23
DON’T CLING TO THINGS
Endowment Effect
The BMW gleamed in the parking lot of the used-car dealership. Although it had a
few miles on the odometer, it looked in perfect condition. I know a little about used
cars, and to me it was worth around $40,000. However,
the salesman was
pushing for $50,000 and wouldn’t budge a dime. When he called the next week to
say he would accept $40,000 after all, I went for it. The next day, I took it out for a
spin and stopped at a gas station. The owner came out to admire the car – and
proceeded to offer me $53,000 in cash on the spot. I politely declined. Only on the
way home did I realise how ridiculous I was to have said no. Something that I
considered worth $40,000 had passed into my possession and suddenly taken
on a value of more than $53,000. If I were thinking purely rationally, I would have
sold the car immediately. But, alas, I’d fallen under the influence of the
endowment effect
. We consider things to be more valuable the moment we own
them. In other words, if we are selling something, we charge more for it than what
we ourselves would be willing to spend.
To probe this, psychologist Dan Ariely conducted the following experiment: in
one of his classes, he raffled tickets to a major basketball game, then polled the
students to see how much they thought the tickets were worth. The empty-handed
students estimated around $170, whereas the winning
students would not sell
their ticket below an average of $2,400. The simple fact of ownership makes us
add zeros to the selling price.
In real estate, the
endowment effect
is palpable. Sellers become emotionally
attached to their houses and thus systematically overestimate their value. They
balk
at the market price, expecting buyers to pay more – which is completely
absurd since this excess is little more than sentimental value.
Richard Thaler performed an interesting classroom experiment at Cornell
University to measure the
endowment effect
. He distributed coffee mugs to half of
the students and told them they could either take the mug home or sell it at a price
they could specify.
The other half of the students, who didn’t get a mug, were
asked how much they would be willing to pay for a mug. In other words, Thaler
set up a market for coffee mugs. One would expect that roughly 50% of the
students would be willing to trade – to either sell or buy a mug. But the result was
much lower than that. Why? Because the average
owner would not sell below
$5.25, and the average buyer would not pay more than $2.25 for a mug.
We can safely say that we are better at collecting things than at casting them
off. Not only does this explain why we fill our homes with junk, but also why
lovers of stamps, watches and pieces of art part with them so seldomly.
Amazingly, the
endowment effect
affects not only
possession but also near-
ownership. Auction houses like Christie’s and Sotheby’s thrive on this. A person
who bids until the end of an auction gets the feeling that the object is practically
theirs, thus increasing its value. The would-be owner is suddenly willing to pay
much more than planned, and any withdrawal from the bidding is perceived as a
loss – which defies all logic. In large auctions, such as those for mining rights or
mobile radio frequencies, we often observe the
winner’s curse
: here, the
successful bidder turns out to be the economic loser when he gets caught up in
the fervour and overbids. I’ll
offer more insight on the
winner’s curse
in chapter
35.
There’s a similar effect in the job market. If you are applying for a job and don’t
get a call back, you have every reason to be disappointed. However, if you make
it to the final stages of the selection process and then receive the rejection, the
disappointment can be much bigger – irrationally. Either you get the job or you
don’t; nothing else should matter.
In conclusion: don’t cling to things. Consider your property something that the
‘universe’ (whatever you believe this to be) has bestowed on you temporarily.
Keep in mind that it can recoup this (or more) in the blink of an eye.
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