Of Bottles and Mugs

Have you ever noticed how much some of the things you own mean to you? That old watch you inherited from your grandpa, those Nike sneakers you just bought last week, or maybe that beat-up car you've been driving around with for years now. For how much would you be willing to sell these items? Or maybe you wouldn't sell them at all?

When the now famous American economist Richard Thaler was just a graduate student, he noticed some very irrational and "un-economic" behavior in one of his professors.
This man was a wine lover and regularly went to auctions to buy some bottles for his collection, never paying more than $35 for one. But he would refuse to sell any of his bottles for less than $100! It didn't make any sense. Owning the good appeared to increase its value.

Thaler didn't realize it right away, but he had just discovered the endowment effect. Something that you own has more value to you than an identical good that does not belong to you. Why? In his book Thinking, Fast and Slow, Daniel Kahneman explains that it has something to do with loss aversion:

"...the willingness to buy or sell the bottle depends on the reference point - whether or not the professor owns the bottle now. If he owns it, he considers the pain of giving up the bottle. If he does not own it, he considers the pleasure of getting the bottle. The values were unequal because of loss aversion: giving up a bottle of nice wine is more painful than getting an equally good bottle is pleasurable." (p. 293)

Since Thaler first observed this kind of behavior in his wine-loving professor, many experiments have been carried out that seem to prove the idea of the endowment effect. In one of these, attractive coffee mugs played a major role. Each one was about $6 worth at the time and they were distributed randomly to half of the participants (these were the Sellers). The other half (the Buyers) were asked to look at their neighbor's mug and indicate the price at which they would be willing to acquire it (using their own money), while the Sellers were asked to name a selling price. The results were clear: the average selling price was about double the average buying price!

In one variant of the experiment, a third group was added -- the Choosers. They could either receive a mug or a sum of money and had to indicate the amount of money that was as desirable as receiving the good. Here's what the average prices looked like:

Sellers      $7.12

Choosers  $3.12

Buyers      $2.87

And here's Kahneman's comment on it:

"The gap between Sellers and Choosers is remarkable, because they actually face the same choice! If you are a Seller you can go home with either a mug or money, and if you are a Chooser you have exactly the same two options. The long-term effects of the decision are identical for the two groups. The only difference is in the emotion of the moment. The high price that Sellers set reflects the reluctance to give up an object that they already own, a reluctance that can be seen in babies who hold on fiercely to a toy and show great agitation when it is taken away. Loss aversion is built into the automatic evaluations of System 1." (p. 296, emphasis mine)

Now if you still don't believe that we are deeply emotional beings and strongly influenced by what we feel in most of the decisions we make, I really can't help you ;-)