Description Sunk_cost

the sunk cost distinct economic loss. example, when new car purchased, can subsequently resold; however, not resold original purchase price. economic loss difference (including transaction costs). sum paid should not affect rational future decision-making car, regardless of resale value: if owner can derive more value selling car not selling it, should sold, regardless of price paid. in sense, sunk cost not precise quantity, economic term sum paid, in past, no longer relevant decisions future; may used inconsistently in quantitative terms original cost or expected economic loss. may used shorthand error in analysis due sunk cost fallacy, irrational decision-making or, simply, irrelevant data.

economists argue sunk costs not taken account when making rational decisions. in case of baseball game ticket has been purchased, ticket-buyer can choose between following 2 end results if realizes doesn t game:

in either case, ticket-buyer has paid price of ticket part of decision no longer affects future. if ticket-buyer regrets buying ticket, current decision should based on whether wants see game @ all, regardless of price, if go free baseball game. economist suggest that, since second option involves suffering in 1 way (spent money), while first involves suffering in 2 (spent money plus wasted time), option 2 preferable.

sunk costs may cause cost overrun. in business, example of sunk costs may investment factory or research has lower value or no value whatsoever. example, $20 million has been spent on building power plant; value @ present 0 because incomplete (and no sale or recovery feasible). plant can completed additional $10 million, or abandoned , different equally valuable facility built $5 million. should obvious abandonment , construction of alternative facility more rational decision, though represents total loss of original expenditure—the original sum invested sunk cost. if decision-makers irrational or have wrong incentives, completion of project may chosen. example, politicians or managers may have more incentive avoid appearance of total loss. in practice, there considerable ambiguity , uncertainty in such cases, , decisions may in retrospect appear irrational were, @ time, reasonable economic actors involved , in context of own incentives.

daniel kahneman

behavioral economics recognizes sunk costs affect economic decisions due loss aversion: price paid becomes benchmark value, whereas price paid should irrelevant. considered irrational behavior (as rationality defined classical economics). economic experiments have shown sunk cost fallacy , loss aversion common; hence economic rationality—as assumed of economics—is limited. has enormous implications finance, economics, , securities markets in particular. daniel kahneman won nobel prize in economics in part extensive work in area collaborator, amos tversky.