Real-world Endowment

September 20, 2012 BY danariely

One of economists’ common critiques of the study of behavioral economics is the reliance on college students as a subject pool. The argument is that this population’s lack of real-world experience (like paying taxes, investing in stock, buying a house) makes them another kind of people, one that conceptualizes their decisions in altogether different ways. And although many decision-making studies in behavioral economics have shown that young adults do not act much differently than adult adults when it comes down to their core behavior (think of MDs whose diagnoses are influenced by defaults and the framing of choices, for example), the argument persists as a sweeping dismissal of using students as the main testing ground.

One area where we can test this assumption is with the endowment effect. Simply put, the endowment effect shows that we value the things we own more than identical products that we don’t own. This causes a mismatch between buyers and sellers, where buyers are often willing to spend less than the seller deems an acceptable price.

If we are to assume that consumers hold constant, well-defined preferences, this puts the stability of valuations into question. As such, the endowment effect has puzzled economists for quite some time because in principle, valuations should not be affected by ownership; if a purple hat is worth $15 to you, it should be worth $15 to you whether or not you have purchased it, and this value should remain consistent both before and after you purchase it.

Let’s say that undergraduate A receives a mug and is asked how much money she would require to sell it to undergraduate B. Studies find that undergraduate A will have a much harder time parting with the very same mug that undergraduate B has no attachment to. Now, these students don’t have much experience with real-world markets. So the question is — would those who do have experience in these markets behave differently than their inexperienced undergraduate counterparts?

In his senior research paper, Sean Tamm studied exactly this*. He approached 30 car salespeople and 46 realtors, a population that presumably has much experience with negotiating their maximum willingness to accept (when selling items), as well as with a maximum willingness to pay (when purchasing items). He endowed half of these participants with mugs, and asked the sellers what it would take to sell the mugs and the buyers what it would take to buy the mugs. And despite the extensive real-world market experience of these participants, willingness to accept was about three times higher than willingness to pay, demonstrating that even expert negotiators are susceptible to the endowment effect. This is consistent with previous research, showing an overvaluation of owned goods of about 2.5 times that of unowned goods.

This is just one more example of real-world experience not playing the protective role that we often assume comes with experience. It also suggests that our brains and the way we make decisions are similar, and that for the most part, students are operating under the same constraints as those with much more experience. In the end, we may just have to accept that students are real people (most of the time).

*“Can Real Market Experience Eliminate the Endowment Effect?” by Sean Tamm, Stetson University


September 8, 2009 BY danariely

Today we have a dark story about the very controversial topic of end of life decision making that demonstrates what we in decision making studies call the “endowment effect.” Again, this wonderful story is written by another one of my undergraduate behavioral economics students at Duke. Hope you enjoy it! You can find it here.