Contrary to theoretical expectations, measures of willingness to accept greatly exceed measures of willingness to pay. This paper reports several experiments that demonstrate that this "endowment effect" persists even in market settings with opportunities to learn. Consumption objects (e.g., coffee mugs) are randomly given to half the subjects in an experiment. Markets for the mugs are then conducted. The Coase theorem predicts that about half the mugs will trade, but observed volume is always significantly less. When markets for "induced-value" tokens are conducted, the predicted volume is observed, suggesting that transactions costs cannot explain the undertrading for consumption goods.

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Experimental Tests of the Endowment Effect and the Coase Theorem

Elimination by aspects: A theory of choice.

The purpose of this paper is to describe a sequential experiment that provides, at each stage in the sequence, an estimate of the utility to the subject of some amount of a commodity (e.g., money), and to present a few experimental results obtained with the method. The procedure is based upon the following well-known ‘expected utility hypothesis’. For each person there exist numerical constants, called utilities, associated with the various possible outcomes of his actions, given the external events not under his control. If, for a given subject, we could know the values of these constants and the (‘personal’) probabilities he assigns to the various external events we could, according to this model, predict his choice from among any available set of actions. He will choose an action with the highest expected utility; i.e., with the highest average of utilities of outcomes, weighted by the probabilities he assigns to the corresponding events. He will be indifferent between any two actions with equal expected utilities. Note that (by the nature of weighted averages) the comparison between expected utilities does not depend on which two particular outcomes are regarded as having zero-utility and unit-utility.

Measuring utility by a single-response sequential method,

We develop a model of reference-dependent preferences and loss aversion where “gain‐loss utility” is derived from standard “consumption utility” and the reference point is determined endogenously by the economic environment. We assume that a person’s reference point is her rational expectations held in the recent past about outcomes, which are determined in a personal equilibrium by the requirement that they must be consistent with optimal behavior given expectations. In deterministic environments, choices maximize consumption utility, but gain‐loss utility influences behavior when there is uncertainty. Applying the model to consumer behavior, we show that willingness to pay for a good is increasing in the expected probability of purchase and in the expected prices conditional on purchase. In within-day labor-supply decisions, a worker is less likely to continue work if income earned thus far is unexpectedly high, but more likely to show up as well as continue work if expected income is high.

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A Model of Reference-Dependent Preferences

We develop a model that fleshes out, extends, and modifies existing models of reference dependent preferences and loss aversion while accomodating most of the evidence motivating these models. Our approach makes reference-dependent theory more broadly applicable by avoiding some of the ways that prevailing modelsâ€”if applied literally and without ancillary assumptionsâ€”make variously weak and incorrect predictions. Our model combines the reference-dependent gain-loss utility with standard economic â€œconsumption utilityâ€ and clarifies the relationship between the two. Most importantly, we posit that a personâ€™s reference point is her recent expectations about outcomes (rather than the status quo), and assume that behavior accords to a personal equilibrium: The person maximizes utility given her rational expectations about outcomes, where these expectations depend on her own anticipated behavior. We apply our theory to consumer behavior, and emphasize that a consumerâ€™s willingness to pay for a good is endogenously determined by the market distribution of prices and how she expects to respond to these prices. Because a buyerâ€™s willingness to buy depends on whether she anticipates buying the good, for a range of market prices there are multiple personal equilibria. This multiplicity disappears when the consumer is sufficiently uncertain about the price she will face. Because paying more than she anticipated induces a sense of loss in the buyer, the lower the prices at which she expects to buy the lower will be her willingness to pay. In some situations, a known stochastic decrease in prices can even lower the quantity demanded.

The notion of “utility” is fundamental in most current theories of human decision. The problem of determining the utility function of a given decision maker, however, presents grave difficulties. It is not sufficient to determine the decision maker's rank-order preference of choices, because such a rank-order preference would determine his utility only on an ordinal scale, not the interval scale required in many decision problems. The problem is further complicated by the fact that even the preference choices of the chooser are often inconsistent with each other. T o circumvent the latter difficulty, stochastic definitions of utilities have been proposed in which probabilities (frequencies) of preference choices become the basic data. Here the implications of some of these models are derived which enable the experimenter to decide whether a given model is consistent with a set of data. Appropriate statistical sampling tests are worked out.

Stochastic models of choice behavior

In this paper we report the results of an experiment designed to test the appropriateness of certain models for choices among wagers. These models and the test procedure to be used have previously been described in this journal in some detail (Becker et al, 1963), but for convenience we will briefly restate them here. The reader should, however, refer to Becker et al. (1963) for precise statements of the basic concepts of rewards, wagers, offered sets, and stochastic models for wagers, and for proofs of theorems.

An experimental study of some stochastic models for wagers

The purpose of this paper is to report an experimental investigation of individual choice behavior in certain situations suggested by Debreu (1960) in his review of Luce’s book (1959). Let T denote the set of all possible alternatives from among which a subject might be required to choose. For any finite subset S of T (we call S the ‘offered set’) and any alternative x in S, let x(S) denote the probability that the subject, when choosing among the alternatives in S, will choose x. Thus x({x, y}) is the probability that the subject will choose from the pair {x, y} the alternative x rather than y. When x({x, y}) = 1, or equivalently j({x,y}) = 0,we say that x is absolutely preferred to y. The Luce model1 as presented in his book (1959) states that if no element of T is absolutely preferred to another element of T, then every element x of T is associated with a positive number v(x) (which we have called ‘strict utility of x’) such that, for every offered subset S of T,

$$x(S) = {{v(x)} \over {\sum\limits_{y \in S} {v(y)} }};$$

(that is, the elements of any offered set are chosen with probabilities proportional to their strict utilities).

Gordon M. Becker

Papers

Measuring utility by a single-response sequential method,

Stochastic models of choice behavior

An experimental study of some stochastic models for wagers

Probabilities of choices among very similar objects: an experiment to decide between two models.