The sunk cost fallacy is when prior investment is used as a reason to continue a course of action, even if it’s not rational. Sunk costs cannot be recovered and should not influence decisions. It can lead to commitment escalation and is sometimes a misinterpretation of decision-making processes.
The sunk cost fallacy is a logical fallacy or bad argument for decision making. In the sunk cost fallacy, prior investment is cited as a reason for pursuing a course of action. The term is usually used to describe persisting in a bad investment, as otherwise the time, money, or effort invested in the project would go to waste anyway. The expression “throwing good money after bad” is sometimes used to describe this behavior.
In economics, a “sunk cost” is any cost that has already been paid and is impossible to recover. In a purely rational decision-making process, the sunk costs should have no influence on the decisions, as they cannot be recovered. For example, consider the situation of a man who, having already purchased a train ticket, is offered a faster ride to his destination. The fact that he has already paid for a train ticket should not affect the decision to take or refuse the faster ride, since the money spent on the first ticket is lost whether he chooses to take the ride or not.
The term “sunk cost fallacy” describes a common situation in human behavior in which sunk costs influence decision-making despite having already been spent and not recoverable. For example, a person who buys a book and starts reading it may find that she doesn’t like it. She could, however, read on, citing the fact that she paid for it. This is irrational, since she will have paid for the book whether she reads it or not, and in fact she is simply wasting time on an unpleasant activity instead of doing something she enjoys. This is an example of the sunk cost fallacy in action.
In some cases, the sunk cost error can lead to a large-scale commitment escalation. For example, British and French government investment in the Concorde supersonic transport actually increased when it became clear that the project could lose money. From a rational point of view, abandoning the project would have been superior to continuing to invest.
The sunk cost fallacy can sometimes be a misinterpretation of decision-making processes. In many cases, actions have consequences that cannot be accounted for by a purely economic analysis. For example, consider the case of a government investing money in a project. There may come a time when, as with Concorde, financially, the best course of action is to abandon the project and invest in an alternative. However, abandoning a project could have negative political consequences such as damaging voter confidence. Persevering therefore brings benefits not accounted for in a purely rational model.
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