Richard H Thaler - Misbehaving- The Making of Behavioral Economics (epub)

one. He also did not sell any of his bottles to Woody. This is illogical. If he is
willing to drink a bottle that he could sell for $100, then drinking it has to be
worth more than $100. But then, why wouldn’t he also be willing to buy such a
bottle? In fact, why did he refuse to buy any bottle that cost anything close to
$100? As an economist, Rosett knew such behavior was not rational, but he
couldn’t help himself.§
These examples all involve what economists call “opportunity costs.” The
opportunity cost of some activity is what you give up by doing it. If I go for a
hike today instead of staying home to watch football, then the opportunity cost
of going on the hike is the forgone pleasure of watching the game. For the $100
bottle of wine, the opportunity cost of drinking the bottle is what Woody was
willing to pay Rosett for it. Whether Rosett drank his own bottle or bought one,
the opportunity cost of drinking it remains the same. But as Rosett’s behavior
illustrated, even economists have trouble equating opportunity costs with out-ofpocket
costs. Giving up the opportunity to sell something does not hurt as much
as taking the money out of your wallet to pay for it. Opportunity costs are vague
and abstract when compared to handing over actual cash.
My friend Tom Russell suggested another interesting case. At the time, credit
cards were beginning to come into widespread use, and credit card issuers were
in a legal battle with retailers over whether merchants could charge different
prices to cash and credit card customers. Since credit cards charge the retailer for
collecting the money, some merchants, particularly gas stations, wanted to
charge credit card users a higher price. Of course, the credit card industry hated
this practice; they wanted consumers to view the use of the card as free. As the
case wound its way through the regulatory process, the credit card lobby hedged
its bets and shifted focus to form over substance. They insisted that if a store did
charge different prices to cash and credit card customers, the “regular price”
would be the higher credit card price, with cash customers offered a “discount.”
The alternative would have set the cash price as the regular price with credit card
customers required to pay a “surcharge.”
To an Econ these two policies are identical. If the credit card price is $1.03
and the cash price is $1, it should not matter whether you call the three-cent
difference a discount or a surcharge. Nevertheless, the credit card industry
rightly had a strong preference for the discount. Many years later Kahneman and
Tversky would call this distinction “framing,” but marketers already had a gut
instinct that framing mattered. Paying a surcharge is out-of-pocket, whereas not
receiving a discount is a “mere” opportunity cost.
I called this phenomenon the “endowment effect” because, in economists’
lingo, the stuff you own is part of your endowment, and I had stumbled upon a