Question

In a study, when asked to choose between an iPod retailing for $100 and $100 cash, people were more likely to choose the money. But when they were given an iPod and then asked if they would trade it for $100, they were more likely to choose the iPod. What effect does this reflect? Is this behavior rational?

Answer 1

The decision to choose money over an item or to keep an item once owned is an example of the endowment effect in behavioral economics, which suggests that ownership increases the value people place on items.

Step-by-step explanation:

The effect observed in the scenario where people are more likely to choose $100 cash over an iPod, but are more likely to keep the iPod when they already own it, reflects the endowment effect.

The endowment effect is a phenomenon in behavioral economics that suggests that people ascribe more value to things merely because they own them. This behavior is not considered rational in traditional economic theory, since the value of the item should not change simply due to ownership. However, behavioral economists understand that people evaluate outcomes relative to a reference point and often think of gains and losses as percentages rather than in terms of absolute savings or value.

This behavioral tendency can lead to seemingly irrational decisions that are heavily influenced by how a choice is presented or 'framed'. A similar example of this behavior is when individuals decide whether it's worth walking five minutes to save $10 on a small purchase like a $20 alarm clock versus on a larger purchase like a $300 phone. While a traditional economist would say that saving $10 is equally valuable in both cases, a behavioral economist would point out that people commonly view the $10 savings as a larger percentage of the total cost in the cheaper item, making it feel like a more significant saving.