Is the endowment effect really irrational?

What's it worth?

There's nothing a psychologist likes better than to wind up an economist, and in the 70s psychology succeeded big time with the endowment effect. Economics expects us to give an object a value, and that value should determine how we would price it to buy it or sell it. But experiments have shown that we value something we own a lot more than the same object if we don't own it.

Economists, and us sciencey types who want people to be more rational, tend to highlight the endowment effect as one of the 'errors' people suffer from in making rational decisions. But I'd suggest, as is often the case in science, it's more complicated than that.

Here are two suggestions as to why the endowment effect can be just as rational as an other approach. I'm going to take a variant of the original experimental demonstration of the endowment effect to show this. In our experiment, some participants are given a mug, then later asked how much they'd accept to sell it back. Others are asked what they would pay to buy the same mug. Those who have been given the mug tend to value it around twice as highly as those who are asked to buy it. But is that really as irrational as some seem to think?

Firstly there's incomplete knowledge. Traditional economics assumes that we have complete knowledge to be able to make a rational decision. But the real world isn't like that. If I've got the mug, I have more knowledge than if I don't. I know, for instance, that it's a solid product that exists and that the other person can't cheat me in the sale. But in the other scenario, I could get ripped off in all sorts of dodgy trader fashions. It's reasonable to value a product you have more information on higher than one you know less about.

That's a well-known challenge to considering the endowment effect an error. But I think there's another one that is less frequently mentioned. Like many people, I've got plenty of mugs. I'll take one if you give it to me, but I'm not going to buy one, even for a small amount. I don't need any more mugs. So my 'what will you buy it for' value is very low. But if I have a mug and you say you'll pay me money for it, I obviously want to maximise my return. I'm not going to say 'It has no value to me, so you can have it for free.' I'll ask what I think I can get away with, based on the typical price of mugs in shops - inevitably a much higher value than my own.

So, next time you see one of those lists of ways humans don't act rationally and it includes the endowment effect, bear in mind that people aren't as simple as this kind of analysis suggests.

Comments

Why I hate opera

If I'm honest, the title of this post is an exaggeration to make a point. I don't really hate opera. There are a couple of operas - notably Monteverdi's Incoranazione di Poppea and Purcell's Dido & Aeneas - that I quite like. But what I do find truly sickening is the reverence with which opera is treated, as if it were some particularly great art form. Nowhere was this more obvious than in ITV's 2010 gut-wrenchingly awful series Pop Star to Opera Star , where the likes of Alan Tichmarsh treated the real opera singers as if they were fragile pieces on Antiques Roadshow, and the music as if it were a gift of the gods. In my opinion - and I know not everyone agrees - opera is: Mediocre music Melodramatic plots Amateurishly hammy acting A forced and unpleasant singing style Ridiculously over-supported by public funds I won't even bother to go into any detail on the plots and the acting - this is just self-evident. But the other aspects need some exp...

Is 5x3 the same as 3x5?

The Internet has gone mildly bonkers over a child in America who was marked down in a test because when asked to work out 5x3 by repeated addition he/she used 5+5+5 instead of 3+3+3+3+3. Those who support the teacher say that 5x3 means 'five lots of 3' where the complainants say that 'times' is commutative (reversible) so the distinction is meaningless as 5x3 and 3x5 are indistinguishable. It's certainly true that not all mathematical operations are commutative. I think we are all comfortable that 5-3 is not the same as 3-5. However. This not true of multiplication (of numbers). And so if there is to be any distinction, it has to be in the use of English to interpret the 'x' sign. Unfortunately, even here there is no logical way of coming up with a definitive answer. I suspect most primary school teachers would expands 'times' as 'lots of' as mentioned above. So we get 5 x 3 as '5 lots of 3'. Unfortunately that only wor...

Why backgammon is a better game than chess

I freely admit that chess, for those who enjoy it, is a wonderful game, but I honestly believe that as a game , backgammon is better (and this isn't just because I'm a lot better at playing backgammon than chess). Having relatively recently written a book on game theory, I have given quite a lot of thought to the nature of games, and from that I'd say that chess has two significant weaknesses compared with backgammon. One is the lack of randomness. Because backgammon includes the roll of the dice, it introduces a random factor into the play. Of course, a game that is totally random provides very little enjoyment. Tossing a coin isn't at all entertaining. But the clever thing about backgammon is that the randomness is contributory without dominating - there is still plenty of room for skill (apart from very flukey dice throws, I can always be beaten by a really good backgammon player), but the introduction of a random factor makes it more life-like, with more of a sense...

Search This Blog