The Endowment Effect

by Craig Shrives

What Is the Endowment Effect?

The Endowment Effect: The Value of Ownership

The endowment effect is a cognitive bias that highlights our tendency to place a higher value on items we own compared to identical items we don't own. Coined by behavioural economists Richard Thaler, Daniel Kahneman, and Jack Knetsch, this bias reveals the emotional attachment and sense of ownership that can influence our perception of an object's worth.

The endowment effect can be observed in various situations. Imagine attending a garage sale where you come across an item you have no particular interest in, such as an old lamp. However, the seller insists on a price that seems unreasonably high to you. You decline the offer, but later, when you see the same lamp at another store for a lower price, you suddenly feel a sense of regret. The emotional attachment associated with owning the lamp at the garage sale influenced your perceived value, making it harder to accept a lower price later on.

This bias can also be seen in everyday life. For example, when selling an item, people often assign a higher price to it than what potential buyers are willing to pay. The emotional attachment to the item, coupled with the endowment effect, leads to an inflated perception of its value. On the flip side, buyers may feel reluctant to part with their possessions, even if offered a fair price, due to the increased value they place on owning the item.

The endowment effect has significant implications in areas such as consumer behaviour, decision-making, and negotiation. Marketers and advertisers recognize the power of the endowment effect and use strategies that create a sense of ownership in potential customers. Free trials, money-back guarantees, and the opportunity to personalize products all aim to establish an emotional connection and trigger the perception of ownership, thus increasing the likelihood of purchase.

In negotiations, the endowment effect can create challenges. Both buyers and sellers may have divergent perceptions of an item's value due to their respective ownership biases. Recognizing this bias can help parties engage in more objective and fair negotiations, considering market values and external factors rather than solely relying on the emotional attachment associated with ownership.

To mitigate the influence of the endowment effect, it is important to cultivate awareness and objectivity. Recognize that the emotional attachment and sense of ownership can impact your judgment of an item's value. When making decisions or engaging in negotiations, consider external benchmarks, market values, and the perspectives of others to arrive at a more balanced and rational assessment.

An Example of the Endowment Effect

I love it coz it's mine

My mate's just bought a sports car. We've known each other for years, and I can't say he's really shown much interest in cars. But, now that he owns a sports car, he never shuts up about it. He's forever justifying the running costs and being dismissive of the lack of practicality. It's a great-looking car, but he never goes anywhere in it, because it's not really designed for taking things to places. For a start, it costs a fortune to fill up. You can't transport any luggage in it – you have to empty your pockets just to get yourself in. Its primary role is to be the subject of blokes' pub chatter.

My mate was an intelligence analyst too. He understands the endowment effect, and he's the first to admit it's alive and well in his head. He knows if I owned the car, he'd be pretty indifferent about it. But I don't. He does. And he loves it…for that very reason. He values it because he owns it. When the water pump packed in, he paid nearly £1000 to fix it. A grand! He is fully aware that his "loss aversion" (i.e., avoiding losing the car) is causing him to accept the running costs. Nowadays, he couldn't bear to be without his rocket go-kart.

I like to think of the endowment effect as the reverse side of the "Fox and Grapes" coin. "The Fox and Grapes" is one of the traditional Aesop's fables. (Aesop was a slave and story-teller who lived in ancient Greece between 620 and 560 BC.) The fable goes like this:

A hungry fox tries with all his might to reach some grapes on a vine, but he fails. As the fox walks off, he remarks: "Oh, you aren't even ripe yet! I don't need any sour grapes."

Incidentally, that's the origin of the term "it's just sour grapes". Anyway, Aesop told this story to teach people not to talk disparagingly about things just because they cannot attain them. Aesop spotted that people mentally tricked themselves into disliking the things they could not have to lessen the impact of not owning them. The endowment effect is the opposite of that. It occurs when people trick themselves into overvaluing the things they own. This could be to justify the cost of buying it, but that's not the whole story. It seems the act of ownership forms an owner-owned relationship in the mind of the owner, who will pay to keep the relationship intact.

Hey, hang on a sec. Maybe I'm being disparaging about my mate's sports car because I can't have one. Am I Aesop's fox? Nah, I wouldn't swap it for my car in a month of Sundays.

A Practical Application of the Endowment Effect

Double your chances of a sale with real magic

The endowment effect causes you to overvalue the things you own. That idea is simple, but also powerful. Salesmen routinely employ it to turn your cash into their cash. It's nearly magic. Here's how it works:

The endowment effect can take hold before you actually own something. "Ownership" can occur as soon as you start to imagine yourself as the owner of the object. And this is how salesmen get you.

For example, when a shop states you can take the sofa home for a week to try it before buying, the salesman knows exactly what he's doing. He knows that once you've got the sofa home, you will develop an attachment to it. Once you are slouched in it at home with your feet up and with a glass of wine, you "own" it. As a result, its value will increase in your mind. This is the endowment effect at work. Suddenly, you're willing to pay the price of the sofa because you don't want to lose it. You are in loss-aversion mode.

In fact, the effect kicks in before you've even got the sofa home. As soon as you start to imagine taking it home, your "ownership" of it has started. Here's an example:

If a TV salesman says "Where you would put such a large TV in your living room?" or "This TV would transform any room into a modern-looking one", he's initiating your feelings of "ownership" towards the TV. You start to imagine it in your house, and you start to value it more. Once those feelings are set, you'll pay not to "lose" the TV. Suddenly, your living room without that TV is starting to look a bit drab. So, your brain is being attacked from two angles.

You want the benefit of the TV. We know that. But now you also want to avoid losing the TV with which you've started to form the owner-owned relationship. With two forces working on you (push and pull), you are more likely to step over the "buy-me" line. In fact, your decision to buy the TV ought to be based on just one force: the "push" force of the TV's benefit to you. The "pull" force you experience through fear of losing a TV you've never owned is real sales magic.

Critical Thinking Test

Are you good at spotting the biases, fallacies, and other cognitive effects? Can you spot when statistics have been manipulated? Can you read body language? Well, let's see! Show Instructions

See Also