I’m going to go all economic nerd (the best kind of nerd, IMHO) this morning and talk about sunk costs.
First, a couple of definitions:
Sunk Cost – a cost that has already been incurred and cannot be recovered
Sunk Cost Fallacy – a tendency to continue an endeavor once an investment in money, effort, or time has been made. This is also referred to as “throwing good money after bad;” it is also called the “Concorde Fallacy,” after the decision by the governments of the UK and France to use their past expenses on the costly airplane as a rationale for continuing the project.
Once we become comfortable with the concept of sunk costs, much of the confusion we feel about economic decisions evaporates.
I’ll give you one example that helped bring home this concept to my high school economics students. I asked them what they would do if they had bought prom tickets but broke up with their date a few days before prom. It was not possible to get a refund on the tickets. Would they go to prom or not?
They all responded with some variation of the thought that if they didn’t go to prom, it would be a waste of their money. When I gave them the sunk costs way of thinking about it, their opinions changed. Here’s the “sunk costs” analysis:
You’ve already spent the money. There’s no way to recoup the money you spent. Now, how would you like to spend the Friday night of prom: having a miserable time with the person you now can’t stand, or staying home, eating popcorn, and watching a movie?
Once they realized the “sunk costs” aspect of things, their thinking changed.
We can apply this to all sorts of scenarios.
You’ve arranged a non-refundable vacation to a faraway place. Break your leg, but you decide to “go anyway” so you don’t waste the money.
o Reframe the decision: having spent the money on the vacation, would you rather spend the next two weeks in pain as you try to navigate a foreign environment while on crutches or a knee scooter, or would you rather stay home with less pain and better chances of recovery?
You go out to eat and there’s too much on the plate to eat comfortably. You eat it all anyway because you want to get your money’s worth.
o Reframe the question: having spent the money, do you want to feel sick or well later in the evening?
You’re on a diet but end up ruining it at lunch by having a pizza. Since you’ve already broken your diet, you decide to eat too much for the rest of the day.
o Reframe the decision: having eaten too much at lunch, do you want to continue to overeat for the rest of the day or do you want to make up for your original decision to overeat at lunch?
You’ve worked for years to get a degree, but you find it almost impossible to get a job in that field. You continue looking for work in the field so that your education doesn’t “go to waste”
o Reframe the decision: having spent years getting a degree, do you want to have a job even if it means changing career paths?
You spend $500 to attend a two-day seminar on a topic you’re interested in. After the first session, you realize that this seminar is not what you thought it would be. But you attend the entire event anyway, so that your money isn’t wasted.
o Reframe the decision: if the seminar is that bad, the money is wasted anyway. Now, how do you want to spend the two days?
Your refrigerator broke and it cost you a lot of money to repair it. When it broke again a month later, you repaired it again so that the money you spent on the first repair didn’t go to waste.
o Reframe the decision: you’ll never recoup the cost of the first repair. Is it smarter to use the potential cost of the second repair to go toward buying a new refrigerator?
You have bought new hardwood flooring and halfway through the installation, you realize that you don’t like the way it looks. You put down the rest of the flooring anyway because you paid for it.
o Reframe the decision: having already spent the money, do you want to finish laying a floor that you don’t like or do you rip up the flooring, return the unused portion, and buy new flooring
You get the idea.
Governments succumb to the sunk cost fallacy as well. Once they’ve committed to funding a program, the initial investment is often used as a justification for continuing to spend money on the program, even if it’s not working out the way the original planners intended.
There are many facets to application of the "sunk cost fallacy" -- some good, some not so good. A Virginia suburb of Washington, D. C. back in the 70's , near where I lived at the time, became disgusted at the rising costs of the new Metro commuter train project to which it had contributed millions with the promise of a rail line to its city. "Enough is enough!" they said, and pulled out, writing off their investment (sunk costs). Years later the project finally came to fruition and became a big success, but did not include the renegade city. They had to crawl back and pay a premium to get back in. Patience may be an antidote to the sunk cost fallacy when the costs are going for something that is a really good idea.
A good nerdy piece. As soon as I saw the photo, you got my attention. In the mid- to late-1970's a group of people got together to create The Coalition Against the SST. They spent a lot of time before Congress trying to convince them what sunk costs were and to please stop spending money on the SST when it could be used for other and/or better things, not to mention the impact the plane would have on the environment. They prevailed, but it wasn't easy. I know this story because I was married for 28 years to the man who started the coalition.