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

Typical situation in every home with babies and children. The kid is playing with his toys except one. We take the toy and start pouting. You feel that you are losing something, something that gives you great value for one simple reason: it is yours.

This phenomenon can be extrapolated to the world of adults and, especially, in the sale of products. It's called the endowment effect, and there's a lot of psychology and scientific research involved.. Let's find out below.

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What is the endowment effect?

The endowment effect is a psychological phenomenon that occurs when people attribute more value to things solely for the fact of owning them. In other words, it is about overvaluing what you already have and fearing, more or less rationally, losing it.

Despite the fact that things have an objective value, the subjective value that we can attribute to them is highly variable depending on whether we already have them or, if not, we want to acquire them. This is very easily understandable bearing in mind situations in which economic transactions take place.

The seller will give a higher value to the object that he wants to sell compared to the buyer, who will want to acquire it at a low price. For this reason, in places without fixed prices such as markets, it is so common to see haggling.

Based on this, it can be understood that the endowment effect, insofar as it is a bias, means that an objective analysis of the value of a certain good is not made. That is why in many economic situations it is necessary the intervention of some professional, such as an appraiser or manager, to give you the price that the product in question deserves sell and buy.

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Research on this effect

The endowment effect was originally described by the economist Richard Thaler who, along with the Nobel laureate in economics Daniel Kahnemann and his colleague Jack Knetsch saw how this particular effect unfolded, as well as approaching 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 fifties. Each bottle had been purchased at a price close to 5 dollars. Years later, the person who had sold these bottles showed up, preparing to offer the new owner of the wine the repurchase the bottles at a much higher price than the original: 100 dollars a bottle, that is, 20 times more than the value original. 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 vendor group, participants had to sell their mugs at prices between $1 and $9.25. In the group of buyers, they had to acquire the cups offering offers that did not exceed 9.25 dollars either. The third group had to choose between the cup and the amount of money offered as an offer.

Differences were seen in the value of the cup depending on the role that the participant would have had. On average, sellers sold their mugs at prices close to $7, while buyers wanted to buy them at prices no higher than $3. Those who had the option of purchasing the mug or an offer of money, accepted around 3 dollars.

In another experiment, instead of putting money in between, participants were given one of two things: either a cup or a bar of Swiss chocolate. After giving each participant one of those two random objects, they were told that they could keep the that they had been given to exchange it with other people in case they would have preferred to have the other object. Most of the participants, both those of the cup and those of the Swiss chocolate, they chose to keep what they had been given.

What causes this phenomenon?

It is possible that a certain sentimental bond has been generated to that object, 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 brother or a friend. We were afraid that it would be lost or broken, and we preferred to keep it by our side.

Another way of understanding 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 number of square meters, all these houses are same, but as a general rule we attribute a higher price to our own house than to the others.

This sentimental value can be generated very quickly, and it need not 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. Vendors were given a pen that they could sell for between $0.25 and $10, with the option to buy it as well. 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 romantic relationship of the past that did not go well and that they wrote about it with the pen that the researchers gave them they gave The other half were asked to write about something everyday, without much sentimental value.

Sellers who wrote about the love affair tended to price the pen higher, from which it can be concluded that it costs us more 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 on a day-to-day basis, since It is one of the psychological phenomena that most strongly affects all our daily decision-making..

Getting rid of something, even if it is done voluntarily, can be interpreted as a loss, and nobody wants to lose. The human being is an animal that wants to retain as long as possible any property that he has in his hands. It is for this reason that, although completely consciously, when deciding to eliminate something from our lives, we try to avoid it, giving it a higher value than it really has, sabotaging a sale or preventing it from being shared with others.

According to Thaler, the buyer sees acquiring a new object as something pleasurable, a need that, although not real, must be satisfied. However, the seller sees getting rid of the object as a loss, something that, despite being rewarded with money, is not willing to feel.

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What implications can 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, if that it is true that it can be used as a beneficial commercial tactic for those who, at first, seemed to be harmed by this phenomenon psychological.

In many stores they have been able to use this psychological effect. To make the clientele, once they have put their attention on a specific product, buy it, those in charge of the establishment usually let customers touch and handle the objects they are interested in. In this way, by having it in your hands, you may unconsciously be developing a certain emotional bond, which will make it harder for you to reject having to buy it.

However, one of the situations in which this phenomenon is most damaging is in finance and the stock market. Many people who are involved in this world of stock trading sometimes unwittingly hold on to certain possessions, behavior which causes them to make financial mistakes.

Investing in the stock market implies having to carry out a very conscientious decision making. If among these decisions is to be too cautious, avoiding selling when the market shows signs that it is the right time, you will start to take losses, which, ironically, is what you avoid having when the effect occurs. endowment.

Bibliographic references:

• Carmon, Z.; Ariley, D. (2000). "Focusing on the Forgone: How Value Can Appear So Different to Buyers and Sellers." Journal of ConsumerResearch. 27 (3): 360–370. doi: 10.1086/317590.
• Dommer, S. and Swaminathan, V. (2013). Explaining the Endowment Effect through Ownership: The Role of Identity, Gender, and Self-Threat. Journal of ConsumerResearch. 39. 1034-1050. 10.1086/666737.
• Kahneman, D.; Knetsch, J. L.; Thaler, Richard H. (1991). "Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias." TheJournal of Economic Perspectives. 5 (1): 193–206. doi: 10.1257/jep.5.1.193.