We were just playing – we love getting requests 🙂

It is good to know that this has been considered in the world of economics, even if it hasn’t made it into a operational framework yet.

Lynn

Here’s another interesting article on endowment effects, and comes with a link to a great you tube video.

Has anyone attempted to explain the mechanism behind the endowment effect – do people underestimate the value of goods they don’t own, or overestimate the value of goods they do own? Introspection suggests the latter to me. Does that List paper suggest which way the prices converge over time (kinda busy sorry)?

While that might be fine for ignoring lab results, if we move back to the endowment effect, wasn’t it shown to exist in actual markets – as a result, this shouldn’t really hold as a critique of ignoring it.

I think that fundamentally everyone is right here. The endowment effect is an explaination for why we may have slow clearing price in markets where the trade occur more rarely (eg the housing market).

It is an example of bounded rationality that still fits well within our “neo-classical” methodology, and as a result is often “implicitly” appealed to be economists.

“People behave as if they’re rational on average in aggregate outcomes”

Moving forward to the importance of labs discussion, I would posit that many economists actually treat the rationality of economic agents as a lot more specific than an “average in aggregate outcomes”. Industrial and micro economists look at far smaller sets of markets and make use of just as many (if not more) rationality assumptions than macro-economists. As a result, labs do give us information on this individual behaviour.

However, my issue with labs is that the results we find there should not be directly compared to real world results, as questions of the stake involved and the “artificial nature” of the decision process will both bias results.

Friedman talked about “as if” rationality. People behave as if they’re rational on average in aggregate outcomes. So, our math models work. But expecting any individual to conform identically to the math model when we put him in the lab and abstract away from all of the context and heuristics that allow him to behave the way he normally does is too much.

So, for example, our models of perfect competition have firms picking the point where MC cuts AC from below. I’d be hard-pressed to think of a firm that actually does that on purpose. Instead, they respond to all of the cues in a competitive marketplace that force them to come pretty close to behaving that way, or to go out of business. You can’t then put a businessman in the lab, give him a math problem, find that he can’t solve the optimization problem and then declare that therefore our models of competition are wrong.

The Austrians talk a lot about process and about the path to equilibrium. They’re probably there onto a decent explanation of why the lab results don’t always conform to what we’d expect, but why things work out once we move to the field experiments where folks can rely on the contextual knowledge they’ve built up over time.

That the strongest empirical evidence emerges from controlled lab experiments shouldn’t really be a surprise either. It’s obviously easier to find evidence of something when you hold other things constant than when you look at the real world. I don’t see why these factors should hold us back from trying to incorporate behavioural results into our analysis.

Perhaps the greatest challenge facing behavioral economics is demonstrating its applicability in the real world. In nearly every instance, the strongest empirical evidence in favor of behavioral anomalies emerges from the lab. Yet, there are many reasons to suspect that these laboratory findings might fail to generalize to real markets. We have recently discussed several factors, ranging from the properties of the situation — such as the nature and extent of scrutiny — to individual expectations and the type of actor involved. For example, the competitive nature of markets encourages individualistic behavior and selects for participants with those tendencies. Compared to lab behavior, therefore, the combination of market forces and experience might lessen the importance of these qualities in everyday markets.

I think this is the main reason most economists have yet to get too excited about it.

I’ll read it tomorrow when I’m not trying to clean up forecasts 😉