Knowledge

The Sunk Cost Fallacy

Imagine you’re out to dinner and have purchased the 3-course prix fixe offering, which includes an appetizer, entrée, and dessert for one price (drinks are extra). You get to dessert and find you’re plenty full from the previous two courses. I’m sure each of us would justify eating the dessert despite being already full with the reasoning that we’ve already paid for it, so we should eat it, right?

Well, from an economists point-of-view, that way of reasoning is dead wrong, and is an example of the so-called “sunk cost fallacy.” While a layman might look at the cost of the eating dessert as including the price already paid, an economist would avoid that sunk cost, and look at only present or future costs (such as feeling ill from eating too much, the cost of extra caloric intake, etc.). The reason for this is because at the time the dessert comes, the actual monetary cost is $0, unless you can convince the restaurant to give you some of your money back (not likely).

Examples of the sunk cost fallacy happen all the time in business, where managers let the sunk cost, i.e. money spent to date influence decisions moving forward. There are sunk cost fallacies associated with the purchase of a home, or car, or vacation. In fact it is quite human to fall for the sunk cost fallacy, and it’s probably mostly an effort to derive as much value from past expenditures as possible, but it is certainly not the way an economist would attack the project.

What examples of sunk cost fallacy have you seen in your life? How do you change your behavior to avoid sunk cost fallacies, if at all?

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