#41: Of Mice and Ecomomics

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"Of Mice and Economics"

column by Dan Seligman, Forbes, August 24, 1998, p. 62

"No proposition in economics is more firmly established in economics than the supreme irrelevance of sunk costs." A sunk cost is money spent in the past. This should have no influence on subsequent decisions except where prior expenditures are recognized in calculating future net cashflow impacted by such things as:

Future taxes (e.g., depreciation)
Net profit for revenue- or cost-sharing in a contract

Some examples where people fall into the "fallacy of sunk costs" include:

Keeping the business venture alive because you have so much invested in it.
Finishing the large pizza beyond the point of being full.
Sitting through a long, boring play because the tickets cost you $60 each.
Playing the poor-performing pitcher or quarterback because you paid a king's ransom for him.
Holding a poorly performing stock in the hope of getting your money back.
Resisting change because of the large investment in the present system, e.g., staying with copper-wire technology in a fiber optic world.
Staying in a field of study or profession because of your tremendous investment to date.

Mice and other animals appear more rational: Many species defend larger litters more vigorously. Earlier losses are simply written off.

It appears that decision makers often feel that the sunk costs are somehow wasted if the asset is not used. We seem compelled to justify the sunk costs in one's life. Don't do it! "Let bygones be bygones."

—John Schuyler, August 1998.