Friday, July 3, 2009

Well Endowed: The Endowment Effect

Okay, that’s a bit of a misleading title for this post, but I am going to say some things today about the Endowment Effect.

First off, a definition: The Endowment Effect is psychological effect discovered by research psychologists and behavioral economists. It reflects the now well-proven fact that people place a greater value on a thing they already own than they would if they did not own that thing and had to buy it.

Kahneman, Knetsch and Thaler studied this effect in this way. What they did is give some participants in a study a mug—yes, like a coffee mug. They did not give other participants a mug. Then, they simply examined how much the people with the mugs would be willing to sell them for (around $7) and compared that to how much the people without mugs were willing to pay for one (around $3). The interesting thing here is that these participants only differed in whether or not they happened to be given a free coffee cup. But once owned, they want more to part with it then they’d have been willing to pay for it in the first place. Quite a bit more, in fact. There are now many studies that show this same phenomena in all sorts of ways.

Psychologist Daniel Kahneman would relate this to his brilliant work with Amos Tversky that showed, in many ways, that people are more motivated to avoid loss than to attain gain. (I say “brilliant” because, after all, they do reflect my own chosen discipline of psychology. Other than that, I’m sure I have no biases, endowment or otherwise.)

Economist Richard Thaler also named this effect the “status quo bias,” because it reflects the fact that it favors keeping what you already have. By the way, this goes a long, long way toward describing why some people do so poorly when they have a garage sale. They are just too attached to their junk. Those who come by are judging from a different standpoint, one that is closer to the real market value of the stuff. (I personally believe that the main purpose of a garage sale is not to make money but to get other nice people to come to your house and carry away all your junk.)

There are some tricky implications for romantic relationships here. For example, for the average pretty good to great marriage, the Endowment Effect helps you stick to their commitment when times are a bit tougher because you so highly value what you already have. And you should, because you’ve invested a lot and what you invested would result in a lot of loss if you don’t stick. If you are married, have built a life together, have children, and all sorts of other things, you are, so to speak, very well endowed.

On the other hand, what if you are dating and trying to find the right person to spend your life with? This Endowment Effect also means that you can easily get too settled with a current partner who’s not really a good long-term fit, and not move on when maybe you should.

I’ll go a bit deeper on some of the implications in my next post. I have a very busy week coming up, so it may be a bit more than a week before I get back to you. But I will be back!