Thursday, November 21, 2019

The Endowment Effect (in my first year microeconomics students)

To liven up a pretty dry and technical lecture on the standard model of consumer choice - marginal rate of substition, tangency condition, income and subsitution effect and all that - I run a fairly simple exercise showing the endowment effect in one of the classes of my first year microeconomics module.

Using the online questionnaire tool Qualtrics I ask the students randomly one of two versions of the following question at the start of the lecture:

Imagine you have a bag of winegums (with approx. 100 winegums) and your friend has a Twix. How many winegums would you be willing to give to your friend to get one of his/her Twix bars in return?
Imagine you have a Twix and your friend has a bag of winegums (with approx. 100 winegums). How many winegums would your friend have to give to you for you to want to give him/her one of your Twix bars in return?
So what I'm doing is asking for the Willingness to Pay (WTP) and Willingness to Accept (WTA) of one Twix bar expressed in number winegums. Over the course of the lecture I explain about the marginal rate of substitution and how theoretically we would expect the WTA and the WTP of a particular good, for instance Twixes, in terms of the other good, say winegums, to be pretty much the same.

I include some comments at the end about to what extent the model accurately describes how regular people make actual consumption decisions and point out that some of the assumptions, in particular the one about the WTP and WTA being the same for one, are falsified by behaviour in the real world. Pointing out their own valuations for the Twix when exchanging it for winegums, or the other way around. This year again, the WTA was higher than the WTP and I use that for a quick discussion of the endowment effect.

It took me a couple of years of trying to find the right way to ask this question. And still this year there were some issues. There were a couple of responses explaining extreme valuations because winegums are haram or non vegetarian. There were even some students who didn't know what winegums were. But, as I explained to the students a couple of weeks ago when I talked about the recent Nobel Prize in Economics for RCTs (in development economics), if you randomly assign participants to the different treatments and you have enough observations, these kind of issues should average out. But still, maybe next year I will specify that these hypothetical winegums are vegetarian, despite the name don't contain any alcohol and include a picture.

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