The World of Work Project

The Endowment Effect: A Cognitive Bias

The endowment effect is the cognitive bias which results in people attributing higher values to goods merely because they own then. In other words, owning something increases an individual’s perception of what it’s worth.

Summary by The World of Work Project

The Endowment Effect

The endowment effect is a cognitive bias which results in people attributing higher values to objects simply because they own then. It’s a bias that’s related to divestiture aversion, loss aversion, prospect theory and “the mere ownership effect”. What this bias really means is that, for most people, the very act of owning something increases that person’s perception of what that item is worth.

Diagram showing the endowment effect in action with theatre tickets

The bias has been observed to result in people being unwilling to sell goods that they own for a fair, replacement, market price. It’s also been observed to lead to situations where individuals are willing to pay (WTP) less for a new good than they would be willing to accept (WTA) for the sale of the same good that they already own.  Again, this demonstrates that the mere act of ownership increases the perceived value of a good.

Learning More

The way we think as humans is fascinating. Cognitive biases clearly explain some of our “irrationality”. The Endowment Effect is just one example of this.

Understanding our Dual Process way of thinking provides some further insight into it. This “irrationality” means that we’re all suggestible and susceptible to nudging and the powers of choice architecture and persuasion.

Another tool that is often used to change people’s behaviors is communication. Ideas like the rhetorical triangle and the five canons of rhetoric shed some light on how this works. For a more detailed look at communicating for persuasion, explore Monroe’s Motivated Sequence.

Increasingly, products are also design to be persuasive, as it were. They are designed to create habits and drive increased use. Examples of this include Fogg’s model and the Hook model of behavioral design.

You can listen to our podcast, below, on nudging to learn more about how our behaviors can be influenced:

The World of Work Project View

The idea behind this cognitive bias has been around for at least as long as the phrase “A bird in the hand is worth two in the bush”. The actual bias is a bit more complicated than what’s explained here, but the main point stands. There are lots of reasons why people value things that they own, not least the effort and risk associated with replacement.

The endowment effect can have a large impact on decision making in relation to trading activities and other aspects of behavioral finance. For example, traders who own certain tradable stocks may attribute higher values to them than other traders who don’t own those stocks. Obviously, this bias can have an impact in all areas of commercial negotiation.

Our overall view is that this is an interesting bias that’s of particular import in certain area of work, but has a minor role in others. It’s worth everyone being aware of this bias as knowing about it may help with decision making, but there are no huge lessons in relation to it for most people.

Sources and further reading

Where possible we always recommend that people read up on the original sources of information and ideas.

This post is based on original work by Richard Thaler and others. You can read in many places on internet. Alternatively, have a look at: “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias“.

Kahneman, Daniel; Knetsch, Jack L.; Thaler, Richard H. (1991). “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias“. The Journal of Economic Perspectives. 5 (1): 193–206.

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