Endowment Effect

Published Mar 18, 2023

Definition of Endowment Effect

The Endowment Effect is a cognitive bias that describes the phenomenon that people attribute more value to an object they own or possess than they would to the same object if they did not own it. In other words, people have a tendency to demand a higher price for the object they own, as opposed to the price they would be willing to pay for the same object if they didn’t already own it.

Example

To understand the endowment effect, let’s consider an experiment conducted by Kahneman, Knetsch, and Thaler in 1990. They gave participants a mug and a chocolate bar and then asked them how much money they would be willing to sell the mug or the chocolate bar for and also how much they would be willing to pay to buy the mug or chocolate bar, respectively. The experiment found that the participants who were given the mug first demanded a higher price to sell the mug than those who were given the chocolate bar first. Similarly, the participants who were given the chocolate bar first were willing to pay less to buy the mug than the participants who were given the mug first. This demonstrates the endowment effect in action.

Another example is a person who buys a new car. After purchasing the car, they may become emotionally attached to it because it is their own possession. They may then be less interested in buying a new car or selling it for what it is worth on the market. Instead, they may demand a much higher price for it because of the ownership bias.

Why Endowment Effect Matters

The endowment effect is an important concept in behavioral economics and marketing. It explains why people may have different perceptions of the same object depending on whether they own it or not and how that perception affects their willingness to buy or sell it. This can have significant implications for businesses as marketers can learn how to frame their advertising messaging in a way that caters to customer emotions and desires and creates greater perceptions of ownership.

For economists, it highlights the importance of studying the differences between market prices and the subjective values that people ascribe to their possessions. Understanding the endowment effect is critical for businesses and marketers as they can use this concept to make effective strategies to motivate customers to purchase their products or services.