The endowment effect is usually explained as a byproduct of loss aversion—the fact that we dislike losing things more than we enjoy gaining them.
Because of loss aversion, when we’re faced with making a decision, we tend to focus more on what we lose than on what we gain. As a result, in general, we are biased to maintain the status quo, rather than shake things up and risk sustaining losses. In one experiment by Daniel Kahneman and Amos Tversky, two of the founding fathers of behavioral economics, participants were asked to imagine that they were in one of two jobs—let’s call them Job A and Job B. They were told they’ve been offered the option of moving to the other job, A or B. The new job was better than their current one in one aspect, but was worse in another. Kahneman and Tversky found that regardless of which job they started out in, most people did not want to move to the other one.2
Another aspect of loss aversion is the fact that, when we make decisions, we usually under-value opportunity costs. Opportunity costs are benefits that we miss out on when we choose one alternative over another, as opposed to out-of-pocket costs, which is the direct payment you make in a transaction. In the endowment effect, when we try to overcharge a buyer for something we own, it is partially because we are more focused on the out-of-pocket cost (losing that item) than we are on the money we miss out on if the buyer doesn’t agree to our price.1
Buyers and sellers value things differently
Although the endowment effect was originally attributed entirely to loss aversion, other researchers have suggested a few other explanations that are better supported by evidence. One of these comes from a 2012 paper by Ray Weaver and Shane Frederick, who argue that the endowment effect actually happens because people are trying to avoid getting suckered into a bad deal. This view is known as reference price theory.
According to this view, when buyers and sellers approach a transaction, they often have different reference prices, or ideas about how much something is worth. Buyers don’t want to pay more than they think an item is worth, but sellers don’t want to sell for less than that item’s market price.4 So, for example, if you were trying to sell a mug that normally retails at $3, you probably wouldn’t want to settle for anything less than that, because then you would feel like you’re losing out. However, for a buyer who’s just casually interested in getting a new mug, $1 might be the most they are willing to pay.3
In other words, the endowment effect happens when there’s a gap between a buyer’s willingness to pay and a seller’s willing to accept a certain price. Sometimes this gap appears because, when trying to decide what a reasonable price for something is, buyers will look to the lowest available price as a reference point, while sellers look at the highest ones. For example, if you were reselling a $250 ticket for a basketball game, and you saw that some people were reselling similar seats for $400, you might feel like a sucker if you sold for less than that. Meanwhile, people who are looking to buy tickets like yours see that others have gone for closer to the original price, and so they’re not willing to pay your higher price.5
Our positive self-concepts spill over to our possessions
Another possible driver of the endowment effect stems from the fact that we tend to like things more when we associate them with ourselves. Whether it’s justified or not (and it’s very often not), we are biased to see ourselves in a positive light, and we often believe that we are exceptional in various ways. Research has shown that this view of ourselves even extends to items that we own. This is known as the mere ownership effect.6
In one study looking at the mere ownership effect, university students who participated in the study were told they were taking part in a consumer preference study, and their job was simply to rate the attractiveness of a bunch of different products, including items like chocolate, a key ring, and soap. One of the items was a plastic drink insulator—a tube you can put around cans to keep them cold. To investigate whether people felt more strongly about items they owned, some of the participants were told they would be given a drink insulator as a “thank you” gift for participating.
If a plastic tube sounds like it would be a boring present to receive, you’re right: researchers chose it because they had found, in a separate study, that people’s feelings about the drink insulator were pretty much neutral. As unexciting as this item ordinarily is, the researchers found that participants who received it as a gift rated it as more appealing, compared to participants who were not offered a gift.6
One interesting aspect of this theory is that people have an even stronger need to enhance their mental image of themselves if they feel like their self-concept is being threatened. Indeed, one study found that after getting a bad rating for their performance on a task, people who had been given a drink insulator as a gift rated it as more appealing, compared to people who had not received negative feedback.6
Psychological ownership is different from actual ownership
Even if something doesn’t technically belong to us, we might still feel like it’s somehow ours. A lot of research has explored how much it takes for us to develop a sense of ownership over something, and the answer turns out to be not very much. This means that there is also a pretty low threshold for the endowment effect to kick in.
In one experiment, researchers gave each participant a chocolate bar, placing it on their desk—but also telling them they weren’t allowed to eat it. For thirty minutes, the participants worked on a project, with the chocolate bar staring them down all the while. Finally, when the project was done, the researchers told the participants that the chocolate bar was theirs. But before they left, people were given a choice: to keep the chocolate, or to sell it back at a price they determined.
On average, participants who sold the chocolate bar back sold it for $1.72. However, in another group, where the chocolate bar was merely handed to people as a reward at the end of the project instead of sitting on their desks for half an hour, people only valued the chocolate at $1.35.7 That’s the endowment effect at work.
As this study shows, psychological ownership can spring up really easily. Other research has found many other ways that people can be made to feel a sense of ownership, including being allowed to touch a product before buying it.7