Endowment effect: what it is and how it affects decision-making

Typical situation in each household with babies and children. The boy plays with his toys except with one. We take the toy and start making jars. Feeling that you are missing something, something that gives you great value for one simple reason: it is yours.

This phenomenon can be extrapolated to the adult world and, above all, to the buying and selling of products. This is called the endowment effect, and there is a lot of psychology and scientific research in between.. Let’s find out below.

    What is the endowment effect?

    The endowment effect is a psychological phenomenon that occurs when people value things more simply because they own. In other words, it is a matter of overestimating what one already has and of fearing, more or less rationally, of losing it.

    Although things have an objective value, the subjective value that we can attribute to it varies greatly depending on whether we already have it or, if not, we want to acquire it. This is very easily understood keeping in mind the situations in which economic transactions are carried out. The seller will give more value to the item he wants to sell compared to the buyer, Who will want to buy cheap. This is why in places without fixed prices like markets, it is so common to see haggling.

    On this basis, it is understood that the endowment effect, insofar as it is a bias, prevents an objective analysis of the value of a given asset. This is why, in many economic situations, the intervention of a professional, such as an appraiser or a manager, is necessary to give him the price he deserves for the product he is trying to sell and sell. ‘buy.

      Research on this effect

      The endowment effect was originally described by economist Richard Thaler who, along with Nobel laureate in economics Daniel Kahneman and his colleague Jack Knetsch they saw how this particular effect developed, in addition to addressing it experimentally. The first thing that got them to think about it was the special case described below.

      One person had bought a box of wine in the 1950s. Each bottle had been purchased at a price close to $ 5. Years later, it was introduced who had sold these bottles, preparing to offer the future new owner to repurchase the bottles at a much higher price than the original: $ 100 a bottle, which is 20 times more than the value. original. Despite the succulent offer, which involved earning an additional $ 95 for each bottle, the new owner of the bottles refused to resell them..

      Faced with this curious case, Thaler’s group set out to tackle this effect experimentally, this time under laboratory conditions and with less expensive objects: chocolate cups and 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 ability to buy or receive money for a particular product.

      In the vendor group, participants were asked to sell their mugs for prices between $ 1 and $ 9.25. In the buying group, they had to buy the cups with offers that were also no more than $ 9.25. The third group had to choose between the cup and the amount of money offered to them as an offer.

      There were differences in the value of the cup depending on the role the participant would have played. On average, sellers were selling their mugs for prices close to $ 7, while buyers wanted to buy them for prices no higher than $ 3. Those who had the option of buying the mug, or an offer of money, accepted about $ 3.

      In another experiment, instead of putting money in the middle, participants were given one of two things: a cup or swab of Swiss chocolate. After giving each participant one of these two random items, they were told that they could keep whatever they were given to trade with other people in case they preferred to have the other item. Most of the participants, both the cup and the Swiss chocolate, they chose to keep what we had given them.

      What causes this phenomenon?

      It is possible that a certain sentimental bond has been generated in this object, which makes it difficult to detach from it, since it is perceived as losing a part of itself. It’s very easy to see when we shared a toy in our childhood with a sibling or a friend. We were afraid that it would get lost or break and we preferred to keep it by our side.

      Another way to understand it, from a more adult point of view, is our assessment of the value of our home relative to that of others. It is possible that in terms of the quality and quantity of square meters, all of these houses are the same, but as a rule, our own house is priced higher than others.

      This sentimental value can be generated very quickly, And it doesn’t have to be very deep for the endowment effect to occur. In fact, research from the Georgia Institute of Technology and the University of Pittsburgh, Sara Loughran Sommer and Vanitha Swaminathan, shows it.

      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, with the option to purchase it as well. Buyers could buy the pen at a price within that range or keep their money.

      Before the study, half of the participants were asked to think about a love affair from the past that didn’t go well and 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 love story tended to put a higher price on the penFrom which we can conclude that it is more difficult for us to get rid of an object once a link associated with this object is created.

      What does this 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 that of loss aversion. This bias is of great importance in everyday life, because it is one of the psychological phenomena that most strongly affects all of our daily decision-making.

      Getting rid of something, even if it is done on purpose, can be interpreted as a loss and no one wants to lose. The human being is an animal who wants to keep all property in his hands as long as possible. It is for this reason that, although fully aware, when we have to decide to take something out of our life, we try to avoid it, by giving it more value than it really has, by sabotaging a sale or preventing it from being shared with others. .

      According to Thaler, the buyer sees the acquisition of a new object as something pleasant, a need which, although not real, must be satisfied. however, the seller sees the detachment of the object as a loss, something which, although repaid with money, is unwilling to feel.

        What implications can this have in the business world?

        While we have explained the endowment effect in terms of buyers and sellers, the latter being less likely to give their product a low value, it is true that it can be used as a beneficial business tactic for those who , in principle, seem to have been injured by this psychological phenomenon.

        Many stores have been able to use this psychological effect. To get customers, once they’ve focused on a particular product, to buy it, facility managers usually let customers touch and staple items of interest to them. In this way, by holding it in your hands, you can subconsciously create a certain emotional connection, which will make you more hard to refuse to buy it.

        However, in one of the situations where this phenomenon is most damaging is finance and the stock market. Many people who get stuck in this world of buying and selling stocks at times, without realizing it, hold on to certain assets, behavior that leads them to make financial mistakes.

        Investing in the stock market involves having to make very conscientious decisions. If among these decisions you have to be too careful, avoid selling when the market signals that it is the right time, you will start to have losses which, ironically, are what you avoid having when the endowment effect is given. .

        Bibliographical references:

        • Carmon, Z .; Ariely, D. (2000). “Focus on the lost: where value can seem so different to buyers and sellers.” Journal of Consumer Research. 27 (3): 360-370. doi: 10.1086 / 317590.
        • Dommer, S. and Swaminathan, V. (2013). Explanation of the property endowment effect: the role of identity, gender and self-threat. Journal of Consumer Research. 39. 1034-1050. 10.1086 / 666737.
        • Kahneman, D .; Knetsch, JL; Thaler, Richard H. (1991). “Anomalies: endowment effect, loss aversion and status quo bias.” The Journal of Economic Perspectives. 5 (1): 193-206. doi: 10.1257 / jep.5.1.193.

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