The endowment effect is that we value more highly what we already have. It’s a variation on the status quo bias that we talk about in Mind Hacks (Hack #74). This cognitive bias is of particular interest to economists, because it has implications for how eonomies work. If it is strongly in effect then people will trade less than is required to bring about the optimal resource allocation that free market’s are theoretically capable of. The most famous demonstration of the endowment effect directly addresses the operation of the endowment effect in a market trading situation [1] – showing that even though preferences for a small arbitrary item (a coffee mug) are randomly distributed, if you give half of the group one and allow them to trade less trading happens than you would predict. In other words more people want to hold on to their mug now they’ve got one, than people without a mug want to get hold of one. The preferences of the group have been realigned according to initial resource distribution.
This is all relevant to marketing, as well as economics of course. You can see why car-salespeople are keen for you to take a test-drive before you purchase, or why shops are happy to offer a money-back-with-no-questions-asked option. You figure the money-back option into your cost-benefit calculation about whether to take something home, but once you’ve got it home your preferences realign – that item is now “yours”, so you’re far less likely to take it back to the shop, even if it doesn’t turn out to be as good as you thought when you bought it.
Refs and Links:
[1] Kahneman, D., J.L. Knetsch and R.H. Thaler (1990). Experimental Tests of the Endowment Effect and the Coase Theorem. Journal of Political Economy. link
Wikipedia: The Endowment effect: : link
Experienced traders can overcome the endowment effect : Economist article
References at behaviouralfinance.net
[Cross-posted at mindhacks.com]