the commercial world?
Although we have explained the endowment effect in terms of buyers and sellers, the latter being less likely to give a low value to their product, it is true that it can be used as a beneficial commercial tactic for those who, at first, seem to They were harmed by this psychological phenomenon.
In many stores they have known how to use this psychological effect. To make customers, once they have paid attention to a specific product, buy it, Those in charge of the establishment usually let customers touch and handle the objects in which they are interested. In this way, by having it in your hands, you may unconsciously be developing a certain emotional bond, which will make it more difficult for you to reject having to buy it.
However, one of the situations in which this phenomenon harms the most is in finance and the stock market. Many people who are involved in this world of stock trading sometimes, without realizing it, cling to certain possessions, behavior which causes them to make financial mistakes.
Investing in the stock market involves having to make very careful decisions. If among these decisions is to be too cautious, avoiding selling when the market gives signals that the time is appropriate, you will begin to have losses which, ironically, is what you avoid having when the endowment effect occurs.
