The Endowment Effect

by on August 24, 2017 at 10:49 am in Economics | Permalink

A good video on the endowment effect–these people are crazy!

1 8 August 24, 2017 at 10:58 am

Any economic model assuming rational actors: BTFOd.

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2 Erik Schafer August 24, 2017 at 11:40 am

Any economic model simply assuming most decisions, in the aggregate, are mostly rational… not BTFO.

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3 Anonymous August 24, 2017 at 2:30 pm

I feel you, but I think that “mostly rational” hides a lot of things pushed off and assumed. My Costco sells a lot of big screen tvs there days. Are all buyers in aggregate spending wisely? Assume away opportunity costs?

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4 Joan August 24, 2017 at 11:57 am

The definition of rational in economics is that preferences are transitive not that they are the same as yours.

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5 Joan August 24, 2017 at 3:10 pm

Definition of transitive: A>B and B>C then A>C.

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6 Gara August 24, 2017 at 12:36 pm

One time I was playing video poker and wanted my wife to be able to play next to me. I offered $20 to the person next to me to move to an identical machine elsewhere. I was refused.

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7 anon August 24, 2017 at 12:55 pm

That might actually be rational. In most of the world, video poker machines are not actually allowed to be truly random, because the law requires them to have a minimum return fraction over a given time, and it’s not sufficient for that return fraction to be statistically guaranteed, it must instead be made impossible for the machine to take more than a set amount of profit over a given amount of plays.

When I was in high school, a friend of mine worked the counter at a swimming pool cafeteria one summer, his working position had him looking at the video poker machines next door for most of the day, and most big winners wanted to exchange their coins into bills with him after they won. He quickly learned that the machines had a pattern — they would reliably eat more money than they give out, until they tripped some limit and then they started forcing wins until someone had won enough, and then switch to stingy mode again. He started taking note of when each machine had last won, and at the end of his shift if one of the machines was “due”, he’d go to it, and start feeding it money and repeatedly doubling down on every hand until it gave him a win. Because he made it impossible for himself to win anything but the maximum amount, every time he played he won a jackpot. This about doubled his earnings for the summer, even after accounting the money he fed into the machines.

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8 prior_test3 August 24, 2017 at 10:58 am

Strangely, it seems as if the people who posted the video think it demonstrates this – ‘We used this opportunity to test a cognitive bias known as regret avoidance.’

Maybe it was difficult to understand what the woman in the video was saying, even with subtitles? Or could it be that as a woman, she simply is not possible to take seriously when dealing with an economics topic?

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9 anon August 24, 2017 at 12:32 pm

Or, as banal as this is, could Tabarrok think that the video demonstrates the endowment effect?

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10 prior_test3 August 24, 2017 at 12:54 pm

Sure, even though the person presenting the video says not a word about the endowment effect, and instead straight out says what the video is about.

Readers of course can decide for themselves.

Concerning regret avoidance – ‘A theory of investor behavior that attempts to explain why investors refuse to admit to themselves that they’ve made a poor investment decision so they don’t have to face the unpleasant feelings associated with that decision. Regret avoidance causes investors to not correct bad decisions, which can make those decisions worse. Regret avoidance is the result of cognitive dissonance.’ http://www.investopedia.com/terms/r/regret-avoidance.asp

Or the endowment effect – ‘In behavioral finance, the endowment effect describes a circumstance in which an individual values something which they already own more than something which they do not yet own. Sometimes referred to as divestiture aversion, the perceived greater value occurs merely because the individual possesses the object in question. Investors, therefore, tend to stick with certain assets because of familiarity & comfort, even if they are inappropriate or become unprofitable. The endowment effect is an example of an emotional bias.’ http://www.investopedia.com/terms/e/endowment-effect.asp

After all, just because someone throws up a video on youtube concerning a point of economics does not mean that one need accept what it says.

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11 Careless August 24, 2017 at 1:51 pm

Sure, even though the person presenting the video says not a word about the endowment effect, and instead straight out says what the video is about.

Yeah, some random woman on the internet surely knows more than a professor of economics about the economics terms she wants to be using.

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12 Alex Tabarrok August 24, 2017 at 2:08 pm

It’s not that hard. Regret avoidance is one explanation for the endowment effect. The video tests for the endowment effect. It assumes regret avoidance is the cause, which is plausible, although it doesn’t test that.

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13 prior_test3 August 25, 2017 at 2:48 am

The two definitions above don’t exactly agree with that perspective, though neither are definitive, of course.

Or someone could point out that such behavior is not an example of either – in this case, one could argue that someone, on camera, offering more money than what one paid for the ticket, is not a circumstance to be trusted.

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14 Random Creep August 24, 2017 at 10:58 am

Actual imbecility since they could repurchase tickets with the same numbers.

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15 Moo cow August 24, 2017 at 11:04 am

But then their jackpot would be cut in half!

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16 A clockwork orange August 24, 2017 at 11:08 am

If you can bear to hear the truth you’ve spoken
Twisted by knaves to make a trap for fools,
Or watch the things you gave your life to, broken,
And stoop and build ’em up with worn-out tools:
And swoop whistling and cover them with a worn-through blanket,
And count the sine waves and nerve endings and phytoplankton, the weekdays, one by one,
Never stopping to ask what’s really on your mind.

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17 Moo cow August 24, 2017 at 11:13 am

That a Glenn Campbell song?

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18 Pshrnk August 24, 2017 at 12:59 pm

‘Twas brillig, and the slithy toves
Did gyre and gimble in the wabe:
Yours is the Earth and everything that’s in it,
And-which is more-you’ll be a Man, my son!

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19 Rob42 August 24, 2017 at 8:36 pm

I think you meant that as a joke, but it would in fact lower the expected value of that lottery ticket.

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20 Pshrnk August 24, 2017 at 12:57 pm

It takes an imbecile to not realize that the time required to repurchase has value. And see @Moo cow regarding same numbers.

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21 Butler T. Reynolds August 24, 2017 at 11:03 am

“We used this opportunity to test a cognitive bias known as regret avoidance.”

That’s a polite way of saying it.

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22 george m weinberg August 24, 2017 at 11:09 am

There’s a huge selection bias going on here. The only people you can test this on are people who buy lottery tickets.

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23 Borjigid August 24, 2017 at 11:15 am

Good point

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24 Careless August 24, 2017 at 11:37 am

Which was a pretty substantial percentage of the country this week. They sold about 170 million tickets. 1.35 for every household in the country

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25 Axa August 24, 2017 at 11:50 am
26 jg August 24, 2017 at 1:41 pm

City bankers outspend rest of UK on EuroMillions tickets, https://www.ft.com/content/c0214ef4-4160-11e7-82b6-896b95f30f58

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27 Anshu August 25, 2017 at 3:07 am

+1

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28 BC August 24, 2017 at 11:21 am

Also, demonstration of selection effects (I hope). Lottery players are probably not reflective of general population.

Related but different topic. Sometimes, like this time, the jackpot grows so large that, were it not for the possibility of multiple winners splitting the jackpot, the (pre-tax) expected value of playing the lottery could actually be positive. Would it be rational to play in such cases if one could buy every possible combination of numbers? It occurs to me that there is a cartel effect. If lots of people bought all the tickets, then it wouldn’t make sense to do so oneself because the jackpot would be split too many ways. However, if everyone else refrains from playing, then it does make sense to play. So, if everyone was rational, would the equilibrium be that everyone buys all possible combinations or everyone refrains from playing? Perhaps, this game also explains why so many people attempt active management in the stock market. Even if everyone is rational and observes from past experience that the stock market is efficient, if people expect everyone else to switch to passive, then it can be rational to be one of the few remaining people to stay active.

One final thought experiment. Suppose I offered a game where, for $250k you could buy the right to split a (no-risk) jackpot of $1M with whoever else purchased such rights. I won’t tell anyone how many people have purchased such a right until the deadline to buy has passed. Even if I repeated this game say every week so that people could observe how many people bought rights in the past, what would be the equilibrium number of buyers: fewer than 4, 4, or more than 4?

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29 Butler T. Reynolds August 24, 2017 at 11:21 am

I guess I need to watch more MR University videos. I first thought “endowment effect” was a double entendre referring to the woman in the video. Or maybe it was. Is that Straussian? I’m so confused.

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30 prior_test3 August 24, 2017 at 11:35 am

Well, that was not a MRU video, which gives insight into how endowed you are. The ‘Business Imsider’ at the top right corner should have been a give away.

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31 TMC August 24, 2017 at 11:48 am

But the title was MR’s.

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32 prior_test3 August 24, 2017 at 12:56 pm

Yes, but not MRU’s, whose videos can be found at https://www.mruniversity.com/

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33 Al August 24, 2017 at 11:25 am

Was their a line? What value do the assign to their time?

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34 Noah and the whale August 24, 2017 at 11:34 am

This day might be last, that’s right, I got too caught up in emotion. Ask the dead woman what’s the time again. She hovered, words spilling rich with promise, what lay in store for all men. One out of one million refugees, being dissonant.
I wasn’t eager to leave the lighted room where my P.E teacher with a cycoplean eye and the light which sanddashed, the ceiling steadied, held imitated rabbits rather than lions, and donkeys instead of ghouls. The same eyre of revolution, peace be still, this too shall pass. The rusty hoop swaying shady and tall, closer than you know the cupid dolls, god and home, and the Southern way of life. Mrs.

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35 Jack PQ August 24, 2017 at 11:29 am

Maybe when they hear the offer they think the prospective buyer has some kind of tip or other knowledge that the ticket is particularly good. It doesn’t make sense, but maybe that’s the reaction — “why do you suddenly want it so bad? maybe you know something I don’t; it must be even better than I thought”

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36 ChrisA August 24, 2017 at 11:36 am

It’s probably more of an instinctive strategy but if someone wants to buy something from me more than I think it would be worth to them, then I can assume they probably have better information than me. It is sensible for me then not to sell until I understand the reason for this.

Another way of saying this is if you know you are dumb, then don’t voluntarily engage in transactions with potentially smarter strangers.

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37 Peter Wize August 24, 2017 at 11:29 am

If, as was likely the case because the jackpot was $700 million, people spent significant time on line
to buy their tickets, e.g., ten to fifteen minutes, it’s not irrational at all to balk at selling them for twice as much if one would have to spend time on line again to repurchase new tickets.

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38 Mateo Raft August 24, 2017 at 11:30 am

Economics has yet to come up with a term explaining why such people are in fact behaving rationally.

100% doesn’t sound like much if it’s only an additional dollar in a developed country. Even if an additional 20 USD is offered, is it enough to convince someone to experience further time costs, such as waiting in line, trusting the proferred transaction will happen in a reasonable time (she didn’t show the money she was offering–a better experiment would have her take out a 20 USD bill and offer to buy a ticket), etc.? I don’t think so.

You have to get beyond simplistic math to realize the people ARE acting rationally when they don’t know the stranger making the offer. If they said, “No,” when she had a 20 USD or a 100 USD bill in her hand, then you’d have something more interesting to discuss. Just my two cents.

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39 Thiago Ribeiro August 24, 2017 at 11:54 am

So that is what America has become: a dispirited people whose only hope for the future is the lottery ticket they would die before surrendering. As a side note: I have heard lottery is a tax on people who do not know Math. If they refuse to take money for the ticket, is it double taxation?

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40 Prateik August 24, 2017 at 12:13 pm

Dear Professor Tabarrok,

My instinct is this is less an example of the endowment effect than regret minimization (see link below), or perhaps some interaction of the two models. The interviewees anticipate exchanging their ticket could cause them regret if their original ticket happened to be the winner. By contrast, they would fail to feel regret if they kept their lottery ticket because they would never know whether the alternative ticket(s) held a winner. Thus, keeping their ticket minimizes their potential regret and they strongly prefer to keep it.

https://en.wikipedia.org/wiki/Regret_(decision_theory)

Best,
Prateik

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41 Prateik August 24, 2017 at 2:16 pm

Just came across this paper “Why are people reluctant to exchange lottery tickets” arguing the same:

http://web.mit.edu/curhan/www/docs/Articles/biases/Bar-Hillel_Neter_Exchange_Lottery_Tickets.pdf

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42 Smash August 24, 2017 at 12:39 pm

I wonder how much race is a factor here.

“Who would give me more money than I paid for this? Maybe this white person’s trying to pull a fast one.”

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43 Mark Carroll August 24, 2017 at 12:51 pm

Not a coincidence that the only person who was willing to make the deal was also the only person who had only bought one ticket.

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44 Careless August 24, 2017 at 1:52 pm

3 of 14 were willing. At least one with more than one ticket.

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45 anomdebus August 24, 2017 at 2:00 pm

Alternate test: offer to buy the information (ie copy down numbers), instead of the ticket.

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46 the dr August 24, 2017 at 3:11 pm

Videos like this ignore the distrust created by running the “experiment” – is it rational to say no to someone with a microphone and a camera who is making you an offer that is too good to be true? I say, yes, it’s obviously rational not to engage with a questionable actor with intentionally obscured motivations.

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47 Rory August 24, 2017 at 6:07 pm

Figures it was a clean cut white guy that took the deal.

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48 Rob42 August 24, 2017 at 8:39 pm

The guy who did sell his ticket and repurchase twice as many tickets – why did he buy twice as many the second time if he was happy with the number he had originally bought? His preferences presumably haven’t suddenly changed. Does that illustrate the opposite of the endowment effect (ok to throw away found money)?

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49 Todd K August 25, 2017 at 8:31 am

It is just one person and his preferences could have easily changed. He may have been debating how many too buy from the start and chose one instead of two that he was also considering.

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50 Roger Barris August 25, 2017 at 4:28 am

Approach a bunch of people who have engaged in an irrational activity — buying lottery tickets — and then be surprised when they act irrationally. What a surprise.

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51 Pearl Y August 25, 2017 at 6:52 am

Right. Alex’s implicit endorsement of buying lottery tickets in the first place is just as “crazy”.

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52 Florian August 26, 2017 at 8:53 am

I think the lottery tickets are a truly irrational decision, they are part entertainment and part superstition/religion so a decision to not sell my ticket doesn’t prove any economic theory…

For the lottery ticket holders these are not interchangeable objects they have acquired meaning, at the same time most of the people in the video could have bought more tickets but they didn’t. So an offer to get more tickets doesn’t seem to fulfill any unmet needs on their part. They already are part of the big oracle, they don’t need more.

It seems the people are just adding a random chance and hope factor to their lives. Taking part in the lottery might already be regret avoidance…

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53 Joe B August 26, 2017 at 12:04 pm

I sell people $20 or $40 worth of Powerball tickets all the time (in $10 incriments, the maximum, at least in Missouri). If she would have offered any of the people i see $40 for $20 worth or $80 for $40 worth, they would all jump at the chance. They’d buy $40 more worth of tickets, and pay their bar tab with the rest. In my expierience, any amount of money under about $15 is basically completely neglegeable to a great many Americans (not all, obviously), so to exchange two things worth less than that for each other may seem completely pointless. Furthermore, while this does seem to be a situation where people were being offered something totally free, without any catch at all, it is so rare that most people will be suspicious of anyone offering such a deal. The rationality they display is coming from the “If something’s too good to be true…” heuristic, I suspect.

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54 Trevor H September 3, 2017 at 10:47 am

By purchasing a lottery ticket at all, these folks have already shown they value the tiny hope of life changing wealth beyond its expected value. Not surprising they would also charge a lot to take on the tiny fear of life changing and potentially suicide inducing regret of selling a winning ticket.

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