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Everyday Economics: Sunk Costs

Quotidian life is filled with finding the balance between costs and benefits, and therefore with constant decision-making. For those of us with difficulty in making said decisions – hopefully I’m not alone in this, otherwise the entire purpose of a relatable column is redundant – there is a way to simplify the process: the concept of sunk costs.

A sunk cost is a cost that has already been incurred and that cannot be changed. In other words, it’s a cost that is irrelevant to decisions because it has already been paid for and is now irretrievable. Economists believe that decisions should be based on future consequences, therefore meaning that sunk costs – which are costs of the past – are illogical when factored in to our choices. Naturally, logic and humanity tend to be mutually exclusive and we enjoy making things far more costly for ourselves than needs be.

Oxtickets, which is effectively an online second-hand events marketplace, exists for a reason: to rid ourselves of (as the name suggests) tickets we bought prematurely and came to regret. But sometimes the marketplace doesn’t function in our favour, and we’re still left with that £6 Bridge ticket. There then appears an inexplicable sense of obligation to go; we’ve already paid and want to reap the reward. But what if you have a tutorial essay due the very next day at, say, nine in the morning? If you go to Bridge – assuming you spend no extra money whilst there – you use the ticket, but will most likely result in a delayed essay and a horrible hangover. In going, you’ve incurred additional costs in order to pursue a reward that probably wasn’t worth it (sorry, Bridge). Had you not gone and simply written your essay, the cost would be exactly the same – again assuming you don’t order a Deliveroo or some other unnecessary but probable purchase – but saving yourself the shame and headaches that follow.

The same applies in a temporal context: have you ever chosen the wrong exam question and found yourself torn between continuing or scrapping what you’ve written and starting anew? The cost of continuing is most likely higher than changing course, but due to the time already invested we find ourselves reluctant to do so. At the risk of a lower overall grade, the temptation is to finish what has already been started in the belief that we’ve passed the point of no return. Some might call it perseverance; others (and these others being economists) like to call it the sunk cost fallacy.

Why exactly does this fallacy exist? Well, according to Daniel Kahneman and Amos Tversky, one plausible explanation is loss aversion. Humans have a greater tendency to take risks when applied to the prospect of losses rather than gains (yet another example of our psychological irrationality) and therefore resist making such gains when there exists the option to avoid such losses. In an exam we view the shift from one question to another as a loss of both time and effort, a perspective that ultimately outweighs the potential for gain. Economists would describe this as an inefficient allocation of our resources; we, unfortunately, do not seem to care.

We probably should. It might make the difference between an essay or a painfully awkward email exchange, a hangover or an enjoyable brunch, or even a 2:i and a first (disclaimer: this is no guarantee that after reading this column and applying common sense to decisions involving sunk costs, you will get a first. That would be like lying in bed and praying that you win the lottery without buying a ticket). Economists need our help; considering sunk costs in our decision-making is a good place to start.