Standard econ - indifference curve
- tradeoffs are the same in both direction
- if willing to trade 1 apple for 2 bananas, should be willing to trade 1 banana for 1/2 apple
- indifferent about being at A and B
- preferences are independent of the direction of the exchange
what is the endowment effect
people value items that they own more highly than they would if they did not belong to them
- people demand more compensation to give up a good (WTA) compared to the maximum amount they are willing to pay (the value they place on it)
- the difference is the emotional attachment
- losses from a reference point are valued more than equal gains
how is endowment and loss aversion related
- endowment effect is explained as a product of loss aversion
- dislike losing things we own rather than gaining new things
- because of loss aversion, we focus on what we lose rather than what we gain
- want more compensation to make up for loss
Knetsch 1989
- measured endowment effect
control = no initial entitlement
treatment = endowed with coffee mugs and has option to trade for candy
- endowed with candy can trade for mug
- randomly allocated
- if no endowment effect expect to see same numbers of mugs and candy in all 3 groups - choose their preference
- testing if whether you are endowed makes you less willing to give it up
results of mug and candy
- free choice = 56 mugs 44 candy
- mug = 89 kept - 11 changed
- candy = 10 changed - 90 kept
- similar numbers = only 10% willing to exchange
- relationship is roughly reversed
- people value the item higher because they own it
Gaechter
= car endowment
- imagine you could buy this car - what is your WTP
- slider option
- imagine you own the car - what is your WTA if you sell
- slider option
- used audi car dealers as sample
standard econ WTP WTA
WTP and WTA should be the same
- owning the car shouldnt matter
Gaechter car results
- WTP mean price = 2.68
- WTA mean price = 6.03
- owning changes evaluation
crossing indifference curves
- elicited indifference curves of participants endowed with 5 pens / 4.50 and constructed average indifference curve for both groups
- ICs cross
- P for M is very steep
- M for P is very shallow
- y = p / x= money
- very different to standard econ
are proffessionals effected by endowement effect
they trade for a living - do they demand higher prices just because they own?
- used 2 unique sports cards
- traders randomly endowed with a card and told they receive it for answering questionnaire
- after survey finished get shown the second card and asked whether they want to trade
result of sports car endowment effect
- effect in inexperienced dealers
- not with experienced
so experience and intention to trade mitigate the endowment effect - experienced = more likely to trade the first card
what is status quo bias
- people preferring their current state
- product of loss aversion also
- people feel a heavier loss by moving away from current position instead of gaining
organ donations status quo bias
people prefer to stay in current position
- if you have to actively opt in = less consent percentages
- if you opt out = consent percentages high
- effort of moving
status quo and standard econ
why does status quo exist
people should choose utility maximising option that aligns with preferences = defaults or effort dont matter
cost of making the decision - effort
Johnson 2003
- online survey - is effort the reason for status quo bias
- did online survey
- click your preference
- opt in , out, neutral
- numbers of opt in being higher than actual country levels = most people neutral and optout
what are the 3 reasons people go with defaults
endorsement = believe that the default reflects a trusted reccomendation
ease = the harder it is to switch away
endowment = the more default reflects the status quo = less likely to want to switch from current position = more attatched to first option
- significant effects = regression analysis
what is loss aversion in risky choices
- gambles involving losses lead to different choices than gambles that involve gains
- loss aversion = losses loom larger than equivalent gains
LA exists in riskless and risky choice s
Kahneman
- lottery choices
- risk averse for gains
- risk seeking for losses
- even when the two lottery choice problems are equivalent in terms of final state wealth
- given 1000, chose between 50% to win 1000 or B get 500 for sure = 500 = risk averse
- given 2000, choose between 50% of losing 1000 or lose 500 for sure
- shows people change their preferences depending on risks
Kahneman
Expected utility theory
- value function that is concave is gain and convex is loss
- people are loss averse and evaluate gains and losses relative to a reference point
- people look at whether they are making a loss or gain not at the final outcome
- steeper in negative
what is wrong with EUT
doesnt consider reference point effects - gain and loss framing effects
- risk aversion = in gain domain
- risk seeking = in loss domain
Gachter
- measure WTA WTP at individual level and derive loss aversion under riskless choices
- measure loss aversion in risky choice in simple lottery choice task
- mark the minimum acceptable price you are willing to sell WTA = see point of indifference between i am ready and not ready to sell at 1, 2, 3
- list of coin tosses with payoffs - i want to toss i dont want to toss - lose 2 heads, win 6 if tails
risk and riskless
loss aversion in riskless and risky choices are correlated
