The Endowment Effect and Discounted Utility: An Alternative Theory of Valuation

Abstract

The endowment effect is a widely studied phenomenon of bias that suggests individuals ascribe value to objects merely because they own them, even when acquired only minutes prior. Widely at variance with conventional economic standards, this phenomenon has received extensive empirical support, although debate remains as to the extent and interpretation of its effect. This study explores the bias in conjunction with discounted utility, the theory that people discount future pleasures, seeking to further understand how valuation bias behaves in real-world situations. Princeton University undergraduates took part in a buying/selling market in which half of participants were given four Princeton-logoed objects (sellers) and the other half were not (buyers). Those in the selling group reported the minimum prices at which they would give up the objects under various time conditions of object exchange and money exchange (i.e. giving up object now or later and receiving payment now or later). Those in the buying group reported the maximum prices they would pay to obtain the objects and over the same time conditions of object exchange and money exchange. Major findings support the additive effect hypothesized, indicating that ownership does increase individuals’ valuations and that this effect increases over time due to discounting future monetary value. These results are important to the study of behavioral economics because they suggest that valuation may be motivated by irrational factors rather than intrinsic value, even with everyday objects received minutes ago. They also provide insight as to how time affects these judgments, and therefore could be useful for economists to make more effective business decisions and to better understand those of others.