Endowment Effect
What is Endowment Effect?
The endowment effect is the tendency to value something more highly simply because you own it, so you demand more to sell it than you would pay to buy it.
Demonstrated in Kahneman, Knetsch, and Thaler's mug experiments, owners' willingness-to-accept exceeds non-owners' willingness-to-pay for the same good. It stems from loss aversion: giving up an owned item feels like a loss, which looms larger than the equivalent gain. The effect violates standard theory's assumption that valuation is independent of ownership and can reduce mutually beneficial trade.
Endowment Effect: a worked example
A teacher hands a branded travel mug to 20 students in a class of 40 and gives the other 20 nothing. Owners write down the lowest price they would sell for; non-owners write down the most they would pay. The median asking price comes back at $7.25, the median offer at $3.00, a gap of $4.25 and a ratio of about 2.4 to 1. Because the mugs were handed out at random, standard theory predicts roughly half of them, about 10, should change hands once trading opens. Only 3 trades clear. The other 17 mugs stay put because owning them raised their price.
The mistake students make with endowment effect
The endowment effect is routinely mistaken for the sunk cost fallacy, as if owners hold out for a high price because of what they paid. In the mug case they paid nothing. What lifts the asking price is possession itself, which is why the effect turns up with gifts and prizes just as strongly. A second slip is labeling every high asking price an endowment effect. It only counts when the same person, asked as a buyer instead, would have offered far less for the identical item.
Endowment Effect questions
What causes the endowment effect?
The endowment effect is usually traced to loss aversion: once an item is yours, giving it up registers as a loss, and losses weigh more heavily than gains of equal size. A second explanation is that ownership moves the reference point people compare against, so the question shifts from acquiring something to surrendering it. Both accounts predict a selling price above the buying price for the very same good.
What is the difference between willingness to pay and willingness to accept?
Willingness to pay is the most a buyer would hand over for a good, while willingness to accept is the least an owner would take to part with it. Standard theory says the two should sit close together for a small everyday item, since value should not depend on which side of the trade you happen to be on. The endowment effect is the observed gap between them.
Does the endowment effect apply to money?
The endowment effect is generally absent for money and for goods held purely for resale. A token that exists only to be exchanged carries no use value to attach to, so an owner's asking price and a buyer's offer tend to line up. The effect bites on things people consume, wear, live in or collect, which is why it slows trade in houses and collectibles far more than in currency.
Related terms
Common comparisons
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