Monthly Archives: December 2013

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Ownership, loss aversion, the endowment effect, and lava lamps

Do you ever see things for sale on eBay with prices that seem astonishingly unrealistic? I get daily emails of newly listed items containing my saved search terms and sometimes the prices are just ridiculously optimistic. Not only that, but the items turn up again and again and again, re-listed and re-listed and re-listed, often at the same price. I know that some of the items will be from consignment sellers who have probably agreed with a client on a set price and to re-list indefinitely until the item sells, but a lot of the listings are just from individuals clearing out their homes and offloading the things they don’t want any more. Just sometimes at prices so high that the items never sell.

What might be responsible for some of these crazy prices is the endowment effect, a psychological phenomenon in which people typically demand a lot more in order to relinquish an item they already own than they would be willing to pay for the item if they didn’t already own it.

In the classic study of the endowment effect by Daniel Kahneman and colleagues, research participants were given a mug and were then offered the opportunity to sell it or to trade it for something of equal monetary value. However, once the participants were given ownership of the mug and felt like it was theirs, they typically expected twice as much money in order to be willing to part with it than they were willing to pay for the mug when they didn’t own it. So when they don’t own the mug, maybe they think it’s worth $5, but when they do own the mug, they expect someone to pay them $10 for it.

One explanation for the endowment effect is loss aversion – owners of items expect the pain of relinquishing the items to be greater than the enjoyment of acquiring the items, so they need extra financial compensation to soften the blow of parting with the item. However, an alternative explanation is related simply to ownership and the possibility that owners might associate the items with themselves, so they are reluctant to part with an item because of this personal connection – not necessarily because they expect to feel any pain from the loss.

Morewedge and colleagues investigated the endowment effect in terms of the loss aversion account versus the ownership account, to see which was more likely to be the real explanation. The problem, of course, is the fact that sellers are usually owners, so even if you just want to look at whether loss aversion occurs when someone considers selling an item, you’re kind of incidentally looking at ownership to some extent too. You need to add some extra factors in to get a clear picture of what’s going on.

Firstly, what if you create a new type of person – someone who’s a buyer but also an owner? Does such a person, i.e. one who is selling a mug but also happens to own another identical mug that they aren’t selling, behave more like a owner-seller (because they are an owner too) or more like a non-owning-buyer (because they are a buyer as well)? The researchers found that owning a mug actually resulted in buyers valuing the mug as much as sellers, which suggests that the high value that sellers place on the mug isn’t because of loss aversion – for instance, a seller might think a mug is worth $10, but someone who wants to buy that mug and already owns an identical mug also thinks the mug is worth $10. It appears to be the ownership that increases the mug’s perceived value; it can’t be loss aversion, since the buyer isn’t losing the mug.

Another clever way to tease apart the issue of loss aversion vs. ownership is to introduce additional parties – brokers who do the bargaining and dealing on behalf of the buyers and sellers. The researchers got some of the research participants to act as brokers to do a deal (on mugs again) on behalf of clients, so these brokers were buying or selling a mug without owning it. The researchers also gave some of the brokers identical mugs to the ones they had to buy or sell, so some brokers were buying or selling a mug they didn’t own but they also happened to own an identical mug. If the loss aversion account of the endowment effect is true, then sellers’ brokers should value the mugs more than buyers’ brokers, since sellers’ brokers will see their client’s sale as a loss and buyers’ brokers will see their client’s sale as a gain. However, if the ownership account is true, then buyers’ brokers and sellers’ brokers should value the mug more when they themselves own identical mugs to the one being bought/sold, compared to if the brokers don’t themselves own identical mugs.

The results showed that, again, owning the mug was the key factor here, and that buyers’ and sellers’ brokers valued the mug that they were buying or selling more if they themselves owned an identical mug. Again, it looks like ownership is the key factor in how valued an item is, rather than loss aversion. So maybe when those items turn up on eBay with crazy prices attached, what we’re seeing is the price for someone to be willing to relinquish something they connect with themselves. You might say it’s a bit like severing a tiny part of their identity, hence the premium price placed on the act.

Also, I just want to congratulate the study’s authors for getting what is essentially an ode to lava lamps into their paper, questioning the very nature of the human connection to lava lamps in language so imbued with poetic imagery and faint melancholy:

“Because the people who own lava lamps demand more to give them up than the people who do not own lava lamps will pay to get them, deals go unmade and storage lockers remain filled with lava lamps that are destined never again to glow. [...] We do not know if people store their lava lamps because parting with them is such sweet sorrow, but we do know that they store them because they like them and that they like them because they’re theirs.”