The Idea of Sunk Costs
A sunk cost is an expense that you cannot recover. Accordingly, economic theory says a sunk cost should not affect your decision making. Psychologically, it is hard to ignore sunk costs. Here are a few examples where sunk costs come into play.
Example 1: Attending an NFL game with already purchased tickets
Sportswriters are discussing the aftermath of Michael Vick’s guilty plea to dogfighting charges. Vick was the main attraction in
What will happen to attendance this year? Lucky for the owners, the season tickets were sold months ago, when Vick was expected to play. Today I heard a sportswriter day that fans will still show up to games this season since they spent $100 on tickets.
In reality, the $100 is a sunk cost. Nothing you can do can change that you already paid for those tickets. Economic theory suggests you should not go to the game simply because you spent that much money. You are better considering your actual alternatives: would it be better to attend the game or sell the ticket, for say, $50? Thinking like this doesn’t always give you comfort-you might end up losing money on the ticket-but it allows you to make the most of a bad situation.
Example 2: How long would you watch a bad movie?
Let’s say you rent a movie and after half an hour decide it is unbearable to watch—it’s not even “good” enough that you can make fun of it. Most of us would watch the rest of the movie since we paid for it, but the truth is, the price of rental is a sunk cost.
What we really face is the choice of watching the rest of a bad movie, or using the time to do something more fun.
I’ll admit I don’t always make the best choice. Psychologically, since I have usually scheduled time to watch the movie, I try to convince myself it was time and money worth spent. And, if I finish a movie, I feel more comfortable rating it on IMDB.
Example 3: Bad food from a restaurant
There are a couple rare times that I’ve ordered food so bad I wanted to stop after a few bites. And I should have.
The cost of the meal is a sunk cost. I can either suffer the rest of the meal by continuing to eat it, or I could order some thing else and enjoy it.
But I’ve never ordered more food in my life, even though I should, because I’ve been trained never to waste food.
8 Responses to “The Idea of Sunk Costs”
I just played my first game of golf last week. I didn’t have to pay for the course or the golf cart but I did have to spend $30 to rent clubs.
However, after the first couple of holes I realized, “this game sucks!”. But I didnt quit half way through, although I did stop keeping score. That’s my sunk cost story, I hope you enjoyed it.
By jyu on Aug 22, 2007
@jyu-Your solution to not keep score is awesome. How did you manage to get out of the course and golf cart fees?
By Presh on Aug 22, 2007
In sort of a twisted way, sunk cost can be applied to your personal time as well (or time in general). I suppose that’s why I always make the best out of unwanted chores and honey-do’s. It’s an attitude.
By Joe P on Aug 22, 2007
@Joe P-That’s a good point that sunk cost can refer to any cost (money, time, emotion) and it is good decisions come by only looking at available choices.
By Presh on Aug 22, 2007
Your article about sunk costs relate to a principle of influence, #2:
http://pages.prodigy.net/mschnall/cialdini.html
The season ticket holders got tickets to see someone specific play, but if they show up, it could also be to rationalize their purchase. After a few games, they’ll probably convince themselves that they care about the team or something else, and might even reverse their opinion on what they originally wanted.
By RohoMech on Aug 23, 2007
@Rohit–didn’t think about it that way, but it is true that we consider sunk cost to be consistent. We’d rather make a bad decision than look flaky.
By Presh on Aug 23, 2007
I particularly enjoyed this post because of the fact that it required me to read the first sentence several times to reflect on various sunk costs.
I have found a large portion of my finances are governed by sunk costs, and in fact many of them are poor decisions. This is significant, yet insignificant when you consider that there will be a sunk cost in the relatively near future impacting every aspect of my life to the point that everything else pales in comparison.
And if you know what I mean, I pose another question:
At what point does a sunk cost become an investment?
Or are they not mutually exclusive?
By Joon on Sep 6, 2007
@Joon: I see your point that we continually have new expenses that become “sunk” so we stop thinking about older ones.
I’m not sure about your distinction from investments and sunk costs. A sunk cost IS an investment; it’s the portion of an investment that you cannot recover. So for instance, if you buy a stock and it drops 50%, the loss is a a sunk cost.
You should not hold on to the stock since you emotionally feel bad selling at a loss. You should only hold on to it if it holds the best investment return (after trading commissions) going forward. Otherwise, sell, sell, sell.
By Presh on Sep 6, 2007