The Endowment Effect - The Reason You Can’t Let Go of Your Possessions

The Endowment Effect

“If you want to know what a man is really like, take notice of how he acts when he loses money.”
Simone Wei

The Endowment Effect Defined

Let's say you own a car. It's nothing out of the ordinary, but it is fast, highly efficient, and most of all, it is yours. You have driven countless miles within it, and you can bring up many different memories that were formed while you were driving with your friends and family. In your eyes, the value of that car is much higher than anything else could imagine. You see past its market value and perceive its greater value to you and your life. Well, you have just fallen victim to an emotional bias called the Endowment Effect.

Essentially, the Endowment Effect is the tendency of people to value items in their ownership as being much higher than what they would determine the value to be if those exact same items did not belong to them. Somehow, the simple awareness of something being yours makes it all the more attractive than if it was not, hence the word endowment.

On a deeper level, we can see how this effect makes sense, as all of us can cite many different forms of attachments we have to things in our possession. Whether it be items of clothing, a television, or pieces of jewelry, we all express some form of the Endowment Effect. This effect explains much of the human clinginess to personal belongings and why we are more likely to retain objects even though many of them have little to no use.

Think back to humanity's early ancestors whose survival depended on how many resources they could gather for themselves. From this perspective, we can see why the Endowment Effect Exists because if we value what is ours, we will be more likely to hold on to it and use it for future applications.

What is the Endowment Effect?

Multiple explanations exist for why humans frequently suffer from the Endowment Effect. In the field of behavioral economics, there is one process that has been frequently cited to explain the mechanisms behind the Endowment Effect and that is Loss Aversion. Loss Aversion refers to the notion that humans disproportionately dislike losing things compared to how they enjoy gaining things. This is why many people say that pain cuts much sharper than happiness cures, and they are essentially correct because the human brain is much more sensitive to negativity than it is to positivity.

This is also why many people use the term "taking for granted" when describing positive events, not negative ones. Most of us feel the full weight of a negative impact but take a positive event for granted when it happens. The same goes for loss, and when we make decisions, we are more focused on the risks surrounding how we could lose than what we stand to gain.

Because of the prevalence of the Endowment Effect within human decision-making, it has been the object of intense scrutiny from economists, psychologists, and other experts because of its far-reaching implications on business and human functioning. Moving beyond Loss Aversion, experts have also traced the Endowment Effect as a byproduct of human evolution, as the tendency to overvalue one's possessions could have been highly congruent with survival in the dangerous environments our ancestors used to live in.

Back in the day, the Endowment Effect may have helped humans gather resources like weapons and food to attract certain mates by assuring protection and daily meals. Today, it comes in the form of flashy cars or successful careers, where multiple studies demonstrate a direct link between material possessions and attractiveness among individuals.

History of the Endowment Effect

The Endowment Effect emerged from the collaboration between two schools of science: Cognitive Psychology and Economics. Richard Thaler (1945-Present), a behavioral economist, was pushing back on the economic concept, which stated that the price a buyer was open to spending on something would be the same as their willingness to accept the loss of the same item. Essentially, the concept highlighted that buying and selling behaviors were equal.

However, this was ultimately false for Thaler, and he wanted to find the mechanisms behind why this was not the case. Subsequently, when he began reading the research of cognitive psychologists Daniel Kahneman (1934-Present) and Avos Tversky (1937-1996), Thaler unearthed that the discrepancy between selling and buying intentions was based on a psychological concept called Loss Aversion, which was a cognitive bias cited by Kahneman and Tversky to influence decision-making skills within people.

From this, the term "Endowment Effect" was coined, and Thaler used this term to challenge large swaths of economic theory resulting in his being awarded a Nobel Prize in Economic Sciences.

Case Examples of the Endowment Effect

• Case 1: One factor of the Endowment Effect that has been extensively studied within research is the process of psychological ownership. Being slightly different from actual ownership, psychological ownership is the process by which we develop a sense of owning something even though it may not be officially ours. Essentially, it is the feeling that something is yours, making it distinct from legal ownership, where it entails a form of emotional attachment to a given object. To study this, some researchers conducted an experiment to instill a sense of psychological ownership in a group of students and see how the perceived value of a given object would change depending on whether it was felt to be owned.

To do this, they approached participants in naturalistic settings (i.e., in normal circumstances) and gave each participant a chocolate bar by placing it on their work desk. However, the experimenters informed participants that they were not allowed to eat the chocolate bar, and for the following thirty minutes, all the participants continued working on their respective projects with a delicious chocolate bar in their line of sight. Thirty minutes later, when the participants finished their projects, the experimenters returned and informed them that the chocolate bar was now theirs and that they had the choice to keep it or sell it back at a price they determined. Effectively, the participants who sold their bars back to the experimenters gave an average price of about 1.72 dollars.

However, the experimenters also did the same experiment with another group, but instead, they gave the chocolate bars as a gift at the end of the experiment rather than in the beginning. Here, the participants sold it for an average of 1.35 dollars compared to the 1.72 of the previous group. Essentially, the experimenters found that the participants who had the chocolate bars for thirty minutes, compared to those who were only given them at the end, developed a sense of psychological ownership of the chocolate. Because of this, they ultimately fell for the Endowment Effect, which can be seen through the difference in selling prices between the two groups.

• Case 2: One perfect example of the Endowment Effect that no one talks about is the use of coupons in marketing strategies. The concept of coupons directly leverages the Endowment Effect by offering a portion of a given product or service in the form of a discount. Without a coupon, a consumer may need to pay the total price of the desired object, which they may be slightly against because it would incur a loss to their financial resources. However, now that the daunting price has been partially broken down by possessing a coupon, the desired object looks much more attractive and accessible.

As a result, individuals become much more invested in spending their financial resources, as they already possess one form of the object through their coupon; why not possess the rest of it? This comes back to the concept of psychological ownership, where even the perceived feeling of owning something will significantly enhance the value and subsequent willingness to pay for something to have legal ownership of the object. This tactic is also significantly employed in selling luxury automobiles, where a car salesperson will always allow a potential buyer to take a spin on a car before they make the decision to buy it. By doing this, they create the opportunity for psychological ownership to form, which greatly increases their chances of selling the car.

• Case 3: In attempts to see if the influence of the Endowment Effect could be replicated across cultures, researchers conducted a study to compare the Endowment Effect between Western and East Asian cultures. The rationale was that Western cultures were predominantly individualistic and valued principles such as independence and self-expression. Conversely, East Asian cultures are more collectivist and value principles such as community and cohesion more than their western counterparts.

Another important distinction between the two cultures was that Western individuals tended to think very highly of themselves, whereas those from collectivist cultures would not. To see if there would be a difference in the Endowment Effect between these two cultures, researchers recruited people from each and had them participate in an experiment.

Here, a participant would be given a mug and given a choice where they could either keep it or sell it for a price. The researchers found that those who decided to sell their mug would price it much higher if they were from Western culture than an East Asian one. To be sure of their findings, the researchers repeated this experiment many times and found that the effect was constant and highly dependent on cultural variables. To explain this, they believe that the Endowment Effect was also heavily driven by the ego, where those who think more highly of themselves would also think more highly of their possessions.