The endowment effect

First diagnosed by Richard Thaler and Daniel Kahneman, the endowment effect is a hypothesis that people value a good more once their property right to it has been established. From Dan Ariely’s Predictably Irrational:

Duke University has a very small basketball stadium and the number of available tickets is much smaller than the number of people who want them, so the university has developed a complicated selection process for these tickets that is now a tradition. Roughly one week before a game, fans begin pitching tents in the grass in front of the stadium. At random intervals a university official sounds an air-horn which requires that the fans check in with the basketball authority. Anyone who doesn’t check in within five minutes is cut from the waiting list. At certain more important games, even those who remain on the list until the bitter end aren’t guaranteed a ticket, only an entry in a raffle in which they may or may not receive a ticket. After a final four game, Carmon and Ariely called all the students on the list who had been in the raffle. Posing as ticket scalpers, they probed those who had not won a ticket for the highest amount they would pay to buy one and received an average answer of $170. When they probed the students who had won a ticket for the lowest amount they would sell, they received an average of about $2,400. This showed that students who had won the tickets placed a value on the same tickets roughly fourteen times as high as those who had not won the tickets.

The endowment effect illustrates the concept of loss aversion, i.e. the observation that losing something hurts a disproportionate amount (as compared to the pleasure gained from receiving an item of the same value). Suppose I ask you whether you want to make a bet. Heads you win $X, tails you lose $100. How much does X have to be for you to take the bet? For most people, the answer to this question lies somewhere around $200. In other words, the prospect of winning $200 is just enough to offset the prospect of losing $100.

The endowment effect is a good explanation of why I’m addicted to buying books – somehow, reading a book from the library doesn’t quite provide the same satisfaction as reading a book I own. The endowment effect might be similarly leading you to make some irrational decisions in life – here’s Jonah Lehrer’s post:

… What does this have to do with fitting rooms and jeans? Once I tried on the pants, I became an implicit owner of them. I stared at myself in the mirror and admired the fit, the wash, etc. I thought about how good they would look with my shoes. I contemplated wearing them to various upcoming events and all the strangers who would look at my pants and think “Those are nice pants!” In other words, I spent a few minutes imagining my life with these new jeans and, once that happened, the pants suddenly became much more valuable. I mentally endowed myself with the object and didn’t want to lose something that I didn’t even own. As a result, the ridiculous price tag ($170 for Levis!) no longer seemed so ridiculous. The lesson? Don’t try something on that you don’t want to buy.

I think we can all identify with that.

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