Series 2, Episode 9: Endowment Effect
Welcome back to the bitesize behaviour podcast.
I have a question for you. Have you ever gone to sell something that you own, only to have the person who is the potential buyer offer you way less that you want. You go to other people and even they offer you less than you think the item is worth. If this sounds remotely like something you’ve experienced, you’ve fallen for the Endowment Effect. In short, the Endowment Effect is where we overvalue something that we own, regardless of its real market value - which of course is objective. Let me explain.
Back in 1990 - scientists took a large group of people and randomly divided them into two groups. Sellers and buyers, and gave all of the sellers a mug as a free gift.
A short while later, they then asked the sellers how much they would sell the mug for, and separately, they asked the other group - the buyers - how much they would be willing to pay to buy a mug.
Now this is where it gets interesting. Because the sellers owned the mug - it was theirs - they had now become psychologically attached to the mug, and so when asked how much they would sell it for, came up with a price, on average, or $7.12.
When they asked the buyers for their price, the average price the buyers were willing to pay was only $2.87. That’s a difference of $4.25. That’s a 85% difference between the buying and selling prices, which is a staggering difference, right? And you can probably see how a behaviour we discussed previously - loss aversion - plays its role here. People will over-inflate the value of the things that they already own MORE than those things that they don’t own.
And the fear of losing the mug, which is loss aversion, creates an issue. It causes confusion and this shows when people need to create a valuation to sell the item. And this effect has been repeated time and time again, and in some cases, with bizarre results.
WINNING LOTTERY TICKETS
In August 2018, in the USA - the jackpot for the Powerball lottery was a staggering £700m. So, researchers took to the streets to try and buy people’s lottery tickets off them; in some cases offering them up to TEN TIMES the amount they had paid for the ticket in the first place.
So - what happened?
Well, when researchers tried to offer, as I said, in some cases significant money to buy people’s lottery tickets off them, 78% of people refused to sell - outright. Full stop. No amount of money offered in the experiment tempted them to sell their ticket. And you’ve got to ask - why not?
Well, it turns out they these people had a strong belief that they had actually bought the winning ticket, or more to the point - and the language is important here - that they now owned the winning ticket, and that ownership was just too strong to make them part with the ticket. The Endowment Effect can make us behave in a really irrational way.
So why does it? Why does it make us act irrationally? Well, when you own something, it takes on extra emotional value to me as the owner, and that means I’m reluctant to let it go for a value that I see as too small to compensate for the emotional turmoil I think I’ll go through.
Worse still, I may be reluctant to let it go at all, and this can lead to us becoming hoarders, keeping hold of items simply because they are mine, and I’ve got an emotional attachment to them.
But you know what else? The world of retail knows all about behavioural biases, and can deploy their tricks of the trade to get us to buy their stuff.
For example, free trials can trick us into liking a product more than you really do simply because we’re using it and have an immediate attachment. Discount coupons can make us spend more not just by offering a discount, but by changing your perception of value for the product. And test driving a car can make you pay more for it or buy extra features that you didn’t even initially want. These experiential based moments, or putting the product in our hands, has an impact on our psyche, and tricks us into behaviours associated with ownership.
And people will tend to believe, through a feeling of ownership, that what they have, what they own, is better than anyone else's. My car, my house, are all better than everyone else’s... and it is this biased view of the world that can lead us to making decisions that may end up not being the best decisions that we’ve ever made.
The next time you’re on Ebay, trying to sell a pair of headphones that you’ve never used, remember that the attachment that you have to them, everyone else will value at zero. In that situation, take a step back and ask yourself, if I didn’t own this, what would I be willing to pay for it. Even that one simple step, can potentially knock you out of the grasps of the Endowment Effect, and the sooner we can recognise this, the sooner we’ll feel liberated.
In the next episode of Bitesize Behaviours we’ll look at a behaviour that sees us looking at different pots of money in different ways.
We’ll be looking at Mental Accounting.
See you next time on bitesize behaviour.