Sunk cost fallacy

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Statement

The sunk cost fallacy is the observation that people may behave in irrational or counterproductive ways because of being influenced by sunk costs (costs that they have already incurred and have no way of recovering, and which should be irrelevant to rational decision-making) in a way as to minimize the feeling that these sunk costs were wasteful.

Examples

Resale price

Loss of item versus loss of money

Suppose a person is planning to buy an object A. Consider the following two scenarios:

Case Non-buy option Buy option
The person loses the same amount of money as the cost of A before buying A Do not buy A Buy A
The person buys and then loses the object A, without retrieving any value from the purchase of A Do not buy A Buy A (again)

Assuming rational behavior, whether a person chooses to buy or not buy should be independent of whether the person loses the money or the object. However, what the sunk cost fallacy predicts that losing the object A makes the person less likely to buy another copy of A, because the person does not want to admit that the initial purchase of A was wasteful.

(On the other hand, the sunk cost fallacy might predict the reverse, if the person has already made other, related fixed expenditures that are complementary to having A and does not want to admit that those expenditures were wasteful).

Behavioral explanations/alternatives for the sunk cost fallacy

Anchoring

Further information: Anchoring and adjustment heuristic

One example of the sunk cost fallacy is that the price a person paid for a commodity influences the price the person is willing to accept to sell the commodity, even if that price differs substantially both from the price potential buyers are willing to pay and the value the person attaches to the commodity. This is explained partially by anchoring, where the original price paid to acquire the commodity is treated as an anchor against which the sale price should be measured.

Endowment effect

Further information: Endowment effect

Another effect observed in behavioral economics, that is similar, but distinct, from the sunk cost fallacy is the endowment effect. The endowment effect is the effect whereby the value a person assigns to an object increases after a property right to the object has been established.

The key difference between the endowment effect and the sunk cost fallacy is that in the latter, the initial price paid plays a disproportionate role in determining the value the person attaches to the object. For instance:

  • Under the sunk cost fallacy, something that was obtained at a significant discount, or as a gift, may be valued as much less than the same item for which a high price was paid. The endowment effect makes no such prediction.
  • Under the sunk cost fallacy, people are less willing to buy another copy of an item they lost. This cannot be explained by the endowment effect, which might in fact predict that people who have lost an item are more likely to purchase another copy than people who haven't yet bought it, because an association with the object creates a property right.