On the Endowment Effect

“There is a very real difference,” my friend told me, “between getting a car ‘new’ and getting it ‘second-hand’. When you’re getting it second-hand, you have no idea what the previous owner did with (or in) the car.”

He should know. We were sitting in his (second-hand) car, bought just a couple of months back, his sixth car in three years. Of these six, only his first two were new.

It reminded me of something I’d been thinking about lately: the endowment effect, of which definition I’ve happily copied and pasted below from good ol’ Wikipedia:

The endowment effect (also known as divestiture aversion) is the hypothesis that people ascribe more value to things merely because they own them. This is illustrated by the observation that people will tend to pay more to retain something they own than to obtain something owned by someone else—even when there is no cause for attachment, or even if the item was only obtained minutes ago.

There have been a number of experiments done to demonstrate this effect, with the one that I’ve read about the most times being the following (also from Wikipedia):

One of the most famous examples of the endowment effect in the literature is from a study by Kahneman, Knetsch & Thaler (1990) where participants were given a mug and then offered the chance to sell it or trade it for an equally priced alternative good (pens). Kahneman et al. (1990) found that participants’ willingness to accept compensation for the mug (once their ownership of the mug had been established) was approximately twice as high as their willingness to pay for it.

But I’ve never actually read about an experiment that tried to explain it in terms of the bid/ask spread as it relates to investing (which compensates for risk) and information asymmetry. Or how it relates to how our default option is really not to trade, and that trading requires motivation and commands a premium.

For example, let’s say you are given the choice to buy the mug. There’s no reason to think that the amount quoted to you would be below the market price.

On the other hand, if you are given the mug, and then someone quotes you a price for it, there’s no reason to think that it would be above the market price, even if that price came in the form of a set of equally priced pens.

In fact, try playing the scenario in your head and see if you’d do any different:

  1. The experimenter (a stranger) comes up to you and says, “would you like a mug or a pen? By the way, both cost the same.”
  2. Randomly, you choose the mug. There is no reason, at this point in time, to think either the mug or the pen costs more than the other.
  3. The experimenter gives you the mug.
  4. After five minutes, the same experimenter comes up to you and offers you the choice to trade, saying, “are you sure you don’t want to have this set of pens instead of the mug? I’m willing to trade if you are…” (these are the same pens talked about in point #1)
  5. What would you think? Personally, I’d think there was a catch. You give me a mug, and five minutes later you’re trying to get it back. It’s got to be worth more than the pens if not why on earth would you want to trade?

Point #5 highlights risk and information asymmetry. There’s a risk I’m getting the shorter end of the stick because the experimenter seems to know more than me (i.e. the “true” value of the mug and pens). Why else would s/he offer to trade? (This, I think, is why new cars command such a premium over pre-owned ones. There’s a big risk pre-owned cars were subject to abuse you’d prefer not to know about. Why else would the car owner want to sell?)

Experiencing this risk would urge me to ask for more. If you give me $X more than you’re offering, I’m willing to take the risk that the mug really isn’t worth more than you say it is worth. If I decided on the trade, it’d mean that I trusted you completely on the fact that they were worth the same.

And let’s not forget the idea that people in general don’t really like to think; we don’t like to expend energy unnecessarily. If there’s a risk that we could be losing out, but we don’t really want to think about it, the default option would be to just say “no”, or quote a price such that it’s easy to say “yes”.

The World as it Should Be

Just thought I would share with you what has to be, for me, the quote of the week. Taken from the book Getting More, a beautiful book on negotiation by Stuart Diamond (emphasis mine):

Lower your expectations. If you come into a negotiation thinking that the other side will be difficult, unfair, rude, or trying to cheat you, you won’t be likely to have dashed expectations–and you won’t be emotional. When you lower your expectations of what will take place in a negotiation, you will be rarely disappointed–and you might be pleasantly surprised. Getting yourself psychologically prepared is important.

You might feel, “Hey, I shouldn’t have to do things like that.” Okay, maybe not. But we live in the real world, not in the “should” world.

The beauty of that statement, I think, lies in the fact that it embraces the irrationality of people, the irrationality of the world. Where things are done sometimes for reasons beyond human comprehension.

And even if you don’t believe in the irrationality of people, as I sometimes find myself wont to do, the fact is we as human beings have so many hidden motivations that though we are, perhaps, ultimately rational, we are for most practical purposes just the opposite.

Choosing the amateur path

I’m currently reading a nice little book called Cognitive Surplus by Clay Shirky that discusses at some length the difference between being a professional and being an amateur. And it seems that being labelled an amateur isn’t really so bad at all, and may in fact be a good thing.

One of the professional vs. amateur examples that Shirky returns to often in his book is about a charity started by a group of Josh Groban fans (or “Grobanites” as they call themselves), aptly called “Grobanites for Charity“. It started off pretty much by chance (enabled by the internet without which it wouldn’t have happened) by people who didn’t know much about starting charities — in other words, amateurs.

And looking at its website, you wouldn’t think otherwise.

Being an avid web-designer earlier on in my life, I’d always prided myself on creating professional-looking sites; the more it looked like something a big corporation would use, the happier I’d with the result.

So when I read about Grobanites for Charity and visited their website I was a little surprised — that though their website looked like it belonged in the early 90’s, it also had a very familial feel to it. It was down-to-earth, honest and relatable. This wasn’t some faceless corporation; it was Kay, and Melanie, and Pat, and Jackie.

In this sense, the amateur look-and-feel of the site actually seemed to work in their favour. Even I, a non-Josh Groban fan, felt compelled to do my bit by donating something or by helping out.

From the book:

Now, the design of a website may not seem to have much to do with fostering a sense of membership, but something designed by an amateur can actually create better conditions of membership than a professional design can.

Consider the kinds of kitchens you see in photographs in House Beautiful and Better Homes and Gardens, designed to a fare-three-well with a place for everything and everything in its place. My kitchen is not like that. (Perhaps yours isn’t either.) But if you were a guest at a dinner party, you likely wouldn’t dare set foot in a House Beautiful kitchen, because the design doesn’t exactly scream Come on in and help! My kitchen, on the other hand, does scream that — you wouldn’t feel much compunction about grabbing a knife and dicing some carrots if you felt like it.

Which makes me wonder about how the context of a “professional space” and “amateur space” might affect how people think about things.

I would imagine that it’d be similar to how money corrupts intentions?

In the name of safety

I read a post by Alex Tabarrok today, regarding  school safety in his son’s school (via the Marginal Revolution blog) today. The post is really a letter that he’d written to his son’s school principal, regarding the introduction of security guards and cameras.

From the post (emphasis mine):

When going to school requires police, security guards and cameras how can I encourage my child to travel to foreign countries, to seek new experiences, to meet people of different faiths, beliefs and backgrounds?

I live in Singapore, arguably one of the world’s safest countries.

In Singapore, each of us is assigned an identification number at birth. This number is used extensively to record our activities in both private and public services. I never thought much about it until I studied in Australia and realised they didn’t have such a thing there, and that it’d have been to them a serious invasion of privacy.

I thought it weird and inconvenient — how did they manage to live without one for so long?

We have cameras everywhere here.  Cameras mounted on street lamps (presumably to monitor traffic); in trains (one in each carriage) and train stations (five, six, or more, clustered together, each facing in different directions); and other public spaces — parks, elevators, shopping centers. And with citizentry brandishing phone cameras and car cameras and posting videos on errant behaviour, his monitoring goes on just about everywhere really.

But I don’t really notice them. Maybe I used to, but not any more. They make me feel safe. Like a drug.

We have gates. Lots of them. Almost all houses have them — those that don’t are the exception. Similarly, all apartments by default come with grill doors in addition to the main, heavy-duty, fire-resistant door. Apartments without grill doors, if any, tend to be situated in gated communities. And they have security guards.

It’s normal to have such security measures in place, isn’t it? At least I think so. It’s not like we have a decent police force and a generally low crime rate here.

Wait a minute. I think we do.

What Alex Tabarrok says is true. Though I feel perfectly safe in Singapore, it’s pretty much at the expense of feeling unsafe in just about everywhere else. How can I encourage myself to venture out into the unsafe when it goes against everything I’ve been brought up to believe? That even without these security measures in place, I will be safe?

In the name of safety I cannot say how many places I’ve been unwilling to travel to. Places people considerably more vulnerable than myself, but brought up in a different environment with a different perspective on safety, would go to at a whim.

Places I wish I could bring myself to go; things I wish I could do.

But it’s not safe.

The Three Christs Experiment (and Business Superstars)

I came across this nice write up on “The Three Christs of Ypsilanti” experiment (via Marginal Revolution) about how a psychologist put three people — all of whom claimed they were Christ — together in a mental institution, in the hope that the effect of their conflicting identities would somehow awaken them to the possibilities that perhaps, just perhaps, they might not be who they thought they were.

In the words of Alan Bellows who wrote the article:

What might happen, he wondered, if a psychologist were to deliberately pair up patients who held directly conflicting identity delusions? Perhaps such psychological leverage could be used to pry at the cracks of an irrational psyche to let in the light of reason. Dr. Rokeach sought and secured a research grant to test his hypothesis, and he began canvassing sanitariums for delusional doppelgängers. Soon he found several suitable subjects: three patients, all in state care, each of whom believed himself to be Jesus Christ. And he saw that it was good.

This was an experiment that I myself as a child and young man had longed to do, or at the very least to witness. That someone else had already done it, and written a whole book on it, is like discovering wifi in remote country. That someone else had nicely summarised that book into a short post was like discovering the afore-mentioned wifi was both free and fast.

As an older man though, my psychologically-inclined curiosity turned to rather more business and professional pursuits.

It’s not uncommon to meet someone in your working life whom you think is absolutely brilliant, but who has views diametrically opposed to some other equally brilliant person. How exciting it would be to put these business superstars together in the same room to debate their views. To see how they — both brilliant, mind you — would stand up to the other’s arguments. Would one of them see the light, as Dr. Milton Rokeach had hoped with his Three Christs?

Even in my current employ these theoretical debates debates have often raged in my mind, as I imagined hard-hitting Howard coming up against smooth-talking Tina in a battle of wits and personality. It’d be like like Manny and Floyd — possibly the fight of the early century, if it ever comes to fruition.

Student loans and how the deed is infinitely stronger than the word

Interesting article giving the perspectives of three people with outstanding student loans and how they’re paying it off.

I’d never been that heavily in debt and I do sometimes wonder what I’d do. Though I cannot say for sure, I do not see myself holding off the payment of loans if I could I help it. But I probably won’t need to theorise much more as in a few years time my mortgage will kick in and it’d be interesting to see if I’d practice what I preach about paying loans off as soon as I can. I cannot say for sure if that’s what I’d do.

That’s the thing about people: they may foresee themselves doing one thing, and saying they’d do it, only to do something else altogether when they really do it. They’d say I’d buy Brand X, definitely and then just as quick go on to buy Brand Y for no other reason than that because they felt like it. That’s definitely something to think about when collecting user responses in surveys and the like when major decisions are going to be made based off of it.

Colour Quiz

I’m a sucker for personality tests. Here’s one I haven’t taken (and believe me I’ve taken many) which though I wouldn’t read too much into its results, does seem in its own little way pretty accurate: ColorQuiz

(I suppose one reason I like personality tests is that I’m always amazed when they get things right, and I’m always wondering how they did it. I suppose one way you could go about doing this is just asking lots of people lots of questions, and depending on how they answered cluster them into one of several pre-defined categories, each associated with certain personality traits. Of course there could be other ways you could go about doing this, but in general there’s going to be data analysis and predictions and other wonderful things. Beautiful.)