Rational Endowment

Recently The Economist published an article about the endowment effect: “[O]nce someone owns something, he places a higher value on it than he did when he acquired it — an observation first called ‘the endowment effect’ about 28 years ago by Richard Thaler, who these days works at the University of Chicago.”

The magazine calls this “a squishy, irrational bit of human behaviour.” One experiment “found that students were surprisingly reluctant to trade a coffee mug they had been given for a bar of chocolate, even though they did not prefer coffee mugs to chocolate when given a straight choice between the two.”

I propose that the endowment effect is perfectly rational for three main reasons.

1. When we acquire an object, we perform mental work to figure out how we’ll use it and what it’s good for. True, we do much of this work before we purchase an item. Yet I routinely find that, after I acquire something, I think of more ways to integrate it into my life. To take a simple example, all of my usual mugs are currently in storage, so I just acquired two new ones. As soon as I did, I thought, “These would fit perfectly on that short shelf in the kitchen, where nothing else fits well.” An object that we’ve spent mental energy figuring out how to better utilize is more valuable to us.

2. Automated habits are very valuable. As soon as we acquire something new, we start to work it into our regular routines. We develop habits for a reason; they’re necessary time-savers. Granted, this point has force only after we’ve had an object for some (often short) period of time.

3. We reasonably avoid risk. Once we get the mug, we can look it over and make sure it isn’t cracked or have any other unanticipated problem. (Before getting the two new mugs, I looked at a mug that I discovered has an irregular surface inside, making it difficult to clean; I ditched that mug.) Meanwhile, I’ve had the experience of opening a chocolate bar and finding that it has turned white and flakey — yuck. Recently I also purchased some chocolate bars that didn’t taste as good as I anticipated, relative to other chocolate I like. Though I might equally prefer a shelved mug and a shelved chocolate bar, a mug in the fist is better than a chocolate bar on the shelf.

The Economist closes:

Other “irrational” phenomena include confirmation bias (searching for or interpreting information in a way that confirms one’s preconceptions), the bandwagon effect (doing things because others do them) and framing problems (when the conclusion reached depends on the way the data are presented). All in all, the rational conclusion is that humans are irrational animals.

But those other things are simply logical errors. (However, joining a bandwagon is not always irrational, absent additional information.) They are problems that can be avoided with careful methods and checks. The fact that we know about these problems, and can take steps to solve them, demonstrates that we are fundamentally rational, not irrational, at least in capacity.

The endowment effect is not a logical fallacy; it is a perfectly sensible preference of the integrated, the habituated, and the known to the unfamiliar, the awkward, and the untested.

2 thoughts on “Rational Endowment”

  1. Is that the same Richard Thaler who, with Cass Sunstein, are big proponents of “nudging”?

    Check out this Boston Globe article from the spring regarding their new book. The concept of giving people a little extra, behind the scenes help in making good decisions (nudging)is more than a little scary.


  2. There is another, though perhaps less common, rational reason for the endowment effect: sentimental value. When we come to treat an object as a symbol for something or someone important, whether because of the conditions under which we got the object or because of some later association, it becomes more valuable then even an exactly equivalent object.

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