The Endowment Effect Quiz

Cognitive Bias: The Endowment Effect

• The endowment effect is a psychological phenomenon where people are more likely to retain an object they own than acquire that same object when they do not own it.
• The endowment theory is an application of prospect theory that suggests loss aversion associated with ownership explains observed exchange asymmetries.
• In a valuation paradigm, people's maximum willingness to pay (WTP) to acquire an object is typically lower than the least amount they are willing to accept (WTA) to give up that same object when they own it.
• In an exchange paradigm, people given a good are reluctant to trade it for another good of similar value.
• The mere ownership paradigm is a controversial third paradigm used to elicit the endowment effect, primarily used in experiments in psychology, marketing, and organizational behavior.
• The endowment effect can be equated to the behavioural model willingness to accept or pay (WTAP), a formula sometimes used to find out how much a consumer or person is willing to put up with or lose for different outcomes.
• The endowment effect has been observed in a wide range of different populations, including children, great apes, and new world monkeys.
• The endowment effect was first explicitly coined in 1980 by the economist Richard Thaler in reference to the under-weighting of opportunity costs as well as the inertia introduced into a consumer's choice processes when goods included in their endowment become more highly valued than goods that are not.
• The leading explanation for the endowment effect is loss aversion, which suggests that selling an endowment means the loss of the object, and as humans are more loss-averse, less utility is obtained from acquiring the same endowment.
• Connection-based, or "psychological ownership" theories propose that the attachment or association with the self-induced by owning a good is responsible for the endowment effect.
• Sellers may dictate a price based on the desires of multiple potential buyers, whereas buyers may consider their own taste. This can lead to differences between buying and selling prices because the market price is typically higher than one's idiosyncratic price estimate.
• Several cognitive accounts of the endowment effect suggest that it is induced by the way endowment status changes the search for, attention to, recollection of, and weighting of information regarding the transaction.
• Natural selection may favor individuals whose preferences embody an endowment effect given that it may improve one's bargaining position in bilateral trades.The Endowment Effect: Definition, Criticisms and Implications

Definition:

• The endowment effect is a cognitive bias where people value an object they own more than the same object if they do not own it.
• It was first identified by Thaler in 1980.

Criticisms:

• Hanemann and Shogren et al. have questioned the effect's existence.
• The experimental technique used by Kahneman, Knetsch, and Thaler to demonstrate the endowment effect created a situation of artificial scarcity.
• The use of hypothetical questions and experiments involving small amounts of money tells us little about actual behavior.

Implications:

• At both the individual and corporate level, the endowment effect can cause market inefficiencies and value irregularities between buyers and sellers.
• The presence of an endowment effect has significant implications for law and economics, particularly in regard to welfare economics.
• The endowment effect has been linked to both economic and psychological impacts of various scales.
• Businesses have expanded more rapidly through the effective integration of the endowment effect into marketing products and services.

Business Implications:

• By offering free trials to select services, businesses not only expand the number of users reached but also give consumers a sense of ownership.
• The free return policy makes consumers more likely to purchase the product due to the perception of it being more endowing.
• Various businesses offer a sense of ownership through showing customers what their product might look like in a relatable environment.