Endowment Effect: Definition & Example

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  • 0:04 It's Special to Me
  • 0:50 The Endowment Effect
  • 1:36 How it Affects Consumers
  • 2:45 How it Affects…
  • 4:03 Lesson Summary
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Lesson Transcript
Instructor: Brianna Whiting

Brianna has a masters of education in educational leadership, a DBA business management, and a BS in animal science.

We all love our things. But when it comes to selling them, what do you feel they are worth? In this lesson, we will learn how we value the things we own.

It's Special to Me

Imagine you meet a little girl named Piper. Piper has a little doll that she absolutely loves. She takes her doll everywhere and sleeps with her every night. One day, you decide that you would like to purchase a gift for your next door neighbor who is the same age as Piper. You know that the little neighbor girl would love having a doll just like Piper's, so you decide to ask Piper if she would be willing to sell it.

You have priced similar dolls for around $10, but when you talk to Piper, she wants you to pay $100. You see, Piper has decided that the doll is worth much more than other similar dolls, just because it is hers. Piper essentially is valuing her doll higher than others simply because she owns it. You and Piper have just experienced what we call the endowment effect.

The Endowment Effect

When it comes to economics, the endowment effect is the term used to describe when someone places a higher value on something they own simply because they own it. The difference in value happens because the individual possesses the item and feels comfortable with it. You might say they have built a personal relationship with the item and do not want to give it up for anything. For example, if you owned a car for three years and took lots of family trips in it, your sentimental attachment to the vehicle may cause you to place a higher value on it than a similar car at the dealership. Furthermore, the car has always been reliable and it has never broken down; therefore, you have placed a value on it based solely on the fact that you own the car. Selling the vehicle will prove difficult, as customers will be reluctant to pay the inflated price you've set.

How It Affects Consumers

So, you may be wondering what impact the endowment effect has on consumers. Well, think about if you were to inherit something from a loved one who has passed away. Maybe it was a dresser that was bright pink with orange stripes. While the dresser may have fit the style and taste of your loved one, you personally do not prefer a dresser that is bright pink with orange stripes. Because you now own the dresser once belonging to a cherished family member, you refuse to sell it for anything less than $600, even though a consumer could find a comparable item for much cheaper from say, a department store. If everyone who owned a dresser asked an unreasonably high price simply because it's theirs, consumers would be faced with the tough decision to either go without a dresser, pay a price much higher than its value, or try to find another dresser.

Thus, the effect on consumers is that it forces them to pay more money to obtain something of a lesser value, or possibly go without. If the consumer decides to overpay for the item anyway, they would be left with an item that immediately has negative equity. The consumer is then forced to set an unreasonably high price and likely take a loss when it comes time to sell.

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