A few weeks ago, my cousins and I met up for a girl’s night out. We decided to see the newest horror movie in theaters. In less than 20 minutes, it was obvious to me that the movie was terrible, and a quick glance at my cousins told me that they agreed. But instead of suggesting to each other that we leave, we stuck it out until the bitter end. The entire ride home we talked about how awful the movie was, and what a bad choice we made.
We didn’t just make that bad choice when we purchased the ticket to see that movie. We continued to make that same bad decision when we decided not to walk out when we realized we didn’t like the film. We chose to suffer through another hour — when instead, we could have cut our losses and used that time to do something we would actually have enjoyed. We fell victim to the sunk cost fallacy.
If there is a single aspect of the economic way of thinking that I struggle to put into practice, it’s the idea of letting go of my sunk costs.
Sunk costs are costs that have already been paid. Since they happened in the past, they cannot be recovered and should have no bearing on a current decision. The relevant costs and benefits to consider are the ones that have not yet occurred.
Economics tells us to weigh our expected future costs and benefits against where we stand at that moment, and ignore any costs or benefits that happened in the past. When we were contemplating leaving, it should not have mattered that my cousins and I each spent $10 to get into that movie. The only thing that should have mattered was the cost and benefits of staying for the rest of the movie relative to the costs and benefits of whatever else we could have done with that time.
We can all think of plenty of instances in our lives when we’ve succumbed to the sunk cost fallacy.
- Putting off firing the employee you spent months training, even though you knew early on that he was never going to be a productive worker.
- Staying in a miserable relationship for several additional years because you don’t want the time you spent together to have been for nothing.
- Continuing to eat a meal you don’t really like, just because you paid for it.
- Watching another season of what used to be your favorite show, even though it’s been two years since you’ve enjoyed it.
All of these are situations in which we should cut our losses and move on, but for some reason most of us don’t.
Often, we justify these decisions by emphasizing the amount of time and energy that went into a project or relationship, and explaining how discouraging it would be for those efforts to go to waste. Instead of recognizing that these resources that we expended can never be recovered, we continue to throw good money after bad (and good time after bad) hoping for things to improve when we have no real reason to believe that they will.
Why Sunk Costs Are So Tough to Ignore
Why is it so difficult for even economists to avoid the sunk cost fallacy? Psychologists and behavioral economists offer a few explanations. One possibility is that this seemingly irrational behavior results from a status quo bias. Status quo bias is when people have an emotional preference for things to remain the same. Individuals internalize their current conditions as a reference point, and any deviation from the current situation is perceived as a loss. In such circumstances, people are reluctant to change course from the status quo even when the cost of doing so is small and the potential benefits of the change are huge.
The sunk cost fallacy is also related to loss aversion, a concept Daniel Kahneman and Amos Tversky first identified in their work on how people make choices when faced with risks. They argue that individuals go out of their way to avoid incurring losses or wasting resources. Further, we experience a greater magnitude of pain from a loss than the magnitude of the pleasure we would experience from an equivalent gain. It is very likely that my cousins and I didn’t walk out of the movie because we didn’t want the money we spent on our tickets to “go to waste.” We were willing to incur additional costs in order to avoid the pain of this perceived loss.
Another possible explanation is that people might refuse to recognize their sunk costs for social reasons. More specifically, people sometimes do not deviate from poor decisions because this would be admitting to others that they have failed or made a mistake. As social creatures, we look to gain the approval of others and to maintain a positive reputation that makes us desirable to others as potential partners and collaborators. When viewed in this manner, a behavior that seems to fit with the sunk cost fallacy might actually be an attempt to hide our shortcomings.
Doubling Down on Bad Ideas
When we don’t learn how to let go of our sunk costs, we are likely to double-down on unwise decisions. This is costly on a personal level, but it can be downright devastating from a public policy perspective.
Entrepreneurs who continually make business decisions based on analyses that include sunk costs will lose money and be weeded out of the market. This provides a check on such behavior, and helps reduce the amount of resources that get misallocated as a result of the sunk cost bias in the market.
The political process, however, provides no comparable feedback to punish decision-makers for making the same type of mistake. As a result, policy-makers are more likely to commit to costly policies that do not achieve their stated goals, such as those associated with the War on Drugs or the War on Terror. Trillions of dollars have been spent trying to win those wars, with very little to show for it. Once we recognize that those are sunk costs, we can focus on the more important question: Is it worth it to keep throwing money at such policies, or is it time to walk away?