Fermat's Library | The Endowment Effect, Loss Aversion, and Status Quo Bias annotated/explained version.

### TL;DR This paper explores three behavioral economic concepts...

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***loss aversion***: the disutility of giving up an object is great...

In a nutshell people tend to value an item they own more highly tha...

***"The experiment was replicated several times, always with simila...

This graph shows two indifference curves that cross, which isn’t su...

Even when people are randomly given an item (like a pen) only momen...

Given a choice **people tend to stick with the default or current o...

**Losing feels more painful than winning. ** People feel losses ...

**People perceive losses as less fair than missed gains, even if th...

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Journal of

Economic Perspectives—Volume

5, Number 1—Winter 1991—Pages 193–206

Anomalies

The Endowment Effect, Loss Aversion,

and Status Quo Bias

Daniel Kahneman, Jack L. Knetsch,

and Richard H. Thaler

Economics can be distinguished from other social sciences by the belief that

most (all?) behavior can be explained by assuming that agents have stable,

well-defined preferences and make rational choices consistent with those

pref-

erences in markets that (eventually) clear. An empirical result qualifies as an

anomaly if it is difficult to "rationalize," or if implausible assumptions are

necessary to explain it within the paradigm. This column presents a series of

such anomalies. Readers are invited to suggest topics for future columns by

sending a note with some reference to (or better yet copies of) the relevant

research. Comments on anomalies printed here are also welcome. The address

is:

Richard Thaler, c/o Journal of Economic Perspectives, Johnson Graduate

School of Management, Malott Hall, Cornell University, Ithaca, NY 14853.

After this issue, the "Anomalies" column will no longer appear in every

issue and instead will appear occasionally, when a pressing anomaly crosses

Dick Thaler's desk. However, suggestions for new columns and comments on

old ones are still welcome. Thaler would like to quash one rumor before it gets

started, namely that he is cutting back because he has run out of anomalies. Au

contraire,

it is the dilemma of choosing which juicy anomaly to discuss that takes

so much time.

• Daniel Kahneman is Professor of Psychology, University of California, Berkeley,

California. Jack L. Knetsch is Professor of Economics and Natural Resources Manage-

ment, Simon Eraser University, Burnaby, British Columbia, Canada. Richard H. Thaler

is Henrietta Johnson Louis Professor of Economics, Johnson School of Management,

Cornell University, Ithaca, New York.

194 Journal of Economic Perspectives

Introduction

A wine-loving economist we know purchased some nice Bordeaux wines

years ago at low prices. The wines have greatly appreciated in value, so that a

bottle that cost only $10 when purchased would now fetch $200 at auction. This

economist now drinks some of this wine occasionally, but would neither be

willing to sell the wine at the auction price nor buy an additional bottle at that

price.

Thaler (1980) called this pattern—the fact that people often demand much

more to give up an object than they would be willing to pay to acquire it—the

endowment

effect.

The example also illustrates what Samuelson and Zeckhauser

(1988) call a status quo bias, a preference for the current state that biases the

economist against both buying and selling his wine. These anomalies are a

manifestation of an asymmetry of value that Kahneman and Tversky (1984) call

loss aversion—the disutility of giving up an object is greater that the utility

associated with acquiring it. This column documents the evidence supporting

endowment effects and status quo biases, and discusses their relation to loss

aversion.

The Endowment Effect

An early laboratory demonstration of the endowment effect was offered by

Knetsch and Sinden (1984). The participants in this study were endowed with

either a lottery ticket or with $2.00. Some time later, each subject was offered

an opportunity to trade the lottery ticket for the money, or vice versa. Very few

subjects chose to switch. Those who were given lottery tickets seemed to like

them better than those who were given money.

This demonstration and other similar ones (Knetsch, 1989), while striking,

did not settle the matter. Some economists felt that the behavior would

disappear if subjects were exposed to a market environment with ample

learning opportunities. For example, Knez, Smith and Williams (1985) argued

that the discrepancy between buying and selling prices might be produced by

the thoughtless application of normally sensible bargaining habits, namely

understating one's true willingness to pay (WTP) and overstating the minimum

acceptable price at which one would sell (willingness to accept or WTA).

Coursey, Hovis, and Schultze (1987) reported that the discrepancy between

WTP and WTA diminished with experience in a market setting (although it was

probably not eliminated, see Knetsch and Sinden, 1987). To clarify the issue,

Kahneman, Knetsch, and Thaler (1990) ran a new series of experiments to

determine whether the endowment effect survives when subjects face market

discipline and have a chance to learn. We will report just two experiments from

that series.

Daniel

Kahneman,

Jack L. Knetsch, and Richard H. Thaler 195

In the first experiment, students in an advanced undergraduate economics

class at Cornell University participated in a series of markets. The objects

traded in the first three markets were 'induced value tokens.' In such markets

all subjects are told how much a token is worth to them, with the amounts

varying across subjects. Half the subjects were made owners of tokens, the other

half were not. In this way, supply and demand curves for tokens are created.

Subjects alternated between the buyer and seller role in the three successive

markets, and were assigned a different individual redemption value in each

trial. Experimenters collected the forms from all participants after each market

period, and immediately calculated and announced the market-clearing price

and the number of trades. Three buyers and three sellers were selected at

random after each of the induced markets and were paid off according to the

preferences stated on their forms and the market clearing price for that period.

These markets contained no grist for the anomaly mill. On each trial, the

market clearing price was exactly equal to the intersection of the induced

supply and demand curves, and the volume of trade was within one unit of the

predicted quantity. These results demonstrate that the subjects understood the

task, and that the market mechanism used did not impose high transactions

costs.

Immediately after the three induced value markets, subjects on alternating

seats were given Cornell coffee mugs, which sell for $6.00 each at the book-

store. The experimenter asked all participants to examine a mug, either their

own or their neighbor's. The experimenter then informed the subjects that

four markets for mugs would be conducted using the same procedures as the

prior induced markets with two exceptions: (1) One of the four market trials

would subsequently be selected at random and only the trades made on this

trial would be executed. (2) On the binding market trial, all trades would be

implemented, unlike the subset implemented in the induced value markets.

The initial assignment of buyer and seller roles was maintained for all four

trading periods. The clearing price and the number of trades were announced

after each period. The market that "counted" was indicated after the fourth

period, and transactions were executed immediately—all sellers who had indi-

cated that they would give up their mug at the market clearing price ex-

changed their mugs for cash, and successful buyers paid this same price and

received their mug. This design was used to permit learning to take place over

successive trials and yet make each trial potentially binding. The same proce-

dure was then followed for four more successive markets using boxed ball-point

pens with a visible bookstore price tag of $3.98, which were distributed to the

subjects who had been buyers in the mug markets.

What does economic theory predict will happen in these markets for mugs

and pens? Since transactions costs have been shown to be insignificant in the

induced value markets, and income effects are trivial, a clear prediction is

available: When the market clears, the objects will be owned by those subjects

who value them most. Call the half of the subjects who like mugs the most

796 Journal of Economic Perspectives

"mug lovers" and the half who like mugs least "mug haters." Then, since the

mugs were assigned at random, on average half of the mug lovers will be given

a mug, and half will not. This implies that in the market, half of the mugs

should trade, with mug haters selling to mug lovers.

The 50 percent predicted volume of trade did not materialize. There were

22 mugs and pens distributed so the predicted number of trades was 11. In the

four mug markets the number of trades was 4, 1, 2, and 2 respectively. In

the pen markets the number of trades was either 4 or 5. In neither market was

there any evidence of a trend over the four trials. The reason for the low

volume of trade is revealed by the reservation prices of buyers and sellers. For

mugs,

the median owner was unwilling to sell for less than $5.25, while the

median buyer was unwilling to pay more than $2.25-$2.75. The market price

varied between $4.25 and $4.75. In the market for pens the ratio of selling to

buying prices was also about 2. The experiment was replicated several times,

always with similar results: median selling prices are about twice median buying

prices and volume is less than half of that expected.

Another experiment from this series allows us to investigate whether the

low volume of trading is produced by a reluctance to buy or a reluctance to sell.

In this experiment, 77 students at Simon Fraser University were randomly

assigned to three conditions. One group, the Sellers, were given SFU coffee

mugs and were asked whether they would be willing to sell the mugs at each of

a series of prices ranging from $0.25 to $9.25. A second group of Buyers were

asked whether they would be willing to buy a mug at the same set of prices.

The third group, called Choosers, were not given a mug but were asked to

choose, for each of the prices, between receiving a mug or that amount of

money.

Notice that the Sellers and the Choosers are in objectively identical situa-

tions,

deciding at each price between the mug and that amount of money.

Nevertheless, the Choosers behaved more like Buyers than like Sellers. The

median reservation prices were: Sellers, $7.12; Choosers, $3.12; Buyers, $2.87.

This suggests that the low volume of trade is produced mainly by owner's

reluctance to part with their endowment, rather than by buyers' unwillingness

to part with their cash. This experiment also eliminates the trivial income effect

present in the first experiment, since the Sellers and Choosers are in the same

economic situation.

One of the first lessons in microeconomics is that two indifference curves

can never intersect. This result depends on the implicit assumption that

indifference curves are reversible. That is, if an individual owns x and is

indifferent between keeping it and trading it for y, then when owning y the

individual should be indifferent about trading it for x. If loss aversion is

present, however, this reversibility will no longer hold. Knetsch (1990) has

demonstrated this point experimentally. One group of subjects received 5

medium priced ball point pens, while another group of subjects received $4.50.

They were then made a series of offers which they could accept or reject. The

offers were designed to identify an indifference curve. For example, someone

Anomalies 197

Figure 1

Crossing indifference curves

who had been given the pens would be asked if she would give up one of the

pens for a dollar. One of the accepted offers (including the original endow-

ment) was selected at random at the end of the experiment to determine the

subject's payment. By plotting the line between accepted and rejected offers,

Knetsch was able to infer an indifference curve for each subject. Then he

plotted the average indifference curve for each of the two groups (those who

started with pens and those who started with money). These plots are shown in

Figure 1. The curves are quite different: the pens were worth more money to

those subjects who started with pens than to those who started with money. As

a result, the curves intersect.

What produces these "instant endowment effects"? Do subjects who receive

a gift actually value it more than others who do not receive it? A recent study by

Loewenstein and Kahneman (1991) investigated this issue. Half the students in

a class (N = 63) were given pens, the others were given a token redeemable for

an unspecified gift. All participants were then asked to rank the attractiveness

of six gifts under consideration as prizes in subsequent experiments. Finally, all

the subjects were then given a choice between a pen and two chocolate bars. As

in previous experiments, there was a pronounced endowment effect. The pen

was preferred by 56 percent of those endowed with it, but only 24 percent of

the other subjects chose a pen. However, when making the attractiveness

ratings, the subjects endowed with pens did not rate them as more attractive.

This suggests that the main effect of endowment is not to enhance the appeal of

the good one owns, only the pain of giving it up.

Status Quo Bias

One implication of loss aversion is that individuals have a strong tendency

to remain at the status quo, because the disadvantages of leaving it loom larger

These curves were obtained from different individuals. Because subjects were randomly assigned

to the two endowment groups, however, it is reasonable to attribute crossing indifference curves to

the representative individual.

198 Journal of Economic Perspectives

than advantages. Samuelson and Zeckhauser (1988) have demonstrated this

effect, which they term the status quo bias. In one experiment, some subjects

were given a hypothetical choice task, such as the following, in a 'neutral'

version in which no status quo is defined: "You are a serious reader of the

financial pages but until recently have had few funds to invest. That is when

you inherited a large sum of money from your great-uncle. You are consider-

ing different portfolios. Your choices are to invest in: a moderate-risk company,

a high risk company, treasury bills, municipal bonds."

Other subjects were presented with the same problem but with one of the

options designated as the status quo. In this case, after the same opening

sentence the passage continues: "... That is when you inherited a portfolio of

cash and securities from your great-uncle. A significant portion of this portfolio

is invested in a moderate risk company ... (The tax and broker commission

consequences of any change are insignificant.)"

Many different scenarios were investigated, all using the same basic experi-

mental design. Aggregating across all the different questions, Samuelson and

Zeckhauser are then able to estimate the probability that an option will be

selected when it is the status quo or when it is competing as an alternative to

the status quo as a function of how often it is selected in the neutral setting.

Their results implied that an alternative became significantly more popular

when it was designated as the status quo. Also, the advantage of the status quo

increases with the number of alternatives.

A test of status quo bias in a field setting was performed by Hartman,

Doane, and Woo (forthcoming) using a survey of California electric power

consumers. The consumers were asked about their preferences regarding

service reliability and rates. They were told that their answers would help

determine company policy in the future. The respondents fell into two groups,

one with much more reliable service than the other. Each group was asked to

state a preference among six combinations of service reliabilities and rates, with

one of the combinations designated as the status quo. The results demonstrated

a pronounced status quo bias. In the high reliability group, 60.2 percent

selected their status quo as their first choice, while only 5.7 percent expressed a

preference for the low reliability option currently being experienced by the

other group, though it came with a 30 percent reduction in rates. The low

reliability group, however, quite liked their status quo, 58.3 percent of them

ranking it first. Only 5.8 percent of this group selected the high reliability

option at a proposed 30 percent increase in rates.

Differences in income and electricity consumption between the two groups were minor and did

not appear to significantly influence the results. Could the results be explained by either learning of

habituation? That is, might the low reliability group have learned to cope with frequent outages, or

found out that candlelight dinners are romantic? This cannot be ruled out, but it should be stressed

that no similar explanation can be used for the mug experiments or the surveys conducted by

Samuelson and Zeckhauser, so at least some of the effects observed are attributable to a pure status

quo bias.

Daniel

Kahneman,

Jack L. Knetsch, and Richard H. Thaler 199

A large-scale experiment on status quo bias is now being conducted

(inadvertently) by the states of New Jersey and Pennsylvania. Both states now

offer a choice between two types of automobile insurance: a cheaper policy that

restricts the right to sue, and a more expensive one that maintains the

unrestricted right. Motorists in New Jersey are offered the cheaper policy as the

default option, with an opportunity to acquire an unrestricted right to sue at a

higher price. Since this option was made available in 1988, 83 percent of the

drivers have elected the default option. In Pennsylvania's 1990 law, however,

the default option is the expensive policy, with an opportunity to opt for the

cheaper kind. The potential effect of this legislative framing manipulation was

studied by Hershey, Johnson, Meszaros, and Robinson (1990). They asked two

groups to choose between alternative policies. One group was presented with

the New Jersey plan while the other was presented with the Pennsylvania plan.

Of those subjects offered the New Jersey plan, only 23 percent elected to buy

the right to sue whereas 53 percent of the subjects offered the Pennsylvania

plan retained that right. On the basis of this research, the authors predict that

more Pennsylvanians will elect the right to sue than New Jerseyans. Time will

tell.

One final example of a presumed status quo bias comes courtesy of the

JEP

staff.

Among Carl Shapiro's comments on this column was this gem: "You

may be interested to know that when the AEA was considering letting members

elect to drop one of the three Association journals and get a credit, prominent

economists involved in that decision clearly took the view that fewer members

would choose to drop a journal if the default was presented as all three journals

(rather than the default being 2 journals with an extra charge for getting all

three).

We're talking economists here."

Loss Aversion

These observations, and many others, can be explained by a notion of loss

aversion. A central conclusion of the study of risky choice has been that such

choices are best explained by assuming that the significant carriers of utility are

not states of wealth or welfare, but changes relative to a neutral reference point.

Another central result is that changes that make things worse (losses) loom

larger than improvements or gains. The choice data imply an abrupt change of

the slope of the value function at the origin. The existing evidence suggests that

the ratio of the slopes of the value function in two domains, for small or

moderate gains and losses of money, is about 2: 1 (Tversky and Kahneman,

1991).

A schematic value function is shown in Figure 2.

The natural extension of this idea to riskless choice is that the attributes of

options in trades and other transactions are also evaluated as gains and losses

relative to a neutral reference point. The approach is illustrated in Figure 3.

Decision makers have a choice between state A, where they have more of good

200 Journal of

Economic

Perspectives

Figure 2

A typical value function

Y and less of good X, and state D, where they have more of good X and less of

good Y. Four different reference points are indicated in the Figure. The

individual faces a positive choice between two gains if the reference point is C, a

negative choice between two losses if the reference point is B, and two different

exchanges if the references are A or D, respectively. For example, if good Y is a

mug and good X is money, the reference points for the sellers and the choosers

in the mugs experiment are A and C. Loss aversion implies that the difference

between the states of having a mug and not having one is larger from A than

from C, which explains the different monetary values that subjects attach to the

mug in these conditions.

For a formal treatment that generalizes consumer

theory by introducing the notions of reference and loss aversion, see Tversky

and Kahneman (1991).

In general, a given difference between two options will have greater impact

if it is viewed as a difference between two disadvantages than if it is viewed as a

difference between two advantages. The status quo bias is a natural conse-

quence of this asymmetry: the disadvantages of a change loom larger than its

advantages. However, the differential weighting of advantages and disadvan-

tages can be demonstrated even when the retention of the status quo is not an

option. For an example, consider the following question (from Tversky and

Kahneman, 1991):

Imagine that as part of your professional training you were assigned to a

part-time job. The training is now ending and you must look for employ-

Loss

aversion does not affect all transactions. In a normal commercial transaction, the seller does

not

suffer a loss when trading a good. Furthermore, the evidence indicates that buyers do not value

the

money spent on normal purchases as a

loss,

so long as the price of the good is not thought to be

unusually

high. Loss aversion is expected to primarily affect owners of goods that had been bought

for

use rather than for eventual resale.

Anomalies

201

Figure

Multiple reference points for the choice between

A and D

ment. You consider two possibilities. They are like your training job in

most respects except for the amount of social contact and the convenience

of commuting to and from work. To compare the two jobs to each other

and to the present one you have made up the following table:

Job

Present job

Job A

Job D

Contact with others

isolated for long stretches

limited contact with others

moderately sociable

Commute Time

10 min.

20 min.

60 min.

The options A and D are evaluated from a reference job which is better on

commute time and worse on personal contact (a point like A' in Figure 3).

Another version of the problem presented the same options, but the reference

job involved "much pleasant social interaction and 80 minutes of daily commut-

ing time," which corresponds to the point D . The proportion of subjects

choosing job A was 70 percent in the first version, 33 percent in the second.

Subjects are more sensitive to the dimension in which they are losing relative to

their reference point.

Some asymmetries between buying and selling prices are much too large to

be explained by garden-variety loss aversion. For example, Thaler (1980) told

subjects that they had been exposed to a rare fatal disease and that they now

face a .001 chance of painless death within two weeks. They must decide how

much they would be willing to pay for a vaccine, to be purchased immediately.

The same subjects were also asked for the compensation they would demand to

202 Journal of Economic Perspectives

participate in a medical experiment in which they face a .001 chance of a quick

and painless death. For most subjects the two prices differed by more than an

order of magnitude.

A study by Viscusi, Magat and Huber (1987) documented a similar effect in

a more realistic setting. Their respondents were recruited at a shopping mall

and hardware store. The respondents were shown a can of fictitious insecticide,

and were asked to examine it for their use. The current price of the can was

said to be $10. Respondents were informed that all insecticide can cause

injuries if misused, including inhalation and skin poisoning (in households with

young children, child poisoning replaced skin poisoning). The current risk

level was said to be 15 injuries of each type per 10,000 bottles sold. Respon-

dents were asked to state their willingness-to-pay (WTP) to eliminate or reduce

the risks. In households without children, the mean WTP to eliminate both

risks was $3.78. The respondents were also asked to state the price reduction

they would require to accept an increase of

1/10,000

in each of the two risks.

The results were dramatic: 77 percent of respondents in this condition said

they would refuse to buy the product at any positive price.

The striking difference between WTA and WTP in these studies probably

reflects the large difference in the responsibility costs associated with voluntary

assumption of additional risk, in contrast to a mere failure to reduce or

eliminate existing risk. The asymmetry between omission and commission is

familiar in legal doctrine, and its impact on judgments of responsibility has

been confirmed by psychological research (Ritov and Baron, forthcoming). The

asymmetry affects both blame and regret after a mishap, and the anticipation of

blame and regret, in turn, could affect behavior.

A moral attitude is involved in another situation where huge discrepancies

between buying and selling prices have been observed, the evaluation of

environmental amenities in cost benefit analyses. Suppose some corporation

offers to buy the Grand Canyon and make it into a water park complete with

the world's largest water slide. How do we know whether the benefits of this

idea exceed its costs? As usual there are two ways to ask the question, depend-

ing on what is the status quo. If there is no theme park in the status quo, then

people can be asked the minimum amount of money they would accept to

agree to add one (WTA). Alternatively, if the corporation currently owns the

right, people could be asked how much they would be willing to pay to buy it

back and prevent the theme park from being built (WTP). Several surveys have

been conducted where the researchers asked both types of questions for such

things as clean air and well-maintained public parks. Most studies find that the

WTA responses greatly exceed the WTP answers (Cummings, Brookshire, and

Schulze, 1986). The difference in typical responses actually does not tell the

entire story. As two close observers of this literature note (Mitchell and Carson,

1989,

p. 34): "Studies using WTA questions have consistently received a large

number of protest answers, such as 'I refuse to sell' or 'I want an extremely

large or infinite amount of compensation for agreeing to this,' and have

Daniel

Kahneman,

Jack L. Knetsch, and Richard H. Thaler 203

frequently experienced protest rates [outright refusals to answer the question]

of 50 percent or more." These extreme responses reflect the feelings of outrage

often seen when communities are faced with the prospect of accepting a new

risk such as a nuclear power plant or waste disposal facility (Kunreuther,

Easterling, Desvousges, and Slovic, forthcoming). Offers of compensation to

proposed communities often do not help as they are typically perceived as

bribes.

Judgments of Fairness and Justice

An implication of the endowment effect is that people treat opportunity

costs differently than "out-of-pocket" costs. Foregone gains are less painful than

perceived losses. This perception is strongly manifested in people's judgments

about fair behavior. Kahneman, Knetsch and Thaler (1986) present survey

evidence supporting this proposition. Samples of the residents of Toronto and

Vancouver were asked a series of questions over the telephone about whether

they thought a particular economic action was "fair." In some cases, alternative

versions of the same question were presented to different groups of respon-

dents.

For each question, respondents were asked to judge whether the action

was completely fair, acceptable, somewhat unfair, or very unfair. In reporting

the results the first two categories were combined and called "acceptable" and

the last two combined and called "unfair." Perceptions of fairness strongly

depended on whether the question was framed as a reduction in a gain or an

actual loss. For example:

Question 1a. A shortage has developed for a popular model of

automobile, and customers must now wait two months for delivery. A

dealer has been selling these cars at list price. Now the dealer prices this

model at $200 above list price.

N = 130 Acceptable 29 percent Unfair 71 percent

Question 1b. A shortage has developed for a popular model of

automobile, and customers must now wait two months for delivery. A

dealer has been selling these cars at a discount of $200 below list price.

Now the dealer sells this model only at list price.

N = 123 Acceptable 58 percent Unfair 42 percent

This is a situation in which people loudly say one thing and the theory asserts another. It is of

interest that the practitioners of contingent valuation elected to listen to the theory, rather than to

the respondents (Cummings, Brookshire and Schulze, 1986). The accepted procedure uses WTP

questions to assess value even in a context of compensation, relying on the theoretical argument

that WTP and WTA should not be far apart when income effects are small.

204 Journal of Economic Perspectives

Imposing a surcharge (which is likely to be judged a loss) is considered

more unfair than eliminating a discount (a reduction of a gain). This distinction

explains why firms that charge cash customers one price and credit card

customers a higher price always refer to the cash price as a discount rather than

to the credit card price as a surcharge (Thaler, 1980).

The different intensity of responses to losses and to foregone gains may

help explain why it is easier to cut real wages during inflationary periods:

Question 2a. A company is making a small profit. It is located in a

community experiencing a recession with substantial unemployment but

no inflation. The company decides to decrease wages and salaries 7

percent this year.

N = 125 Acceptable 37 percent Unfair 63 percent

Question 2b. A company is making a small profit. It is located in a

community experiencing a recession with substantial unemployment and

inflation of 12 percent. The company decides to increase salaries only 5

percent this year.

N = 129 Acceptable 78 percent Unfair 22 percent

In this case a 7 percent cut in real wages is judged reasonably fair when it

is framed as a nominal wage increase, but quite unfair when it is posed as a

nominal wage cut.

The attitudes of the lay public about fairness, which are represented in

their answers to these fairness questions, also pervade the decisions made by

judges in many fields of the law. Supreme Court Justice Oliver Wendell Holmes

(1897) put the principle this way: "It is in the nature of a man's mind. A thing

which you enjoyed and used as your own for a long time, whether property or

opinion, takes root in your being and cannot be torn away without your

resenting the act and trying to defend

yourself,

however you came by it. The

law can ask no better justification than the deepest instincts of man."

Cohen and Knetsch (1990) showed that this principle, embodied in the old

expression that "possession is nine tenths of the law," is reflected in many

judicial opinions. For example, in tort law judges make the distinction between

"loss by way of expenditure and failure to make gain." In one case, several

bales fell from the defendant's truck and hit a utility pole, cutting off power to

the plaintiff's plant. The plaintiff was able to recover wages paid to employees

which were considered "positive outlays" but could not recover lost profits

which were merely "negative losses consisting of a mere deprivation of an

opportunity to earn an income" (p. 18). A similar distinction is made in contract

law. A party that breaches a contract is more likely to be held to the original

terms if the action is taken to make an unforeseen gain than if it is taken to

avoid a loss.

Anomalies 205

Commentary

It is in the nature of economic anomalies that they violate standard theory.

The next question is what to do about it. In many cases there is no obvious way

to amend the theory to fit the facts, either because too little is known, or

because the changes would greatly increase the complexity of the theory and

reduce its predictive yield. The anomalies that we have described under the

labels of the endowment effect, the status quo bias and loss aversion may be an

exceptional case, where the needed amendments in the theory are both obvious

and tractable.

The amendments are not trivial: the important notion of a stable prefer-

ence order must be abandoned in favor of a preference order that depends on

the current reference level. A revised version of preference theory would assign

a special role to the status quo, giving up some standard assumptions of

stability, symmetry and reversibility which the data have shown to be false. But

the task is manageable. The generalization of preference theory to indifference

curves that are indexed to reference level is straightforward (Tversky and

Kahneman, 1991). The factors that determine the reference point in the

evaluations of outcomes are reasonably well understood: the role of the status

quo,

and of entitlements and expectations are sufficiently well established to

allow these factors to be used in locating the relevant reference levels for

particular analyses.

As Samuelson and Zeckhauser noted, rational models that ignore the status

quo tend to predict "greater instability than is observed in the world" (p. 47).

We have added the claim that models that ignore loss aversion predict more

symmetry and reversibility than are observed in the world, ignoring potentially

large differences in the magnitude of responses to gains and to losses. Re-

sponses to increases and to decreases in price, for example, might not always be

mirror images of each other. The possibility of loss aversion effects suggests,

more generally, that treatments of responses to changes in economic variables

should routinely separate the cases of favorable and unfavorable changes.

Introducing such distinctions could improve the precision of predictions at a

tolerable price in increased complexity.

After more than a decade of research on this topic we have become

convinced that the endowment effect, status quo bias, and the aversion to losses

are both robust and important. Then again, we admit that the idea is now part

of our endowment, and we are naturally keener to retain it than others might

be to acquire it.

• The authors wish to acknowledge financial support from Fisheries and Oceans

Canada, the Ontario Ministry of the Environment, the Russell Sage Foundation, and

Concord Capital Management.

206 Journal

Economic Perspectives

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Discussion

Other papers by the authors that you can find annotated Fermat's Library: - [Mental Accounting and Consumer Choice - Richard Thaler](https://fermatslibrary.com/s/mental-accounting-and-consumer-choice) - [Judgment under Uncertainty: Heuristics and Biases - Amos Tversky and Daniel Kahneman](https://fermatslibrary.com/s/judgment-under-uncertainty-heuristics-and-biases) - [Prospect Theory - Daniel Kahneman and Amos Tversky](https://fermatslibrary.com/s/prospect-theory-an-analysis-of-decision-under-risk) This graph shows two indifference curves that cross, which isn’t supposed to happen if a person's choices are consistent. Each curve represents combinations of pens and dollars that give the same level of satisfaction to the consumer. If the curves cross, it means the same combination of goods is both equally satisfying and not equally satisfying, which is a contradiction. In a nutshell people tend to value an item they own more highly than an identical item they do not own. ***loss aversion***: the disutility of giving up an object is greater that the utility associated with acquiring that same object. **Losing feels more painful than winning. ** People feel losses more strongly than equivalent gains, leading to decisions that are biased toward avoiding loss even when it’s not rational. This helps explain why people resist trades or changes that would otherwise benefit them. The concept is central to understanding many deviations from standard economic behavior. ***"The experiment was replicated several times, always with similar results: median selling prices are about twice median buying prices and volume is less than half of that expected."*** Even when people are randomly given an item (like a pen) only moments before, they become significantly more likely to choose it over other alternatives. The observations here reinforce the idea that ownership instantly changes preferences where the pain of losing something outweighs any rational evaluation of its value. ### TL;DR This paper explores three behavioral economic concepts: the endowment effect, loss aversion, and status quo bias. These concepts challenge the standard economic assumption that people have stable and rational preferences. Through a series of clever experiments and real-world examples, the authors show that: - individuals value items more highly simply because they own them (endowment effect) - feel the pain of losses more acutely than the pleasure of equivalent gains (loss aversion) - and tend to stick with default options even when better alternatives exist (status quo bias). These behaviors persist even in settings that should encourage rational behavior, suggesting that they are deep-rooted tendencies. These concepts are especially important for understanding how people respond to losses and defaults, especially in a world filled with nudges, dark patterns, and subscription traps. The ideas in this paper continue to shape behavioral economics, influencing everything from retirement plan participation to healthcare decisions and digital product design. It’s a must-read if you want to understand why people often act in ways that defy classical economic logic. The authors argue that **these behavioral patterns are not just exceptions but core features of decision-making.** Standard economic models need to adapt by recognizing reference points and loss sensitivity. Doing so can make predictions more accurate and useful in the real world. Given a choice **people tend to stick with the default or current option, even when better alternatives exist.** This bias gets stronger as the number of options increases. It’s another example of loss aversion, where changing feels riskier than staying the same. Given a choice, people tend to stick with the default or current option even when better alternatives exist. This bias gets stronger as the number of options increases. It’s another example of loss aversion - **changing feels riskier than staying the same.** **People perceive losses as less fair than missed gains, even if the outcomes are identical.** This affects how they judge pricing, wages, and policies. These fairness judgments are deeply influenced by how situations are framed.

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