Economics Endowment Effect Questions Medium
The Endowment Effect is a cognitive bias that describes how individuals tend to value an item more highly simply because they own it. This means that people often demand a higher price to sell an item they own compared to the price they would be willing to pay to acquire the same item if they did not own it.
Prospect theory, on the other hand, is a behavioral economic theory that explains how individuals make decisions under uncertainty. It suggests that people evaluate potential gains and losses relative to a reference point, rather than in absolute terms. According to prospect theory, individuals are more sensitive to losses than to gains, and they tend to make decisions based on the potential value of gains and losses rather than the final outcome.
The Endowment Effect and prospect theory are related in that they both highlight the influence of ownership and reference points on decision-making. The Endowment Effect can be seen as a manifestation of the reference point bias described in prospect theory. When individuals own an item, they establish a reference point that represents the value they associate with it. This reference point influences their perception of the item's worth, leading to the Endowment Effect.
In summary, the Endowment Effect and prospect theory are connected through the concept of reference points. The Endowment Effect demonstrates how ownership affects individuals' valuation of an item, while prospect theory explains how individuals evaluate potential gains and losses relative to a reference point. Both concepts contribute to our understanding of how cognitive biases and subjective perceptions influence economic decision-making.