Endowment effect

From Academic Kids

The endowment effect is a hypothesis that people value a good (object) more once their property right to it has been established. In other words, people value something more as soon as they own it. In one experiment, people demanded a higher price for a coffee mug they had been given but put a lower price on one they did not own yet. The endowment effect was described as inconsistent with standard economic theory which asserts that a person's willingness to pay (WTP) for a good should be equal to their willingness to accept (WTA) compensation to be deprived of the good. This hypothesis underlines consumer theory and indifference curves.

The effect is related to loss aversion and status quo bias in prospect theory. It was first theorized by Richard Thaler.

The existence of the effect has been questioned by economists. Hanemann (1991) noted that economic theory only suggests that WTP and WTA should be equal for goods which are close substitutes, so observed differences in these measures for goods such as environmental resources and personal health can be explained without reference to an endowment effect. Shogren et al (1994) noted that the experimental technique used by Kahneman and Thaler (1990) to demonstrate the endowment effect created a situation of artificial scarcity. They performed a more robust experiment with the same goods used by Kahneman and Thaler (chocolate bars and mugs) and found no evidence of the endowment effect.

Whether or not the endowment effect is a relevant economic phenomenon is somewhat uncertain; it is possibly a reflection of conventional substitution effects.

See also

References

  • Thaler, R. (1980). Towards a positive theory of consumer choice. Journal of Economic Behavior and Organization, 1, 39-60.
  • Jason F. Shogren; Seung Y. Shin; Dermot J. Hayes; James B. Kliebenstein 'Resolving Differences in Willingness to Pay and Willingness to Accept' The American Economic Review, Vol. 84, No. 1. (Mar., 1994), pp. 255-270
  • W. Michael Hanemann 'Willingness to Pay and Willingness to Accept: How Much Can They Differ?' The American Economic Review, Vol. 81, No. 3. (Jun., 1991), pp. 635-647de:Endowment-Effekt
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