WHAT IS THE ENDOWMENT EFFECT?
The Endowment Effect centers around the idea that humans have a tendency to feel like they own things that they come into contact with. For example, when you sit in a new car, you tend to feel like its already yours and as a result, nobody else should touch it.
When prospective buyers take the car out for a test drive, the endowment effect begins to take effect and influence them. They pretend to be the real owners of the car in question and as a result, are ready to spend more money on it to avoid losing it and because of their emotional attachment which grows stronger the longer they have it. This is also a reason why some people end up becoming hoarders.
A study by Knetsch and Sinden, conducted in 1984 revealed that most of the participants in a study they conducted were unwilling to exchange the lottery tickets they were simply given first (and for free) for money when offered. This was despite the money of course having an obvious higher and risk-free value. However, the opposite held true when the money was given to the participants first instead of the lottery tickets.
Ultimately, people are usually unwilling to part with something that they own they own once they have created a psychological and to some extent physical attachment with it. In fact, this attachment can happen within the first few seconds of placing that object in their hands!
Despite the endowment effect being originally attributed entirely to loss aversion, other psychology researchers have argued a few other explanations that are increasingly supported by evidence. One of these explanations comes from aRay Weaver and Shane Frederick who published their findings in a 2012 paper. They argue that the endowment effect actually happens as a result of people trying to avoid getting conned or tricked into a bad deal. This is also known as reference price theory.
According to this view, when consumers approach a transaction, they often have different reference prices whether they are a buyer or a seller. Similarly their ideas about how much something is worth also differes. Buyers generally don’t want to pay more than they think an item is worth, and conversely, sellers don’t want to sell it for less than that item’s market price.
As an example, if you were trying to sell a painting that normally retails at $30, you probably wouldn’t want to sell it for anything less than that, because if you did, you would feel like you’re getting ripped off. However, from a buyer’s perspective, who’s just casually interested in getting a new painting to hang on their wall, $10 might be the most they are willing to pay.
In essence, the endowment effect happens when there’s a gap between a buyer’s willingness to pay a certain price for an item or service and a seller’s willingness to accept a certain price for the same thing. Occasionally this gap appears because buyers will look to the lowest available price as a reference point, whilst sellers may do the opposite and instead look at the highest price as a reference point.
For example, if you were reselling a $50 ticket to see a pop star in a concert, and you saw that some people were reselling similar concert tickets for $100, you might feel like you were missing out if you sold the tickets for anything less than that. Conversely, people who are looking to buy tickets like yours may have seen that other tickets have been sold closer to the original price, and as a result, they may be less willing to pay your higher price.
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