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Behavioral Economics 2

 

Endowment effect – is a hypothesis that people value a good or service more once their right to it has been established. In other words, people place a higher value on objects they own, than objects that they do not.

En experiment was repeated many times. A group was divided in to two smaller groups. One group was shown a mug and asked how much would you pay for this mug. The average answer was $4. The other group was given a mug for free and asked how much you would have to receive to part with the mug. The answer was $8. It is basically the same question but possession or ownership made the mug more valuable.

Simply owning something, like our homes, makes it more valuable. We really do not like losing something once we have it. The pain of losing outweighs the joy of winning. This is called ‘loss aversion’. Buying a house vs. renting. We tend to view renting as lost money, like throwing it away. Sometimes it makes sense to rent if you are not planning to stay in one place for a long period of time.

Once you see the endowment effect and feel loss aversion, you will understand and make adjustments.