The Endowment Effect

In preparation for this weeks lecture our group was given the reading by John. A List, 'Neoclassical Theory Vs. Prospect Theory.'

The reading and lecture was based on 'The endowment effect' which can be described as people value a good a lot more once their property right to it has been established. I'm sure a lot of people would agree with this as it seems a reasonable statement, we tend to feel more attached to said good if it is ours rather than a good on a shelf. The paper that we read was focusing on the endowment effect and the way in which both the neoclassical and prospect theory can or can't explain it.

The prospect theory is seen as being a good explanation for the endowment effect as by loosing the item it is weighting more heavily that gaining a new one. However, the endowment effect is inconsistent with economic theories such as the neoclassical theory as according to them, you would weight the price of the item the same for what you would sell it for as for what you would buy it for. So the neoclassical theory cannot explain this effect, whereas in the prospect theory there is weighting around a reference point.

The neoclassical theory's argument for the endowment effect, is that simply inexperienced buyers would experience it, and that it is something that needs to be learned and a mistake made by an inexperienced consumer. The more experience in the market place you have the more likely your behaviour will resemble that of the neoclassical model.

An experiment took place in which there were 4 conditions, you were endowed with either a mug or candy bar, both or neither. There were two groups, non-dealers and dealers. The results showed that the non-dealers, with very little experience in the marketplace once endowed with a candy bar 81% kept it when asked if they would like to trade for a mug. Only 7% wanted to trade. This provides evidence of the endowment effect supported by prospect theory, but also for the idea that with experience it does not effect you. As in the experiment the Dealers were not influenced by the conditions.

I have found the idea of the endowment effect very interesting and easy to get to grips with as i can see how i would be influenced in it within my own decisions. The wiki is due in next week and our group is doing it on decision framing, my part is to generally analyse decision making as a whole and make some concluding remarks!