How natural endowment acquire value? Explain with an example.?
Answers
Explanation:
The endowment effect describes a circumstance in which an individual places a higher value on an object that they already own than the value they would place on that same object if they did not own it.
Endowment effect can be clearly seen with items that have an emotional or symbolic significance to the individual.
Research has identified "ownership" and "loss aversion" as the two main psychological reasons causing the endowment effect.
Understanding the Endowment Effect
In behavioral finance, the endowment effect, or divestiture aversion as it is sometimes called, describes a circumstance in which an individual places a higher value on an object that they already own than the value they would place on that same object if they did not own it.
This type of behavior is typically triggered with items that have an emotional or symbolic significance to the individual. However, it can also occur merely because the individual possesses the object in question.
Example of the Endowment Effect
Let's look at an example. An individual obtained a case of wine that was relatively modest in terms of price. If an offer were made at a later date to acquire that wine for its current market value, which is marginally higher than the price that the individual paid for it, the endowment effect might compel the owner to refuse this offer, despite the monetary gains that would be realized by accepting the offer.
So, rather than take payment for the wine, the owner may choose to wait for an offer that meets their expectation or drink it themselves. The actual ownership has resulted in the individual overvaluing the wine. Similar reactions, driven by the endowment effect, can influence the owners of collectible items, or even companies, who perceive their possession to be more important than any market valuation.
Under the restrictive assumptions of rational choice theory, which undergirds modern microeconomic and finance theory, such behavior is irrational. Behavioral economists and behavior finance scholars explain such allegedly irrational behavior as a result of some sort of cognitive bias that warps the individuals thinking.
According to these theories, a rational individual should value the case of wine at exactly the current market price, since they could purchase an identical case of wine at that price if they were to sell or otherwise give up the case that they own already.
The Endowment Effect Triggers
Research has identified two main psychological reasons as to what causes the endowment effect:
Ownership: Studies have repeatedly shown that people will value something that they already own more than a similar item they do not own, much in line with the adage: "A bird in the hand is worth two in the bush." It does not matter if the object in question was purchased or received as a gift; the effect still holds.
Loss aversion: This is the main reason that investors tend to stick with certain unprofitable assets, or trades, as the prospect of divesting at the prevailing market value does not meet their perceptions of its value.
The Endowment Effect Impact
People who inherit shares of stock from deceased relatives exhibit the endowment effect by refusing to divest those shares, even if they do not fit with that individual's risk tolerance or investment goals, and may adversely impact a portfolio's diversification. Determining whether or not the addition of these shares negatively impacts the overall asset allocation is appropriate to reduce negative outcomes
Answer:
In phycology and behavioural economics the endowment effect ( also known as divestitures aversion and the mere ownership effect in social psychology (1)} is the finding that people are more likely to retain an object they own than acquires that same object when they do not own it .
For example , being unwilling to sell a painting for a price that is greater than the price you would be willing to pay to buy the painting if you didn't already own it is an example of the endowment effect. A cost that has already been paid and cannot be recorded.
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