Sunk costs are costs that have been incurred and cannot be recovered. In economics, sunk costs are contrasted with expected costs, which are future costs that can be avoided by taking action. In other words, sunk costs are the amount paid in the past and have nothing to do with future decisions.
Some examples of sunk costs:
You buy a movie ticket, but later find yourself unable to go to the movie. The price of a movie ticket is a sunk cost.
You invested in a company, but then the company went bankrupt. The money you invest is the sunk cost.
You start a project, but then find out that the project can't be successful. The time and money you invest in a project is a sunk cost.
Sunk Cost Fallacy.
The sunk cost fallacy refers to the phenomenon in which people take sunk costs into account when making decisions. For example, in the movie ticket example above, if people decide to go to the movies because they have already paid for the price of the tickets, even if they don't want to, this is the sunk cost fallacy.
The sunk cost fallacy is rooted in people's aversion to loss. People are often reluctant to admit that they have made mistakes and will therefore try to make up for past losses by continuing to invest. However, this practice often leads to greater losses.
How to avoid the sunk cost fallacy.
When making decisions, try to avoid considering sunk costs. Here are some ways to avoid the sunk cost fallacy:
Think only about future costs: When making decisions, think only about future costs, not past costs. Future costs refer to the costs that may occur after an action is taken, such as the cost of the project, the cost of the product, the risk of the investment, etc.
Don't try to recoup sunk costs: Sunk costs are no longer recoverable, so don't try to recoup sunk costs by continuing to invest. For example, if a project has failed, you should stop your losses in time and not invest more money.
Stop loss in time: If you find that a project or decision cannot be successful, you should stop your loss in time to avoid greater losses. For example, if you invest in a company and later find out that it is not doing well, you should sell it in time to avoid losing more.
Sunk costs can be applied to a variety of decisions, such as:
Investment decisions: In investment decisions, sunk costs can help investors avoid investing in failed projects. For example, before investing in a company, investors should carefully analyze the company's financial status, operating conditions, etc., and avoid investing in projects that have already incurred sunk costs.
Production decisions: In production decisions, sunk costs can help businesses avoid producing products that are too costly. For example, before deciding to produce a product, companies should carefully calculate the cost of the product and avoid producing products that are too costly and have low profit margins.
Consumption decisions: In consumption decisions, sunk costs can help consumers avoid buying unnecessary goods. For example, before buying a certain product, consumers should carefully consider their needs and budget, and avoid buying products that are outdated, impractical, or excessive.
Sunk cost is an important concept in economics that can help people make better decisions. Sunk costs are costs that have been incurred and cannot be recovered. When making decisions, try to avoid sunk costs and only consider future costs. Sunk costs can be applied to various decisions, such as investment decisions, production decisions, and consumption decisions.
Expansion of sunk costs.
Accounting for sunk costs.
In accounting treatment, sunk costs are considered fixed costs and refer to costs that are not related to production volume. Fixed costs include depreciation, rent, overheads, etc.
Psychological explanations of sunk costs.
From a psychological perspective, the sunk cost fallacy is a cognitive bias. People tend to develop a psychological attachment to past inputs, so they are reluctant to admit that they have made mistakes and try to make up for past losses by continuing to invest.
Case study of sunk costs.
In real life, cases of sunk cost fallacy are common. For example, in order to recoup past investments, some companies will continue to invest money even if the project has lost money, which ultimately leads to greater losses.
Future development of sunk costs.
With the deepening of economic and psychological research, people's understanding of sunk costs will also be deepened. In the future, the concept of sunk cost may be applied to more fields, such as public policy making, business management, etc.