Sunk cost facts for kids

In economics and business decision-making, a sunk cost is money or effort you've already spent that you can't get back. Think of it like "water under the bridge." It's a cost that happened in the past. These costs are different from prospective costs, which are future costs you might still avoid. Economists say sunk costs shouldn't affect your future choices. But in real life, people often let past spending influence what they do next, like fixing an old car or house.

Why Past Costs Don't Matter for Future Choices

According to economists, when you make a smart decision, you should only think about future costs. What's already spent is gone, no matter what you decide now. The best choice depends only on your current options and what will happen next. Past mistakes don't matter.

The "Water Under the Bridge" Idea

Imagine you bought a movie ticket for $10. But then you hear the movie is terrible. That $10 is a sunk cost. You can't get it back. A smart decision would be to decide if you want to spend two hours watching a bad movie, or do something else you enjoy. The $10 you spent shouldn't make you go to the movie if you don't want to. It's "water under the bridge."

Sometimes, people might ignore this rule for personal reasons. For example, a manager might continue a project to show they are determined, even if it's not the best choice for the company. Or they might want to avoid blame for past decisions.

The Sunk Cost Fallacy: Why We Keep Going

Even though economists say we should ignore sunk costs, people often don't. This is called the sunk cost fallacy. It means we tend to keep doing something or spending more money because we've already invested a lot of time, effort, or money into it. It's like "throwing good money after bad." We find it hard to "cut our losses."

Real-Life Examples of the Fallacy

• Someone might stay in a friendship or activity that isn't working out because they've already put so much time and effort into it.
• People might argue that a big project must continue because so much has already been invested. They feel that stopping would make all that past effort seem wasted.
• The famous "Concorde fallacy" is a great example. The British and French governments kept spending money on the supersonic Concorde airplane. They continued even when it was clear the plane wouldn't make a profit. They felt they had already spent so much, they couldn't just stop.
• For businesses, money spent on advertising a brand or on research and development (R&D) are sunk costs. Once spent, these costs shouldn't affect future decisions, like how much to charge for a product.

The sunk cost fallacy has also been called the "Concorde fallacy." The British and French governments continued funding the costly supersonic jet. They used past expenses as a reason to keep going, instead of "cutting their losses."

Sticking to the Plan: Plan Continuation Bias

This is a similar idea. Plan continuation bias means we tend to stick to a plan, even when things change and the plan isn't working anymore. It's a mental shortcut that can lead to problems.

For example, aircraft pilots or ships' captains might stick to a dangerous course instead of changing it. This can happen even when it's clear there's a problem. A famous case was the Torrey Canyon oil spill. The captain kept to a risky path, causing the tanker to run aground. This bias has been a factor in many accidents.

This bias often happens because people are too optimistic about success. Also, if you feel personally responsible for a plan, it's harder to admit it was wrong.

Why Do We Fall for the Sunk Cost Fallacy?

Scientists who study how our brains make decisions have found a few reasons why we fall for the sunk cost fallacy:

How We See Things: Framing Effects

This is about how information is presented to us. The way a choice is "framed" (whether it sounds positive or negative) can change how we decide. This happens even if the actual options are the same. For example, saying "200 people will be saved" sounds better than "400 people will die." Both statements describe the same situation out of 600 people. This "framing" can make us more likely to continue investing in something if we see stopping as a "loss."

Thinking We'll Win: Overoptimistic Bias

After we've invested in something, we often become more confident that it will succeed. In one study, people who had just placed a bet on a horse believed their horse had a much better chance of winning. This was compared to people who were about to place a bet. Our belief in success goes up after we've committed.

Feeling Responsible: Personal Accountability

If you feel personally responsible for an investment or a decision, you're more likely to keep investing in it. This happens even if it's not going well. It's harder to give up on something you started. Studies have shown that managers who made an initial investment were more likely to put more money into a struggling project. This was true compared to managers who inherited the project from someone else.

Not Wanting to Waste: Avoiding the "Wasteful" Label

No one wants to feel like they've wasted money or effort. If you stop a project or leave an event you paid for, it might feel like you "wasted" what you already put in. So, people might continue just to avoid that feeling, even if it means wasting more time or money.

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  The psychology of cognitive biases shows how our brains sometimes make quick decisions that affect our choices in economics.

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