Thinking Fast and Slow 27: The Endowment Effect

In this chapter we find some more examples of “theory induced blindness”‘ and how the idea of indiference can lead us to forget about previous conditions while making a decision, which is clearly a bad idea, but seems quite common in economics that don’t consider loss aversion while one person has to move from one job to an “equivalent” one.

The endowment effect, tested in various original experiments, shows how when something belongs to us, suddenly we value it more. When I am introduced to an item, a cup, for example, I wouldn’t pay more than $5. But once it is mine, and I’m asked how much I’d like to receive for it, I might end up asking for $15.

Prospect theory can solve that, pointing out at the fact that now the reference point to value the cup has changed.

Not everything generates an endowment effect. In order to do so it has to be an item you can use. If you use for exchange it won’t be activated. So if you sell cups and you won’t feel any special relationship with them and just sell them at market value.

According to others experiments, physical possession of the object is key to create an endowment effect. Being poor can also diminish or even making dissapear the endowment effect.

My overall impression is that any decision implies so many emotional and irational implications, that prospect theory can’t really take into account whether endowment effect is going to be activated and with what strenght. Unfortunately, Kahneman seems to be best when saying why we are not rational and less good when proposing alternative models.

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2 thoughts on “Thinking Fast and Slow 27: The Endowment Effect

  1. >> Unfortunately, Kahneman seems to be best when saying why we are not rational and less good when proposing alternative models.
    Well, to know that a simplistic theory that we were considering to be true is not and that the real world is much more complex that that, is an accomplishment good enough.

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