Economics Online

What is the Sunk Cost Fallacy?

Saddique Ansari -

The sunk cost fallacy explains the tendency to follow through on something if one has already invested money, time, or effort into it, regardless of whether the current costs exceed the benefits.

Table of Contents

 

Where Does The Sunk Cost Fallacy Occur?

Imagine you purchased a concert ticket a couple of months ago for $100. On the day of the concert, you’re not feeling well, and it’s raining outside. You know that you risk getting sicker if you go to the concert, and traffic is going to be worse since the weather is bad. But even though the current drawbacks seem to outweigh the benefits, why is it that you’re most likely to choose to go to the concert anyway?

This concept is called the sunk cost fallacy. If we’ve invested in an endeavor through effort or monetary investment, then we’re likely to continue it. Often, this means going against evidence that shows going through with the endeavor isn’t the best decision, for instance, when illness or bad weather is affecting the event. 

Individual Effects

From an economic perspective, costs that have been incurred and cannot be recovered are called sunk costs. In the previous example, the $100 spent on concert tickets wouldn’t be recovered, regardless of whether you attended the concert. Therefore, it shouldn’t be a factor in our current decision-making; it’s irrational to make a present decision based on irrecoverable costs. If we’re to act rationally, only future costs and benefits should be taken into account. No matter the ways in which we’ve already invested, we won’t get our investments back regardless of if we follow through on our decision.

The sunk cost fallacy says we’re making irrational decisions by factoring in influences outside of the current alternatives. This fallacy affects multiple areas of our lives, leading to less than optimal outcomes. These outcomes might range from spending more money renovating an old house than it would cost to buy a new one, to staying with a partner even if we’re unhappy because we’ve already invested so much effort and time into our lives with them.

Systemic Effects

The sunk cost fallacy doesn’t just have an impact on small decisions like going to a concert; it has also been proven to affect the decisions made by companies and governments. One famous example of a sunk cost fallacy that affected large-scale decisions is the Concorde fallacy. 

The Supersonic Transport Aircraft Committee, made up of French and British governments and engine manufacturers, met in 1956. Their purpose: to discuss the building of a supersonic airplane named the Concorde. The project was estimated to cost nearly $100 million dollars. But long before the project was completed, it became clear that the eventual financial gains of the plane would not offset the increasing costs of the project. The project continued anyway; the manufacturers and governments decided to follow through since they’d already dedicated a lot of time and made significant financial investments in the project. Ultimately, Concorde operated for less than 30 years, and millions of dollars were wasted.  

If large companies and governments such as those involved in the Concorde project are likely to fall prey to cognitive fallacies like the sunk cost fallacy, it’s simple to see that large amounts of time, effort, and money will be wasted since the sunk costs will never be recovered, whether or not the project is abandoned. And because governments sometimes use taxpayers’ money for their projects, their conformity to the sunk cost fallacy can negatively affect all of us. 

Why Does the Sunk Cost Fallacy Happen?

The reality is that because we are often influenced by our emotions, we are not purely rational decision-makers, and so the sunk cost fallacy occurs. When we’ve made a previous investment into a choice, it’s likely we’ll feel regretful or guilty if we choose not to follow through on our decision. There is an association between the sunk cost fallacy and commitment bias. Commitment bias refers to our tendency to support our past decisions, even when new evidence shows that they weren’t the best course of action.

Similarly, we fail to realize any money, effort, or time that we’ve already expended cannot and will not be recovered. Therefore, we make decisions based on past costs rather than present and future costs and benefits. Ironically, present and future costs and benefits are the only ones that make a difference in a rational sense. 

Loss aversion may play a part in the sunk cost fallacy. Loss aversion refers to the fact that the impact losses leave on us feels much worse than the impact gains have on us. For this reason, we’re more likely to avoid losses than to seek out gains. We often feel as if our past investment will be lost if we don’t follow through on our decision, and we then make a decision with a basis in loss aversion instead of considering the benefits that come with the choice not to continue our original commitment.

We know that not following through on a decision can lead to a feeling of loss, but why? One reason is that the overall endeavor is mentally framed together rather than in stages. So if we don’t follow through on a decision, the narrative becomes one of failure, even if the decision not to follow through was in our best interest. Consider the earlier example of going to the concert despite the rain and not feeling well. Even if the costs are higher when we decide to follow through, we can still frame the narrative as a success overall. If we didn’t go to the concert, the story wouldn’t be that we made a well-informed decision for our overall health and wellbeing. The story would be that we wasted $100. 

Why Is the Sunk Cost Fallacy Important?

As you can see from the examples discussed throughout this article, the sunk cost fallacy has an impact on multiple areas of daily life, as well as larger decisions that will have a long-term impact. The sunk cost fallacy means we are making irrational decisions that lead to less than optimal results. We’re focusing on past investments rather than present and future costs and benefits. We’re committing ourselves to decisions that aren’t in our best interests.

Unfortunately, the sunk cost fallacy is a vicious cycle. We continue to invest our effort, time, and money into endeavors that we’ve already invested in. As we continue to invest, we feel more and more committed to continuing the endeavor. We’re likely to put in even more resources in order to follow through on our decision.

How Can the Sunk Cost Fallacy Be Avoided?

It goes without saying that it can be challenging to overcome inherent cognitive fallacies. But if we’re aware of the sunk cost fallacy, we can ensure we focus on current and future costs and benefits, rather than past commitments. The best thing is to focus on concrete actions and not the feeling of guilt or wastefulness that so often comes from dropping a commitment. Studies have shown that the effects of the sunk cost fallacy are reduced when we’re deterred from making emotion-based decisions.

In reality, our emotions provide a powerful influence over our decisions, and they’re hard to ignore. That’s when we can turn to technology to aid us in our decisions. Information technology systems aren’t impacted by the chain of decisions that came before, and so they make rational choices. 

How Did the Sunk Cost Fallacy Begin?

Economists and behavioral scientists are always trying to gain an understanding of why we have a tendency to make irrational decisions. A pioneer of behavior science named Richard Thaler was the first to introduce the sunk cost fallacy. He suggested that when a person must pay for the right to use a good or service, the rate at which it will be utilized increases. 

Catherine Blumer and Hal Arkes are two notable psychologists who wanted to study the sunk cost effect in practice. Their goal was to expand Thaler’s definition of the sunk cost fallacy beyond money. Blumer and Arkes defined the fallacy as a higher tendency to continue an endeavor once one has made an investment in the form of time, effort, or money. 

These two psychologists conducted multiple experiments to prove that decision-making was influenced by the sunk cost fallacy. The first experiment consisted of a questionnaire. Participants were asked to imagine they had spent $200 on a ski trip to Michigan, and later, they spent $100 on a ski trip to Wisconsin. Only after purchasing tickets for both trips did they realize they’d made the plans for the same weekend! The participants were told that they believed they’d enjoy the Wisconsin trip more. They were then asked which of the ski trips they would choose to go on if they were unable to return either of the tickets. 

Fascinatingly, 54% of the study’s participants reported that they’d choose to go on the Michigan trip, even though it would be more rational to go on the ski trip they considered more enjoyable since the costs are lost in either case. Blumer and Arkes made the conclusion that more than half of the participants chose to go to Michigan because they’d made a larger initial investment into that decision. This provided evidence for the sunk cost fallacy.

But Blumer and Arkers wanted to make sure that the sunk cost fallacy applied to real-life situations and not just hypothetical questionnaires. They decided they would provide discounted seasonal tickets at a theater to observe whether the money spent on a ticket affected the frequency of people attending the shows.

In this experiment, people either paid the normal price of $15, were given a $2 discount, or were given a $7 discount–but only if they said they wanted to buy a seasonal ticket, which showed that they were willing to pay the normal price. Then, Blumer and Arkes recorded the number of shows each individual attended. They found that those in the no-discount group went to an average of 4.11 shows, compared to 3.32 shows for the people in the $2 discount group and 3.29 shows for those in the $7 discount group. Blumer and Arkes concluded that the reason for the contrast in groups was because the no-discount group had the highest sunk costs. Therefore, they continued investing their time into going to the theater. 

Example #1: Decisions in Education

Before education even really begins, it requires much time, effort, and money. Therefore, we can think of the costs of education as sunk costs. Since education can be quite expensive, with postsecondary institutions in the United States being a nearly $600 billion industry, a psychologist named Dr. Martin Coleman wanted to see if the sunk cost fallacy came into play regarding the decision to continue education.

Coleman’s participants were told they’d been offered a job. The catch was that they were required to get a qualification in communication skills that would cost about $100. The participants were told that their employers said they could take any of the courses since they were all essentially the same. They were told they had found one course that had a 75% pass rate, and it had a discounted rate for today only. Some participants’ discounted rate was set at $50, others $100, and others $150. All were told that they had signed up for this particular course because they didn’t want to miss out on the deal. 

Then, participants were told that a friend had found a course that was exactly the same, except that it had an 85% success rate and it was free. Their friend had signed them up. Then, participants were asked the following questions.

Do you go to the classes that you spent money on? Do you attend the free classes with a higher chance of success? Or do you go to a few of each?

Rationally, the best decision would be for the participants to attend the classes with the 85% pass rate since this decision is most likely to help them succeed. But Coleman found that participants who had spent $150 on the original course were much more likely to remain committed to it, even with the lower pass rate. In comparison, those who had spent $50 on the initial course were more likely to attend the free course rather than remaining committed. 

Dr. Coleman’s study suggested that we are more likely to continue with education the more we invest into it due to the sunk cost fallacy. 

Example #2: Watching Boring Movies

Have you ever started watching a movie, only to realize half an hour in that you don’t like it, but you continue watching it anyway? This is thanks to the sunk cost fallacy. We often choose to continue wasting our time on a boring movie, just because we’ve already invested 30 minutes into it. The likelihood that we will keep watching a boring movie is even larger the younger we are. A psychologist named JoNell Strough, along with a team of researchers interested in the effects of age on decision-making, investigated this particular phenomenon.

The participants in Strough’s study were either between 18 and 27 years old or between 58 and 91 years old. All the participants were shown vignettes of two scenarios. In the first, they were told they’d paid $10.95 to watch a movie on Pay Per View, but five minutes into the movie, they were bored and it seemed like a poorly-made movie. In the next vignette, the participants saw the same scenario, but this time, the financial investment was removed. Then, participants were offered five options for each of the two scenarios: stop watching the movie entirely, watch the movie for five more minutes, watch the movie for ten more minutes, watch the movie for 30 more minutes, or watch the movie until the end. 

Those participants in the 58 to 91-year-old age group were less likely to succumb to the sunk cost fallacy. They were less likely to continue watching the movie for an extended period of time or to watch it until the end. In addition, the older participants were more likely to make a consistent decision for both of the scenarios. Therefore, Strough concluded that young people are less consistent with their decisions and more likely to be influenced by the sunk cost fallacy. 

The Bottom Line

What Is the Sunk Cost Fallacy?

The sunk cost fallacy explains our tendency to continue pursuing an endeavor that we’ve already committed time, effort, and money into, even if those costs are not recoverable.

Why Does the Sunk Cost Fallacy Happen?

The sunk cost fallacy takes place because we aren’t rational decision-makers; instead, our emotions cause us to deviate from rationality. After we commit to an endeavor and invest resources into it, we’re likely to feel negative feelings like guilt and wastefulness if we choose to abandon it. We want to avoid the negative feelings of loss, so we’re likely to follow through on decisions we’ve invested in, even if they’re not in our best interests. 

Example #1: Decisions in Education

In the United States, education is a billion-dollar industry. We’re often expected to pay for educational programs in advance, and once we’ve paid for a particular program, we’re not likely to drop it–even if we find a free program with a better success rate. This is because we’ve already invested our money into a specific program and thus feel committed to following through with it. 

Example #2: Watching Boring Movies

Not only does the sunk cost fallacy have an impact on significant long-term decisions, but it also affects smaller daily decisions, such as continuing to watch a movie if we’ve invested time and money into it. This disregards the fact that we will not be able to recover our investments by continuing to watch the bad movie. Age seems to impact the amount of time we’re willing to spend continuing to watch the movie, with young people left more susceptible to the sunk cost fallacy.

How Can The Sunk Cost Fallacy Be Avoided?

The sunk cost fallacy is considered a result of our desire to avoid negative emotions. Therefore, we should make an effort to take our emotions off the table when making decisions. But emotions are difficult to ignore; they can be very powerful. Thus, sometimes it is best to bring in technology to help us make decisions, especially in scenarios where it’s clear we may be influenced by the sunk cost fallacy.

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