What is Sunk Cost Definition, Examples, FAQs

In economic decision making, sunk costs are treated as bygone and are not taken into consideration when deciding whether to continue an investment project. The sunk cost fallacy leads how to sell tradelines and make easy money people to believe that past investments (i.e., sunk costs) justify further investments and commitments. They believe this because the resources already invested will be lost.

  • The sunk cost fallacy is the belief that additional investments should be made in an activity, or else earlier investments in it would have been wasted.
  • As a result, many investors tend to remain committed or even invest additional capital into a bad investment to make their initial decision seem worthwhile.
  • Every decision you make carries an opportunity cost of some kind.
  • The sunk cost fallacy is deeply rooted in biological tendencies, as researchers from the University of California San Diego analyzed the sunk cost effect in humans as well as pigeons.
  • Sunk costs are the expenses you already incurred and do not play a role in purchases you plan to or will make.

Sunk costs can lead to a self-fulfilling cycle where more money is invested to prevent the pain and suffering of what is perceived as a financial loss. Another example is that market research shows that a movie may not be popular or appeal to a wider audience. The studio then decides to spend more money on advertising to raise awareness and avoid loss.

The gasoline used in the drive is a sunk cost—the customer cannot demand that the gas station or the electronics store compensate them for the mileage. The Project Manager must start by working out what costs are ‘sunk’ in the project that can’t be changed. While these sunk costs remain important data points, the Project Manager must exclude them from the analysis of alternatives for a decision. After 18 months, the project has incurred 800k of costs and is forecasting another 1,000k to complete. There is pressure from the project Board to limit the overspend so the Project Manager must start looking at how. Sunk costs are expended costs that cannot be recovered by the project.

For example, the rent on a factory is a fixed cost as it does not change as output changes. If a company produced 100 widgets or 10 widgets, the fixed cost of rent for a factory would be the same. Say your employees frequently travel as part of their work for your business.

The sunk or lost cost in economics refers to those retrospective expenses that have been made and that cannot be recovered over time. Costs are considered sunk even if an item is never completely used. Suppose a company, SMR Producers, purchases a machine for $5,000 with an expected useful life of five years. Using straight-line depreciation, the company should recognize $1,000 in depreciation expense per year.

Let’s say you run a sneaker company and you’re brainstorming ideas for a new product line. You spend $5,000 on market research for a new design you’re excited about. The research comes back and shows that the design would not only be expensive to make, but it would also have a low chance of turning a profit. The money you spent on the research becomes a sunk cost — You can’t recover it whether or not you move forward with the new design. As the costs escalated and the challenges mounted, the government and project stakeholders were faced with a dilemma.

Fixed and Sunk Costs for Businesses

This often leads to inefficient resource allocation, as capital is invested based on what can no longer be changed instead of what has the most future benefit. When considering opportunity costs, it is critical to disregard sunk costs. That is because these costs have already been incurred; because there is no ability to recover these funds, the sunk cost should have no financial bearing on future decisions. Whether its the groceries already in your refrigerator, the employees on a company’s payroll, or capital expenditure plans by your local government, sunk costs are a natural part of finance.

Another example is keeping an incompetent employee on staff rather than replacing them because the company has already invested tens of thousands of dollars training them. Commitment bias is the human tendency to stick with previous behaviors and beliefs. The sunk cost fallacy can prevent an individual or organization from acting in their own best interest. So if the time they’ve spent in medical school is a sunk cost, does that mean they should stick with pursuing the degree?

  • Therefore, if a rational decision maker were to choose between these two functions, the likelihood of each function being chosen should be the same.
  • This mistake may result in improper long-term strategic planning decisions based on short-term committed costs.
  • Suppose you want to launch an application and for this you did a market study that cost you 15 thousand pesos that takes 7 weeks.

It’s not financially prudent to walk away from something because of the money you’ve put into the decision, but you also can’t walk away because doing so will cost you more money as well. The sunk cost fallacy is persuasive because losses tend to feel more significant than same-size gains. For example, losing $50 generally feels like a bigger deal to your finances than gaining $50 does. These are two years the individual could otherwise spend exploring other career options.

Example of the Sunk Cost Fallacy

A real-world historical example of the sunk cost dilemma can be found in the construction of the Sydney Opera House in Australia. While these functions are framed differently, regardless of the input ‘x’, the outcome is analytically equivalent. Therefore, if a rational decision maker were to choose between these two functions, the likelihood of each function being chosen should be the same. However, a framing effect places unequal biases towards preferences that are otherwise equal.

About Sunk Cost Fallacy

You might expect to find economic concepts in the pages of an economics textbook. But you know where you can really see a lot of economic concepts in action? Financial responsibility does not mean avoiding these expenses but knowing when and how to mitigate the damages. The dilemma then arises whether to continue painting the same color as you have already purchased the paint and completed two rooms or to buy a new color that meets your preferences. These costs are contrasted with the possible earnings of one alternative compared to another.

What Is a Sunk Cost vs. a Fixed Cost?

It is within human nature too fiercely despise losses which drives some people into doing everything it takes to avoid them. AAs with the example of the gambler, they constantly continue to lose money in order to prevent the initial loss. It might seem illogical, but that is often the result of an emotional reaction.

What Is Sunk Cost, and How Does it Impact Your Business?

On the flip side, sticking with medical school also means eventually graduating with an MD and, during that time, potentially finding a medical specialty that fits their career goals and needs. Yes, any salary that has been paid to an employee is a sunk cost. As long as those wages are not recoverable, that salary represents an expense that has been incurred and can not be captured back by the company. While the Jets were considered the most quarterback-hungry team in football after Aaron Rodgers went down, the Browns have taken the driver’s seat.

And lastly, Bridgewater remains a backup in Detroit but has found himself in plenty of spots like this one with a desperate team looking for a warm body under center that won’t cost them games. Taylor Heinicke, Sam Darnold, and Carson Wentz are also options. Construction companies often come up against legal action – perhaps due to encroachment on land, or another legal factor. This can occur whilst construction is already taking place – meaning that it may be forced to abandon the work it has already done. So when considering whether to fight a legal battle, the existing costs that went into the construction are often considered – despite being a sunk cost.

While Tannehill is off to a slow start, he remains a far better option than Walker and is part of a team that is looking to get their rebuild underway. Taylor is a name that would have never been mentioned a few weeks ago, but a string of solid spot starts in Daniel Jones’s absence has brought him back to the forefront. Once Jones gets healthy, it may not be a bad idea to see what Taylor would be worth at the deadline.