As many a behavioural economist would contend, when people make decisions about buying or selling there are many psychological effects that can lead to seemingly “irrational” behaviour.
Since these psychological tics often play an important role in consumer behaviour, it is important to understand them better. Madison Lukaczyk, an intern at FT Alphaville in New York and a junior at Syracuse University, explains the concept of “the endowment effect”.
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As Dr. Paul Sanberg, a professor of neuroscience and director of the Center of Excellence for Aging and Brain Repair at the University of South Florida College of Medicine in Tampa explained:
Understanding the brain mechanisms that lead to decision-making is important for appreciating how difficult it can be to break bad habits
Consider the following example: if you had a chance to swap a stock that you own for another equally risky stock that was valued at $50 more than the one you have now, would you? The result, more than not, is no – because, as the Economist put it, “mankind’s inner chimpanzee refuses to let go”.
This inner chimpanzee is properly known as the endowment effect, which describes the tendency of human beings to value their own items more than those belonging to another.
Doctor Dan Gilbert – a professor at Harvard University – experimented on hospitalized patients suffering from severe amnesia or other problems that caused them to lose their ability to create new memories. He related this experiment during a 2004 TED talk on the subject of happiness.
The patients were presented with some paintings that were relatively similar and asked to rank – in order – how much they liked each one. After the patients ranked them, Doctor Gilbert told the patients that he would give them the painting they had ranked as number four.
After half an hour, the doctor met with the patients again. The patients had no recollection of who he was or of the experiment they had done previously. Doctor Gilbert once again presented the paintings to the patients, but this time, he asked them which picture they owned.
The patients, Dr Gilbert said, had no idea which picture he had given them, and ended up picking a painting at random. He then asked them once again to rank them.
The results of the latter question were striking: on average, the patient ranked the pictures they had been given (their previous number four) higher than they had the first time around.
In other words, even though the patients didn’t “know” they even owned the picture, they indicated that they liked that picture better compared with their first (non-owner) ranking. This may demonstrate that the endowment effect actually changes the way your brain perceives the value of something.
Moreover, as Brian Knutson, an assistant professor in the department of psychology and neuroscience at Stanford University argued:
this effect often seems to exist not because people are more driven to appreciate the things they own and find them more attractive, but because they simply can’t stand the thought of losing a possession.
This phenomenon affects consumer to consumer selling, because its compels people to over-price their items – something to think about the next time you hold a garage or car boot sale and no one seems willing to buy those ratty band t-shirts you’ve priced at $25.
Related links:
People are loss averse and short sighted – FT Alphaville
Mental Accounting Matters – Richard Thaler
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Madison Lukaczyk is entering her junior year at Syracuse University. She studies marketing and advertising at the S.I. Newhouse School of Public Communications and the Whitman School of Management. She is currently an intern at FT Alphaville in New York.