The Endowment Effect, Loss Aversion, and Status Quo Bias
Kahneman, Knetsch, and Thaler (1991)
* The Endowment Effect: The value of a good increases when it becomes a part of a persons endowment. The person demands more to give up an object then they would be willing to pay to acquire it.
Kalmeman, Knetsch, and Thaler (1990) Ran studies to determine whether the Endowment effect survives when subjects face market disciplines and have a chance to learn.
Study 1: undergraduate economics class participated in a series of markets. Alternating students given Cornell coffee mugs valued at $6.00.
Four markets conducted Two exceptions:
Economic Theory prediction: When the market clears, the objects will be owned by those subjects who value them most.
Results: Low volume in trades
Reason: median selling prices are about twice median buying prices. "Owners" unwilling to sell for less than$5.25 "Buyers" unwilling to pay more than $2.25-$2.75.
After first study interested in investigating whether the low volume of trading is produced by a reluctance to buy or a reluctance to sell.
Study 2: 77 students selected at random and assigned to one of three conditions. "Sellers" - Given mugs and asked whether willing to sell at a series of prices ranging between $0.25-$9.25.
"Buyers" - Asked whether willing to buy at the same series of prices.
"Choosers" - Asked to choose for each price in the range between receiving a mug or that
amount of money.
Results: "Choosers" behaved more like "Buyers" than "Sellers". "Choosers"-$3.12 "Buyers"- $2.87 "Selters"- $7.12.
Suggests that the low volume of trade is produced mainly by owners reluctance to part with their endowment rather than buyers unwillingness to part with their cash.
In general, a given difference between two options will have a greater impact if it is viewed as a difference between two disadvantages than if it is viewed as a difference between two advantages.
* Status Quo Bias: One implication of loss aversion is that individuals have a strong tendency to remain at the status quo, because the disadvantages of leaving it loom larger than advantages.
Samuelson and Zcckhauser(1988) Study using hypothetical choice tasks. Two conditions 1. neutral version, no status quo defined. 2. same problem with one item defined as status quo.
Results: An alternative became significantly more popular when it was designated as the status quo. Also the advantage of the status quo increases with the number of alternatives.
Judgments of Fairness and Justice
Kahneman, Knetsch, and Thaler (1986)
* An implication of the endowment effect is that people treat opportunity costs differently than out-of-pocket expenses
* Foregone gains are less painful than perceived losses (A perception manifested in people's judgments about fairness)
Study supporting this claim:
~ Samples of residents were asked a series of questions over the telephone about whether they thought a particular economic action was "fair".
~ In two groups,respondents were asked to judge whether a particular action was:
a) completely fair
c) somewhat unfair
d) very unfair
Note: at the end, the first 2 categories were combined into one, 'acceptable'; and the last 2 categories were combined into 'unfair"
Perceptions of fairness strongly depended on whether the question was framed as a reduction in a gain or an actual loss
Loss Aversion: the disutility of giving up an object is greater than the utility associated with acquiring it.
Changes that make things worse (losses) loom larger.
Question la. A shortage has developed for a popular model of car and customers must now wait two months for delivery. A dealer has been selling these cars at list price. Now the dealer prices this model at $200 above list price.
N = 130 Acceptable 29% Unfair 71%
Question lb. A shortage has developed for a popular model of car and customers must now wait two months for delivery. A dealer has been selling these cars at a discount of $200 below list price. Now the dealer sells this model only at list price.
N = 123 Acceptable 58% Unfair 42%
Imposing a surcharge (likely to be judged as a loss) is considered more unfair than eliminating a discount, (reduction in a gain).
This distinction explains why firms that charge cash customers one price and credit card customers a higher price, always refer to the cash price as a discount rather than to the credit card as the surcharge.
The different intensity of responses to losses and to
foregone gains may help explain why it is easier to cut real wages during inflationary periods:
Question 2a. A company is making a small profit. It is located in
company decides to decrease wages and salaries 7 % this year.
N = 125 Acceptable 37% Unfair 63%
Question 2b. A company is making a small profit. It is located ina community experiencing a recession with substantial unemployment and inflation of 12%. The company decides to increase salaries only 5% this year.
N = 129 Acceptable 78% Unfair 22%
In this case, a 7% cut in real wages is judged as reasonably fair when it is framed as a nominal wage increase, but quite unfair when it is posed as a nominal wage cut.
Studies show that people respond emotionally to events in their lives with thoughts about "What might have been"--"what almost was"...
Psychologists know that how you compare your situation to other people's situations has a high impact on how you feel about your own situation.
It is also fair to say that how you expected an outcome of a
situation to be also affects your satisfaction with the actual outcome.
Medvec, Gilovich and Madey studied the emotional responses of silver and bronze medalists at the '92 Summer Olympics to test the role of counterfactual thinking in peoples' satisfaction of their objective circumstances.
Here are the possible counterfactual thoughts of the bronze and silver medalists. The silver medalist is most likely thinking that they almost got the gold. They were only one step away from being THE BEST. They beat everyone else, except for that one person that won the gold. The silver medalist focuses their counterfactual thoughts upward.
The bronze medalist on the other hand is most likely thinking that at least they got a medal. At least they are on the medal stand and not in the showers like the fourth place finisher. The bronze medalist focuses their counterfactual thoughts downward.
This difference in the counterfactual thought directions might cause the person who is objectively worse off-- the bronze medalist in this case-- to have more satisfaction in their situation than the silver medalist-- who is objectively better off.
Medvec, Madey and Gilovich conducted 3 studies to test this idea.
Analyzed the reactions of silver and bronze medalists after placing in their events in the '92 Olympics.
They combined video clips of the bronze and silver medalists' reactions to their placement and made 2 tapes with the footage.
The first tape showed all the bronze and silver medalists at the exact moment when they found out how they had placed. The second tape showed all the bronze and silver medalists standing on the medal stands for the awards ceremony.
Twenty Cornell University undergrads who were not sports fans were shown the tapes and they rated the emotions that the athletes expressed on a ten-point scale from "agony to ecstasy".
Hypothesis: the third place finishers would show higher satisfaction than the second place finishers.
Results: the participant's ratings were very reliable and they did follow the prediction. On average, the bronze medalists were rated as appearing happier than the silver medalists.
This is not surprising if we think about the counterfactual thoughts that the medalists might be thinking. The silver medalist is thinking "if only I would have..." and the bronze medalist is thinking "at least I...
The study did not go into this, but I think it would be good to know exactly how close the scores were and what places the athletes were expected to get. Because if the bronze medalist expected to get the silver and lost by a tenth of a second or something, it seems like they would have the same kinds of counterfactual thoughts.... (?)
Testing the actual counterfactual thoughts of the medalists.
They made another video of the clips of bronze and silver medalists at the '92 games who were interviewed by NBC.
They showed the tape to 10 Cornell University students and asked them to rate how much the medalists focused on how they actually performed versus how they "almost" performed.
Results: Again, the participants' rating reliability was very high. Just like predicted, the participants rated the silver medalists as focusing more on what they almost did than the bronze medalists.
They rated bronze medalists to be more focused on their own performance than the silver medalists.
All this provides support for the differences in counterfactual thinking, and also for the expressed reactions seen in study 1. Both of these studies, however, did not use the actual thoughts of the medalists.
Examined the reported thoughts of bronze and silver medalists after the '94 Empire State Games-- a big event in New York.
150 bronze and silver medalists combined were asked to rate their own thoughts about their performance on the 10 point "at least I.. to I almost..." scale.
Just as predicted, the silver medalists were more concerned with "I almost" than the bronze medalists.
The findings from all three studies were consistent. They show that silver medalists do seem to be more focused on what they almost did than bronze medalists.
This difference in counterfactual thinking shows how bronze medalists seem to be more satisfied with their performance than silver medalists.
This can apply to everyday life-- not just athletic competitions. There are times when people who are better off may feel worse than those who are actually worse off. A student who is one point away from an A-is going to feel a lot worse than a student who got an 83%, even though the student with the 83% objectively did worse.
Someone who gets 5 of the six lottery numbers right still gets more money than someone who did worse, but they tend to focus on how they almost won all the money if only they would have guessed one number differently.
Many counterfactual thoughts seem to be automatic for us and can be used strategically.
Downward comparisons (thinking that something could be worse) is kind of comforting in hard situations. Whereas upward comparisons (thinking of what could have been) can motivate you to do better next time.
One thing that does need to be studied is the duration of these counterfactual thoughts. We don't know for how long bronze medalits seem to be happier than silver medalists.
Siminson, I. (1992). The Influence of Anticipating Regret and Responsibility on Purchase Decisions. Journal of Consumer Research, 19, 105-118.
Norm Theory: People are expected to feel greater regret and responsibility for actions that deviate from the norm or default options because it is easy to imagine doing the conventional thing.
ex. when searching for a name on a list, an individual who decided to start at the end and finally found the name at the beginning of the list would be expected to feel greater regret and be more upset with the search strategy than one who started at the beginning and found the name at the end of the list.
Omission Bias: The finding that actions are associated with greater regret and responsibility than are inactions.
On Purchase Decisions..
Individual A decides to make the purchase early, then finds out the same product was offered on better terms later.
Individual B decides to wait for a better deal, then finds out that the earlier (missed) opportunity turns out to be more attractive than later options.
In this case, individual A may feel that it was not possible to predict the better sale and, therefore that she/he is not responsible for the outcome. However, individual B is expected to feel greater regret and be more upset with the purchase-timing decision than individual A because deciding to wait may be more of a gamble and reflect a deliberate strategy on the part of the consumer for getting a better deal than what is currently available.
Choosing Between Brand Name and Price
If the consumer selected the more expensive alternative and it failed, then the responsibility for the failure would rest on the manufacturer rather than on the decision of the consumer. But, if the consumer chose the cheaper alternative and it failed, then the consumer might feel responsible for the failure and regret the decision.
The conclusion from this study is that the considerations of decision errors tends to increase the preference for earlier purchases and better-known brands.
Regret vs. Responsibility
*It was assumed that regret and responsibility were highly positively
correlated, with a higher sense of responsibility leading to greater regret. However, selections of better-known brands were associated with less responsibility and greater regret. Thus, regret and responsibility should be regarded differently.
Regret represents the sorrow over something done or not done, regardless of the decision maker is responsible for. Therefore, the magnitude of regret is to depend on the difference between the actual and the alternative outcomes, lesser degree on whether the selected option represents the "norm".
On the other hand, the magnitude of responsibility represents the degree of self-blame for the decision that led to the obtained outcome.