Sunk Cost Fallacy

It's easy to make up excuses for why it might still be rational to go to the movie. Here's how to factor all that out and cut to the real issue:

Scenario 1: You bought a $10 non-refundable ticket to a show. (And note that you definitely would not have done so if the show cost $20.) As you get to the theater you realize you lost your ticket. Luckily, they have more available, still at $10. Do you buy another ticket?

Scenario 2: You didn't buy a ticket ahead of time. As you get to the theater you realize that $10 has fallen out of your pocket and is lost. Luckily, you still have enough to buy a ticket. Do you do so?

Everyone agrees on Scenario 2. Of course you do. No one's on such a tight budget that an unexpected change in wealth of $10 changes their utility for theater.

But many people refuse (I've checked) to see that Scenario 1 is fully equivalent. They can't bear to pay another $10 for a show they already paid $10 for. If Scenarios 1 and 2 don't feel fully equivalent, you're probably suffering from the sunk cost fallacy!

I assert that the sunken cost "fallacy" is actually a quite sophisticated mechanism of human reasoning. People who take into account sunken costs in everyday decisions will make better decisions on average.

My argument relies on the proposition that a person's estimate of his own utility function is highly noisy. In other words, you don't really know if going to the movie will make you happy or not, until you actually do it.

So if you're in this movie-going situation, then you have at least two pieces of data. Your current self has produced an estimate that says the utility of going to the movie is negative. But your former self produced an estimate that says the utility is substantially positive - enough so that he was willing to fork over $10. So maybe you average out the estimates: if you currently value the movie at -$5, then the average value is still positive and you should go. The real question is how confident you are in your current estimate, and whether that confidence is justified by real new information.

We tend to use trivial examples to illustrate sunk costs, like deciding whether to go to the movies, or deciding whether to leave a restaurant if the food is bad, but there are important real world situations where these considerations matter. For example, many people are afraid to change careers mid stream because they are afraid that all their education and experience up to that point would be a waste of time. They've already spent thousands of dollars on a degree, or tens of thousands of dollars on a professional degree, and now they have to start over? But isn't that better than being miserable for the rest of your career? You can't get your tuition and your time back, but you can still make yourself happier.

There are reasons to do things that look like honoring sunk costs. The most common example, that I have seen mentioned in almost every discussion I have read on sunk costs, is reputation - if doing what you had planned, rather than what you would currently prefer would have negative future reputational costs, then it is still rational to do it, even though you would now prefer not to.

The second reason is one that occured to me while reading your post - sometimes I regret not doing something I had planned, because I didn't feel it was the best use of my time when it came up. So, if you felt motivated enough to buy the ticket in the first place, then it may still be rational to use it, despite how you feel at the time, if you think you may later regret not using it.

Notice neither of these is actually honoring sunk costs. In both cases, you do what you had planned despite changing your mind about how desirable you think it would be in order to avoid future problems - reputational or regrets.

I became aware of the sunk-cost fallacy one day when I bought a giant diet coke that tasted funny.

My first impulse was to drink it because I had paid for it, and because it was huge, and because it seemed a shame to waste it. I think I was too far away from the fast food place to complain.

Then I realized that I wasn't particularly thirsty (I'd been interested in the taste and had eaten the food I wanted to drink it with), it had no nutritional value, and I didn't get it for the caffiene boost. There was absolutely no reason to drink it, so I didn't. And felt pretty proud of myself for noticing how stupid it would have been to have drunk it.

Another reason for honoring the sunk cost of the movie ticket (related to avoiding regret) is that you know yourself well enough to realize you often make mistakes. There are many irrational reasons why you would not want to see the movie after all. Maybe you're unwilling to get up and go to the movie because you feel a little tired after eating too much. Maybe a friend who has already seen the movie discourages you to go, even though you know your tastes in movies don't always match. Maybe you're a little depressed and distracted by work/relationship/whatever problems. Etc.

For whatever reason, your past self chose to buy the ticket, and your present self does not want to see the movie. Your present self has more information. But this extra information is of dubious quality, and is not always relevant to the decision. But it still influences your state of mind, and you know that. How do you know which self is right? You don't, until after you've seen the movie. The marginal costs, in terms of mental discomfort, of seeing the movie and not liking it, are usually smaller than the marginal benefit of staying home and thinking about what a great movie it could have been.

The reasoning behind this trivial example can easily be adapted to sunk cost choices in situations that do matter.

The sunk cost fallacy is easy to understand and to point out to others, but I caution against using it too often. The point of the fallacy is to show that only future costs and benefits matter when making a decision. This is true, but in reality those costs and benefits (and especially their probabilities) are hard to define. It is not clear whether the extra information that was received after 'sinking' the cost has an impact on the cost and benefit probabilities. You also know that, in any case, if the decision to sink the cost in the first place was the right one after all, the decision to continue is even more rational as a large part of the cost has already been spent. You can go see a movie for free that other people still have to pay for.

Going to the theater in this case can be viewed as respecting the wishes of your past self, and possibly future selves (who may desire to have seen the film in question). Without some ability to do this, long-term planning would be impossible.

Your current self counts, but not necessarily more than temporally displaced selves.

There's also a sort of reverse sunk cost fallacy. Example: you're reading a book that's worth 8 hours of your time but only if you read all of it, and after 5 hours of reading you realize it's going to take another 5 hours to finish the book, so the original investment of 5 hours was a mistake, so to "correct" the mistake you stop reading when you can now get 8 hours' worth of time for only an additional 5 hour investment.

ETA: I googled "reverse sunk cost fallacy" and found this, which makes the same point.

Seth godin has a few examples of sunk costs. I believe these examples better represent true sunk costs than some of the examples given here (such as the movie ticket).

For example, suppose you have paid 50 dollars for a Bruce Springsteen concert. You have searched long and hard for tickets this cheap. Suddenly, somebody offers you 500 dollars for the ticket. Do you sell it? The ticket is now worth $500 to you, and you would have never paid $500 for a ticket in the first place.

Suppose you have n shares of stock X, and you're trying to decide whether to sell or to hold onto it for a bit longer; and suppose that if you instead had the current cash value of those shares, you would easily decide not to buy those shares. So it would seem that this amount of money is currently worth more to you as available cash than as shares of this stock. Yet if you already have those shares, particularly if you bought them at a higher price, you may be reluctant to sell them immediately — you'd be inclined to hold onto it in hopes of recouping your loss, even if, given those shares' value in cash instead, you could think of a better use for it than investing it back in the same stock.

Questions:

• This probably happens a lot, right?
• Is this pattern of thinking ever not a bad idea? Or should stock traders consistently apply this sort of reversal test to stocks they already own?
• Is there a name or description for this particular fallacy/bias or is it just grouped with the sunk cost fallacy?

It reminds me a bit about how Jefferson Hope went about getting his betrothed's ring back. He hired an actor to fool Holmes, to salvage what he knew he'd lost. He could (if he were a real criminal, and not a dummy for Holmes's deductions) gain more than only his ring back, if the actor also brought him valuable intelligence (or even incapacitated Holmes in some way). Would it be turning a sunk cost into a purchase, or am I mistaken?

Related: http://lesswrong.com/lw/9si/is_sunk_cost_fallacy_a_fallacy/

this just seems like loss aversion.

1. not all costs are financial. 2. controlling habit patterns 3 and most importantly its a BAD example. If i wanna see a movie and i don't want to see it taht night, i know i'll want to see it in the future, so you go to see it to avoid a FUTURE cost. This blog reminds me of LTCM.