One of the bedrocks of (neo)classical economic theory is the premise that humans act as homo oeconomici or ‘economic agents.’ This boils down to the assumption that when given a choice between two items, people will make a rational decision and choose the item that they value the most. As simple and intuitive as the premise sounds, it is also deeply flawed in that experiments have demonstrated it to be downright false.
By conducting experiments researchers from the fields of psychology and behavioural economics have identified a laundry list of common biases that cause people to act ‘irrationally’ i.e., against their own apparent interests. The so-called ‘endowment effect’ – where the mere fact of possessing an item raises its value to the owner – is one of these biases.
A classic endowment effect experiment consists of giving participants one of two items, for example either a chocolate bar or a mug, and then asking if they would like to trade for the other. Since the starting allocation is random one can assume that there is a 50 percent chance that a person will receive the item that he or she likes most and thus the chance of someone looking to trade their item should also be 50 percent. However, in practice people only trade 10 percent of the time, with the vast majority preferring to hold onto their newly endowed item.
Implications of the endowment effect are the distortion of market prices, whereby owners demand much more to give up their object than even they themselves would be willing to pay to acquire it and a subsequent reduction of trade overall. Given that we live in an economy that is driven by consumption and is thus inherently unsustainable, there are many arguments in favour of moving further towards a so-called ‘sharing economy,’ whereby individuals hire out things such as cars, homes, and personal time to other individuals and in doing so reduce overall consumption. The existence of the endowment effect can have a significant impact on the adoption of such forms of shared consumption, since it can be reasoned that many people may only be willing to share their goods at a restrictively high price, if at all. This would hamper market transactions and reduce the sharing of good and thus also the efficacy of such a form of economy.
Furthermore, based on the same reasoning as mentioned above regarding the sharing economy, there are also arguments in favour of moving towards a ‘circular economy,’ these two concepts of economic systems are not in any way mutually exclusive. The aim of such a circular system is to keep products, equipment and infrastructure in use for longer in order to improve the productivity of these resources and minimise the use of resource inputs and the creation of waste, pollution and carbon emissions. The mechanism by which this can be achieved is by reusing, sharing, repairing, remanufacturing, and recycling in order to create a closed-loop system. It can be contended that also this form of economic system may be impacted by the endowment effect, in particular when it comes to individual’s willingness to give up items for recycling, as well as sharing and allowing the reuse of their goods by other.
Early laboratory demonstrations of the endowment effect were offered by Knetsch and Sinden (1984) and were followed up by many further experimental results that solidified the findings. However, these experiments generally involved participants from so-called ‘WEIRD’ – western, educated, industrialised, rich and democratic – societies. Therefore, the question arises whether the bias is truly universal and has always been present in humanity’s evolutionary past or if the bias is possibly society-specific. Answers to these questions regarding the origin of the endowment effect can help in the identification of potential ways of averting the bias and thus aiding individual and societal transformation towards a more sustainable economic system.
Coren Apicella and her colleagues (2014) contributed considerably to solving these questions by conducting endowment effect experiments with the Hadza people of Tanzania. The Hadza are one of the last hunter-gatherer populations of the world, living in small nomadic camps where nearly all possessions are shared communally in the group. While some of the Hadza people live in areas with greater exposure to modern society, undergoing activities such as buying items from stores in the nearby village or selling bows and arrows to tourists, others are virtually isolated because a large lake separates them. The researchers found out that the people near the village traded about 25 percent of the time, which is close to the 10 percent one sees with WEIRD participants, and thus clearly exhibited the endowment effect. The isolated people, however, did not exhibit the endowment effect and traded their item about 50 percent of the time – which is what one would expect rational people to do.
It can thus be inferred that culture does seem to play an important role in transmitting the bias. What remains unclear is whether the discovered lack of an endowment effect in the isolated people is due to not coming in contact with capitalistic societies and thus never learning the biased behaviour, or whether the effect is indeed being experiences also by the isolated people but merely suppressed due to social pressures in the communal group. Either way, it would seem that societies are able to unlearn or suppress the endowment effect in particular through cultural processes.
Apicella, C. L., Azevedo, E. M., Christakis, N. A., & Fowler, J. H. (2014). Evolutionary origins of the endowment effect: Evidence from hunter-gatherers. American Economic Review, 104(6), 1793-1805.
Kahneman, D., Knetsch, J. L., & Thaler, R. H. (1991). Anomalies: The endowment effect, loss aversion, and status quo bias. Journal of Economic Perspectives, 5(1), 193-206.
Knetsch, J. L., & Sinden, J. A. (1984). Willingness to pay and compensation demanded: Experimental evidence of an unexpected disparity in measures of value. The Quarterly Journal of Economics, 99(3), 507-521.