Endowment Effect

… a core concept used in Policy Analysis and Process and Atlas101

Concept description

Behavioraleconomics.com, citing Kahneman, Knetsch, & Thaler (references below), defines the endowment effect as a bias that “occurs when we overvalue a good that we own, regardless of its objective market value.”

Behavioraleconomics.com goes on to say:

“It is evident when people become relatively reluctant to part with a good they own for its cash equivalent, or if the amount that people are willing to pay for the good is lower than what they are willing to accept when selling the good. Put more simply, people place a greater value on things once they have established ownership, which is especially true for goods that wouldn’t normally be bought or sold on the market, usually items with symbolic, experiential, or emotional significance. The endowment effect is an illustration of the status quo bias and can be explained by loss aversion.”

Paul Wells, writing in McLean’s (reference below), describes how the endowment effect produces challenges for governments trying to implement measures such as tax changes that, in principle, produce more winners than losers. But the potential losers feel the prospective loss more deeply than the potential winners feel the prospective gain.

“On Monday the Nobel Prize for economics went to Richard Thaler, whose advances in “behavioural economics” help explain why individuals don’t always behave as rational actors. Thaler won for a wide range of work, but some of it has to do with the “endowment effect,” by which people put a much higher value on something they have in hand than they would have been willing to pay to acquire it.

The experiments Thaler and his colleagues, including fellow Nobel laureate Daniel Kahneman, describe in the paper … are so fun they’re worth your time. In one, half the students in an experimental group were given crappy logo mugs from the university bookstore, and then a bidding market was opened among students. The students with the mugs priced them way above their market value; the ones without mugs offered less than the market price. Very few mugs changed hands, because almost the only people who wanted a mug were the ones who’d just been handed a mug at random.

“This all suggests, the authors wrote in that 1991 paper, that “individuals have a strong tendency to remain at the status quo, because the disadvantages of leaving it loom larger than advantages.” That should have rung some bells in the Finance department this summer. A major premise of Morneau’s reform is that the rate of incorporation for tax purposes has more than doubled in recent years. The assumption that went along with that premise was that these recent gains could be easily rolled back. But that’s asking a lot of human nature: You’ve only recently figured out how to save thousands of dollars on your taxes, so we’re hoping you won’t mind being made to unlearn how to do it.

“Morneau and Justin Trudeau are learning the power of the endowment effect. It’s got to sting, because as Conservative finance critic Pierre Poilievre reminds them every chance he gets, those two should know something about endowments.”

Atlas topic, subject, and course

Interests and the Policy Process (core topic) in Policy Analysis and Process and Atlas101 Policy Analysis and Process.

Sources

Behavioraleconomics.com, Endowment effect, at https://www.behavioraleconomics.com/mini-encyclopedia-of-be/endowment-effect/, accessed 12 October 2017.

Kahneman, D., Knetsch, J., & Thaler, R. (1991). Anomalies: The endowment effect, loss aversion, and status quo bias. Journal of Economic Perspectives, 5(1), 193-206.

Paul Wells (2017), Throw another minister on the bonfire: the ballad of Bill Morneau, McLean’s, 9 October 2017, at http://www.macleans.ca/politics/ottawa/throw-another-minister-on-the-bonfire-the-ballad-of-bill-morneau/, accessed 12 October 2017.

Page created by: Ian Clark, last modified 27 March 2017.