Endowment effect

In behavioral economics, the endowment effect (also known as divestiture aversion) is a hypothesis that people value a good or service more once their property right to it has been established. In other words, people place a higher value on objects they own than objects that they do not. In one experiment, people demanded a higher price for a coffee mug that had been given to them but put a lower price on one they did not yet own. The endowment effect was described as inconsistent with standard economic theory which asserts that a person's willingness to pay (WTP) for a good should be equal to their willingness to accept (WTA) compensation to be deprived of the good. This hypothesis underlies consumer theory and indifference curves.

The effect was first theorized by Richard Thaler. It is a specific form, linked to ownership, of status quo bias. Although it differs from loss aversion, a prospect theory concept, those two biases reinforce each other in cases when the asset price has fallen compared to the owner's buying price. This bias has also a few similarities with commitment and attachment.

Some economists have questioned the effect's existence. Hanemann (1991) noted that economic theory only suggests that WTP and WTA should be equal for goods which are close substitutes, so observed differences in these measures for goods such as environmental resources and personal health can be explained without reference to an endowment effect. Shogren et al. (1994) noted that the experimental technique used by Kahneman and Thaler (1990) to demonstrate the endowment effect created a situation of artificial scarcity. They performed a more robust experiment with the same goods used by Kahneman and Thaler (chocolate bars and mugs) and found no evidence of the endowment effect.^{[citation needed]}

Whether or not the endowment effect is a relevant economic phenomenon is somewhat uncertain; it is possibly a reflection of conventional substitution effects.^{[citation needed]}

See also

• Behavioral economics
• List of cognitive biases
• Sunk costs
• Transaction cost

References

• Thaler, R. (1980). Toward a positive theory of consumer choice. Journal of Economic Behavior and Organization, 1, 39-60.
• Jason F. Shogren; Seung Y. Shin; Dermot J. Hayes; James B. Kliebenstein 'Resolving Differences in Willingness to Pay and Willingness to Accept' The American Economic Review, Vol. 84, No. 1. (Mar., 1994), pp. 255–270
• W. Michael Hanemann 'Willingness to Pay and Willingness to Accept: How Much Can They Differ?' The American Economic Review, Vol. 81, No. 3. (Jun., 1991), pp. 635–647
• Ziv Carmon and Dan Ariely (2000) 'Focusing on the Forgone: How Value Can Appear So Different to Buyers and Sellers' Journal of Consumer Research

External links

• "The WTP-WTA Gap, the 'Endowment Effect,' Subject Misconceptions, and Experimental Procedures", Charles Plott et al., American Economic Review 2005
• The Endowment Effect's Disappearing Act, Larry E. Ribstein, December 4, 2005
• "Exchange Asymmetries Incorrectly Interpreted as Evidence of Endowment Effect Theory and Prospect Theory?", Charles Plott et al., American Economic Review 2007