The Endowment Effect

The Endowment Effect is a cognitive bias where people assign higher value to objects simply because they own them. For example, if you were to sell your car, you would most probably set it or at least think of a higher price than market price. While you may argue that you’ve kept it in perfect condition or there are not many miles on it, etc, the biggest reason or one of the biggest reasons for your bias and the inflation of prices is the Endowment Effect. 

The Endowment Effect was first proposed by Richard Thaler in 1990. The experiment was surprisingly simple. Here’s how it goes: there’s two groups. Each person in the first group was given a mug and were told it was theirs. Then, they asked how much they would sell it for. The second group were just shown the mug and were asked how much they would buy it for. The result? The first group demanded about twice as much money for the mug than the second group were willing to offer. Now, they knew (at least inferred) that this was not a real transaction; nobody was getting real money for the mug, so it couldn’t have just been a higher price due to marketing and sales. There had to be a psychological reason. Thus, the Endowment Effect. But why does this occur?

Scientists claim there’s two reasons we behave like this. Firstly, we experience losses more intensely than equivalent gains. Once we own something, giving it up feels like a loss, which we naturally try to avoid—even if keeping the item isn’t beneficial. This is commonly called Loss Aversion, which is a core component of Prospect Theory (let’s talk about that tomorrow). The second cause of this effect is Status Quo Bias. Simply put, people hate change; they tend to prefer keeping things the way they are, resisting changes even when switching could be advantageous. One way of expressing this is inflating prices to avoid selling, thus avoiding change.

Next time you’re selling something, try to think like a buyer. Ask yourself, “if I were to buy this product, how much would I be willing to pay for this?”. That should stop or atleast slightly hinder the bias from taking over, leading to a more reasonable price.