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How Much Relevance Does Reality Imply? (Re)Considering the Endowment Effect

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  • Brennan, Timothy J.

    (Resources for the Future)

Abstract

A leading approach to understanding significant discrepancies between observed willingness to pay (WTP) and willingness to accept (WTA) in policy evaluation is the “endowment effect”—that preferences are based on a reference point or anchor that leads WTA to exceed WTP. Unlike assertions that consumers make biased choices not reflecting their underlying welfare, the endowment effect possibility is consistent with neoclassical economics. Examples where endowments matter suggest they are not malleable. WTA can exceed WTP if endowments differ across contexts. “Loss aversion” interpretations do not apply, as those concern the utility of money, not willingness to give up one good for another. Kinked indifference curves can increase WTA over WTP, but calling the quantity at the kink an “endowment” adds nothing to the concept. A likely interpretation of the endowment effect is normative: WTA should be relevant to policy evaluations where consumers should have something they currently do not.

Suggested Citation

  • Brennan, Timothy J., 2016. "How Much Relevance Does Reality Imply? (Re)Considering the Endowment Effect," RFF Working Paper Series dp-16-31, Resources for the Future.
    • Handle: RePEc:rff:dpaper:dp-16-31
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    File URL: http://www.rff.org/RFF/documents/RFF-DP-16-31.pdf
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    More about this item

    Keywords

    endowment effect; willingness to accept; willingness to pay; policy evaluation; loss aversion;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • B41 - Schools of Economic Thought and Methodology - - Economic Methodology - - - Economic Methodology
    • Q51 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Valuation of Environmental Effects

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