>> OLIVIA KANG: Today's podcast begins with a coffee cup.
In 1990, a team of psychologists led by Daniel Kahneman at the
University of California, Berkeley conducted a
simple study.
They gave a group of people coffee cups, told them the cups
were theirs to have, and then asked them to price their new
possessions: How much money would they sell the cups for?
The answers varied, but the average price they settled on
was $5.78.
If you're thinking "fair enough," so did I when I first read about
this experiment. But there's a second part of the study, and
that's where things get interesting.
Another group of people weren't given a cup at all.
Instead, they were shown the same cup and then asked "how much
would you pay to buy it?" And the price they came up with
was $2.21.
If you're keeping track, that's a 62% discount from what sellers
were asking for.
And here's another percentage that came out of the study: 80.
Sellers lost 80% of their projected sales, just because
they had no idea what their cups were actually worth.
So what happened?
Why would just knowing a coffee cup is yours lead you to more
than double its value?
Today's podcast is all about the strange phenomenon that
psychologists call the Endowment Effect and how it impacts the
decisions we make.
I'm Olivia Kang, and this is Outsmarting Human Minds.
So here's how the Endowment Effect works:
Own something
—easier yet, just hold it— and it will increase in value.
Just like that.
The catch, of course, is that it's only more valuable to you.
Now, some psychologists think this comes from a good place—a
love of ourselves and, by extension, anything attached
to us.
And others think maybe we just have this aversion to loss.
But that graveyard of unsold coffee cups from the Kahneman
study makes one thing clear:
this bias is far from harmless.
Now, when I first saw those numbers—cups more than doubling
in perceived value, 80% losses in sales—I was surprised, and
then I had some questions.
First, were economists worried about this?
After all, a single coffee cup is one thing. But what if you're
trying to sell a thousand?
What if you're trying to sell your car or your home?
And then, does any of this matter outside of the psychology lab?
>> DR. SANTOSH ANAGOL: The Endowment Effects Project is
about new investors in the financial marketplace - how
behavioral biases change their decisions.
>> OLIVIA KANG: This is Dr. Santosh Anagol.
He's an economist and an assistant professor at Wharton
in the Business Economics and Public Policy Department.
He has spent years investigating endowment effects as they occur
in the world of business.
>> DR. SANTOSH ANAGOL: In basic economic theory, one of the main
tenets is that people should have one valuation for what an
object is worth to them.
It shouldn't matter whether they currently own that object.
>> OLIVIA KANG: And yet it does matter.
>> DR. SANTOSH ANAGOL: And that turns out to be very important.
Okay, so take for example clean air.
We want to know, what is living in an environment with clean air
worth to someone?
Well, it turns out if you ask people "how much would I have to
pay you to give up clean air," they typically report valuations
of clean air that are two to three times higher than what
they'd be willing to pay to get clean air.
>> OLIVIA KANG: So just to be clear, the same person who would
only pay $100 to get clean air would need $300 to give it up.
>> DR. SANTOSH ANAGOL: That's a problem, because which of those
numbers should we use to figure out how much we as a society
should spend on creating an environment with clean air?
And this of course is relevant not just for public goods like
clean air, but also, like, if a firm is thinking about trying to
sell a new product, and they want to figure out, like, well, how
much are people willing to pay for this product?
It would depend on how you ask them.
>> OLIVIA KANG: So it's not just coffee cups.
It's clean air.
It's new products.
It's that pet project you keep investing in at work, when you
should be letting it go.
It's those famously bad trades sports teams make because they
prize one of their players just a little too much.
And Dr. Anagol's research shows this can cost us cold hard cash.
What is an IPO lottery?
>> DR. SANTOSH ANAGOL: It's kind of a unique regulatory structure
where basically when there's excess demand for IPO shares,
the firm is required to run lotteries where it's randomly
chosen which of the applicants actually get the shares.
>> OLIVIA KANG: Because this is completely random, whether you
win or lose the lottery should have nothing to do with how you
value the stock once it's traded on the market. But that's not
what Dr. Anagol found.
>> DR. SANTOSH ANAGOL: Winners are about 63% more likely to
hold the stock than losers. And even if you look at guys who are
very experienced in the market, who have done lots of IPOs
before, they're still about 40% more likely to hold the stock.
>> OLIVIA KANG: Let me just remind you that this is
happening in a setting where the whole point is to accurately
assess value.
And if you're thinking, "well, maybe holding onto the stock is
a good idea," it wasn't.
Dr. Anagol estimates that the endowment effect cost lottery
winners right around 5% of their portfolio values.
>> DR. SANTOSH ANAGOL: It just seems like these investors never
asked themselves, "would I want to buy this stock on my own if I
hadn't been randomly assigned it?"
>> OLIVIA KANG: So maybe this is something we should be asking
ourselves, whether we're talking about simple coffee cups or the
broader context of our global markets or anything in between:
How can we detach ourselves from our decisions?
Here's a few ideas.
First, know your numbers.
Gut instinct can just feel right, but relying on actual data—for
instance the market values of mugs, cars or the homes we wish
to sell—will always pay off in the long run.
Second, keep the decisions in the here and now.
If you're wondering whether to keep a struggling stock, ask
yourself, "would I buy it today?
Do the reasons for buying it in the first place still hold?"
Finally, take yourself out of the equation.
When it comes to hard decisions at work, imagine that you're
advising someone else on what to do. Or crowdsource
your decisions.
Seeing other's valuations will show you if your numbers are or
aren't adding up.
Knowing that things attached to us acquire this extra glow in
our minds—
that's fine when we're talking about grandmother's watch or a
coffee cup that doesn't cost us our retirement savings. But in
the world of work, it's only rational to value things for
their actual worth, no more and no less.
Outsmarting Human Minds is a program founded by Mahzarin
Banaji, devoted to improving decision-making using insights
from psychological science.
Support for Outsmarting Human Minds was provided by a grant
from PwC to Harvard University.
This episode was developed by Mahzarin Banaji and Olivia Kang
and featured Dr. Santosh Anagol.
Sound editing and mixing was done by Evan Younger.
Music was composed by Miracles of Modern Science.
For all studies cited in this podcast, go to
outsmartinghumanminds.org.