What is the Endowment Effect?
The endowment effect is a cognitive bias which was first hypothesized by economist Richard Thaler. According to Thaler's theory, people value an object more if their ownership is clearly established. The results of this effect can sometimes be quite interesting, and being aware of it can be very important whether you are buying or selling something.
Numerous studies have been conducted to explore the endowment effect. In a classic study, people were asked to assess the value of coffee cups which had been given to them. Another group in the study was also asked to estimate the value of coffee cups, but these coffee cups were generic, rather than being owned by the subjects. The subjects who owned their coffee cups consistently valued them higher than the other subjects, and in some cases they said that they would prefer to keep their coffee cups, rather than selling them.
This effect seems to apply specifically to objects. When people in a similar study were offered tokens which could be exchanged for coffee cups, the endowment effect was not observed, suggesting that people formed an attachment to the specific object, not to an abstract concept.
You can probably think of some examples of the endowment effect in your own life. For example, real estate prices are often subject to this effect, with the sellers asking a price which exceeds consumer willingness to pay. On a smaller level, you can probably see it if you look around your house and think about the value of the items you own. For example, how much do you think the chair that you are sitting on is worth?
This cognitive bias is also known as Divestiture Aversion, referencing the idea that because people become attached to objects they own, they often develop an aversion to selling them or passing them on. One significant contribution of the endowment effect to the field of economics has been a reworking of the understanding of the relationship between willingness to pay for items, and willingness to accept compensation for such items. As a general rule, people are willing to pay less for items they don't own, and they expect more compensation to sell the items they do own, despite the fact that this contradicts traditional economic theory.
The endowment effect appears to be linked to the status quo bias, which states that people prefer situations to remain static and unchanged. Change of ownership would obviously disrupt the status quo, causing unease.
@Sunny27 -I think that sometimes you see this divestiture aversion mentioned in the article when people become hoarders. I know that this is an extreme example, but these people think everything that they own has value even when the items are not allowing them to live a normal life.
They can’t ever get rid of anything and their home becomes a junkyard. It is really sad. I have my attachment to things, but I know when it is time to sell some things because we need more space in the home.
If I am going to sell something that I own that has some value, I try to do online research to see what the going market value is. If it is too low, I don’t bother selling, but if the price is reasonable, I usually do. Once I make my mind up to sell, I usually do because I have realized what the item is really worth and sometimes the money is more valuable than the item to me.
There is definitely a bias effect when you are trying to sell a home or a family heirloom. A home has a lot of sentimental value and while a homeowner might feel that their home is a treasure a prospective buyer might not think so.
In fact, I was watching a television show that featured owners that couldn’t sell their homes and part of the problem was the fact that they felt that their homes were worth so much more than it actually was.
It was really hard for them to come to terms with discounting the price of their home which is why it sat there as long as it did with no buyers. This also happens on those pawn shows in which people go in to sell their items to a pawn shop on television.
The people selling always feel that their items are worth so much more than what the pawn shop is willing to pay, but what they don’t realize is that the pawn shop business is a business and they can’t buy something that they can’t resell for a profit.
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