Endowment effect

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This article gives a basic definition in behavioral economics.
View a complete list of basic definitions in behavioral economics

Definition

The endowment effect is an effect whereby the value a person places on a good is greater if the person owns a good, i.e., if a property right to the good is established. The endowment effect is often measured in terms of a WTA/WTP gap: a gap between the money the person is Willing To Accept (WTA) to sell the good, and the money the person is Willing To Pay (WTP) to acquire the good.

Alternative explanations for apparent endowment effect

Mistaking amount paid for Willingness To Pay

Just because a person is unwilling to sell something for the price at which he/she bought it does not mean that an endowment effect is operational. Rather, the endowment effect is operational if the minimum amount the person is willing to accept exceeds the maximum amount the person is willing to pay.

For instance, I might value a book at a hundred units of money, but I might get it in the market at only ten units of money. In this case, the fact that I am unwilling to sell the book for ten units of money does not indicate an endowment effect, because the value of the book is a hundred units of money to me.

Note that this alternative explanation would not apply in cases where I can easily buy the book again for ten units of money. In other words, while this alternative explanation helps explain away the apparent gap between Willingness to Accept and the original amount paid, it does not explain the apparent gap between Willingness to Accept and the current replacement cost.

Transaction costs

In some cases, a gap between willingness to accept and willingness to pay may simply reflect transaction costs. For instance, if the value of a good to me is units, the cost of selling is units and the cost of buying is units, my willingness to accept is units and my willingness to pay is units, even in the absence of an endowment effect. The gap between the two prices reflects the sum total of the transaction cost of selling and the transaction cost of buying.

Customization

In some cases, the buyer may have spent effort customizing the good after purchase, hence adding value to the original purchased product. For instance:

  • Somebody who bought a computer may have installed a number of softwares and customized the settings of the computer.
  • Somebody who bought a book may have made annotations in the book.

Status quo bias

In some cases, an unwillingness to resell a good may simply be a status quo bias. Here, a property right to a good does not increase my attachment to it but inertia and laziness prevent me from reselling it. The status quo bias may therefore prevent me from seeking buyers for goods I own. However, if I merely have a status quo bias and no endowment effect is operational, I may be less likely to reject a specific offer that somebody else makes.