Author's Note: This is the second installment of the series "In The Short Run." (Part 1) John Maynard Keynes, perhaps the most famous economist of the 20th century, famously said, “In the long run, we’re all dead.” The purpose of this series is to propose that in the short run, we are all alive, and economics can teach us to live well.
One day, my family and I were driving home from a soccer game. My parents were discussing the possibility of replacing their car. It had about 80,000 miles on it and had lost its clutch and transmission in the last 18 months. They were going back and forth on the pros and cons, but finally, being a nascent economics major, I couldn’t take their wandering any longer.
“How much do you think you could sell your car for?” I asked.
“Probably about $10,000.”
“And how much would a new car cost you?”
“Somewhere around $20,000,” my mom answered.
“So would you rather keep your car or pay $10,000 dollars for a new one?”
“… Pay $10,000 for a new one,” my mom answered, hesitantly now.
“Then get a new car,” I concluded confidently.
“But… we’ve poured so much into it.”
It was true. My mom and dad had put a lot of money into fixing that car — a new clutch and transmission aren’t cheap. But they were falling prey to the Sunk Cost Fallacy. This fallacy has its roots in behavioral economics. Sunk costs are costs that cannot be recovered. When making decisions, these costs ought to be ignored because they are past circumstances that cannot be changed. Often, however, emotions stubbornly cling to the memory of sunk costs.
My mom and dad had spent a lot of money on their car. These costs were sunk. We weren’t getting the money back. Based on their current situation, they would have rather bought a new car — that’s exactly what my mom told me! Yet, attachment to past expenditures was holding them back.
My mom and dad are not the only victims of this intuitive yet illogical thinking. People fall into the Sunk Cost Fallacy every day. But being aware of its deft grip on your decisions will begin to liberate you from its clutches.
Let us take dating as an example. For many, one of the primary motives for dating is to determine if the date is a possible spouse. If a couple has been going steady, but now realize that the only outcome of this relationship is a break-up, then they are best off to do it immediately. It is futile to argue that you have poured so much into the relationship, so you should string along a little further. If marriage is clearly not the end game, then pouring further resources into the relationship is wasting the resources. Wasting more resources is not the proper response to those that are already sunk.
Additional common snares are jobs and athletics. If you have worked at a company or played for a team for a long time, it’s often difficult to walk away. You have given so much to that cause. Walking away is hard. But if you would be happier or more successful elsewhere, then that’s where you ought to go.
Right before I was about to leave for college, a respected friend of mine gave me one of the best pieces of advice I’ve ever received: “All you can do is make the next right choice.” I find this to be the Sunk Cost Fallacy boiled down to its core and served poetically. It frees me of the past yet gives me the responsibility to make a brighter future.
Despite my best efforts, my parents still have not bought a new car. To impel them and anyone else still struggling to pull him or herself out of the Sunk Cost Fallacy, I have a couple snippets of advice.
The Sunk Cost Fallacy can make it seem as if sunk costs are wasted. They’re not; they are merely spent. You didn’t make a bad decision in spending them; it’s simply that the decision does not matter right now.
And finally, for a final push, just do it! Your sentiments may feel betrayed, but take the words of my great-grandmother to heart: “In a year, you won’t even remember.” Make the next right choice.
