Colloquially known as “throwing good money after bad,” sunk cost is a concept from behavioral economics that reflects our tendency to keep going with an investment long after it turns south, because we are psychologically unable to let go of a once good thing.
Sunk cost is considered a fallacy, because it represents an example of behavior that is technically irrational while being culturally ubiquitous.
The concept of sunk cost plays a crucial role in both traditional economics and behavioral economics, though it’s interpreted and applied somewhat differently in each field. At its core, a sunk cost refers to any expense that has already been incurred and cannot be recovered.
In conventional economics, this might include money spent on non-refundable purchases, investments in projects, or any other expenditures that, once made, cannot be refunded or reused. The fundamental principle here is that sunk costs should not influence ongoing or future decision-making, since these costs cannot be altered by any current or future actions.
Sunk cost in behavioral economics
However, when we transition to the realm of behavioral economics, the perspective on sunk costs shifts to focus on the psychological impact these irretrievable expenditures have on individuals’ critical thinking and decision-making processes.
Despite the rational advice to disregard sunk costs, individuals often fall prey to the “sunk cost fallacy.” This fallacy leads people to continue investing time, money, or other resources into ventures or products simply because they have already made significant investments, even if the current evidence suggests that continuing would not be beneficial. This behavior is driven by emotional factors such as commitment, fear of waste, or the desire to not appear inconsistent, rather than by logical economic reasoning.
Understanding the sunk cost fallacy is vital in both personal and professional contexts. It highlights the importance of making decisions based on future value and potential outcomes, rather than being anchored to past investments. Recognizing and overcoming this bias can lead to more economically rational decisions, allowing individuals and businesses to allocate resources more effectively and pursue paths that are more likely to yield positive results. In essence, the concept of sunk costs and the associated fallacy serve as a reminder of the complex interplay between economic theory and human psychology.