Endowment Effects Joe Abittan

Endowment Effects

In his book Thinking Fast and Slow, Daniel Kahneman discusses an experiment he helped run to explore the endowment effect. The endowment effect is a cognitive fallacy that helps explain our attachment to things and our unwillingness to part with objects, even when we are offered something greater than the objective value of the the object itself. We endow the object with greater significance than is really warranted, and in his book, Kahneman shows that this has been studied with Super Bowl tickets, wine, and coffee mugs.

 

Kahneman helped run experiments at a few different universities where college students were randomly given coffee mugs with the university logo. The mugs were worth about $6 each, and were randomly distributed to about half of a classroom. Students were allowed to buy or sell the mugs, and the researchers saw a divergence in the value assigned to the mugs by the students who randomly obtained a mug and those who didn’t. Potential sellers were willing to part with the mug for about $7 dollars, a price above the actual value of the mug. Buyers, however, were generally only willing to purchase a mug for about $3, or half the value of the mug.

 

Kahneman suggests that the endowment effect has something to do with the unequal values assigned to the mug by those who received a mug and those who didn’t. He suggests that it is unlikely that those who received the mugs really wanted a university mug and particularly valued a mug relative to those who didn’t receive a mug. Those students should have been willing to trade the mug for $3 dollars which could be used to purchase something that they may have actually wanted, rather than a random mug. To explain why they didn’t sell their mugs, Kahneman suggests that the mugs became endowed with additional value by those who received them.

 

A further study showed similar effects. When all students in the class randomly received either a chocolate bar or a mug, researchers found that fewer students were willing to make a trade than the researchers predicted. Again, it is unlikely that a random distribution of mugs and candy perfectly matched the mug versus candy preferences of the students. There should have been plenty of students who could have used a sugar boost more than an extra mug (and vice versa), but little trading actually took place. It appears that once someone randomly receives a gift, even if the value of the gift was very small, they are not likely to give it up. The gift becomes endowed with some meaning beyond its pure utility and value.

 

Kahneman describes part of what takes place in our minds when the endowment effect is at work, “the shoes the merchant sells you and the money you spend from your budget for shoes are held for exchange. They are intended to be traded for other goods. Other goods, such as wine and Super Bowl tickets, are held for use to be consumed or otherwise enjoyed. Your leisure time and the standard of living that your income supports are also not intended for sale or exchange.”

 

The random mug or candy bar were not seen as objective items intended to be traded or bartered in exchange for something that we actually want. They were viewed as a windfall over the status quo, and thus their inherent value to the individual was greater than the actual value of the object. Kahneman suggests that this is why so few students traded candy for mugs, and why mug sellers asked far more than what mug buyers wanted to pay in his experiments. The endowment effect is another example of how our emotional valence and narrative surrounding an otherwise objectively unimportant object can shape our behaviors in ways that can seem irrational. Next spring when you are trying to de-clutter your house, remember this post and the endowment effect. Remember that you are imbuing objects with value simply because you happen to own it, and remember that you would only pay half price for it if it was actually offered to you for purchase now. Hopefully that helps you minimalize the number of mugs you own and declutter some of your cabinets.
Revealed Preference

Revealed Preference – Insights from Government, Healthcare, and Sports

I have written in the past about government budgets as seen through the eyes of people who have studied government and political science. The budget serves as a written calculation that enumerates the government’s priorities. In economics terms, we might call this revealed preference, where the government puts a dollar figure down next to the things that candidates and political leaders said was important. The dollar figure they put next to an educational program, a defense program, or towards a new Veteran’s Administration Hospital reveals just how much they actually care about that thing. If we elect a whole set of candidates who promised to improve our local school buildings, but then budget only a tiny new amount of money toward school maintenance while offering a big tax break to financial institutions, their real preferences have been revealed, and they didn’t match what was in their campaign message.

 

I wanted to present a detailed example of government budgeting and revealed preference to set up an observation that comes from Dave Chase in his book The Opioid Crisis Wake-Up Call: Health Care is Stealing the American Dream. Here’s How We Take it Back. Chase was working in the healthcare industry as a revenue cycle consultant, what he describes as someone who helps hospitals with, “generating as a big a bill possible, getting it out as fast as possible, and getting paid as quickly as possible.” After the loss of a close friend, whose encounter with the healthcare system at a young age was incredibly financially costly, Chase saw behind the hospital curtain, and was shaken by the revealed preferences that he uncovered.

 

“Despite breakthrough technologies that could improve patient outcomes, that’s not what hospital wanted to buy. All they wanted were systems tuned to game every reimbursement opportunity the industry had to offer.”

 

I don’t want to say that all hospitals are evil and that hospital management only wants to maximize the money they get out of their patients at every encounter. However, Chase’s quote reveals that the goals of being a financially solvent hospital or healthcare system serving the needs of patients can be displaced by the goal of profit or increased margins. The financial side of a hospital is important – you don’t want your hospital to go under and leave people without medical care – but if the hospital is advertising itself as an organization that puts patient’s first, then its actions should support that messaging. Revealed preference shouldn’t show us that patient care and outcomes fall far behind maximizing profit.

 

Chase was so shaken by the observation in his quote that he left the healthcare field altogether. When revealed preference shows us something hypocritical about the space we are in, whether it is government, healthcare, or even sports, it creates cynicism and drives away the talented innovators who are needed for making the world and field a better place. Chase argues that the revealed preference that he uncovered, increasing hospital margins/profits, was actually damaging to the health and well-being of Americans, and not just in a financial way. If we are in a leadership position, if we are part of the team that makes decisions between the public goal and the internal goal of the organizations we are a part of, we should be asking what our actions and decisions reveal about our preferences. In healthcare, are we really just chasing the dollar, or are we trying to help people live longer and better lives? In government, are we really trying to serve people well, or are we just trying to get really good at following the rules so that we don’t get called in front of a legislative committee? In sports, are we really focused on the game and improving the experiences of athletes and fans, or are we again just maximizing the dollars we get from butts in seats and eyeballs on tvs? The bet I’m willing to make, one that I think Chase would make as well, is that our real preferences will be revealed to the people who interact with our organizations, and in the long-run, if the revealed preference is not what we advertise, people will know, and our organization will lose trust, lose customers, lose talent, and will ultimately fail.