THE SUNK COST FALLACY
An exploration of student decision-making
My Question
How does the sunk cost fallacy impact decision-making among college students, and what strategies or traits correlate with improved decision-making?
How did the sunk cost fallacy originate?
Traditional economics assumes that humans make rational decisions. However, research has proven this false time and time again, showing that we instead rely on mental shortcuts to simplify our choices. Psychologists Amos Tversky and Daniel Kahneman pioneered what they called “Prospect Theory” in the 1970’s to lay out several of these mental shortcuts based on their research. Several of these shortcuts include:
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treating losses differently than equivalent gains
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overvaluing goods that one owns
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uncertain outcomes are undervalued or ignored
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prior investments are overweighted in present decisions
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In addition to the research proving these seemingly irrational behaviors, we can think of anecdotal examples. If I offered you the chance to flip a coin to either win $100 for heads or lose $100 for tails, would you take the bet? Most people wouldn’t; in fact, you would have to raise the winnings to about 2.5 times the potential losses for most people to agree, demonstrating what psychologists call loss aversion.
Loss aversion is related to many decision-making biases, including the sunk cost fallacy. Ignoring sunk costs of time, money or effort in our decisions is difficult because we feel that we will lose our progress, even if that progress points us in an undesirable direction.
Loss aversion is one of the cornerstone theories for what economist Richard Thaler dubbed “behavioral economics,” a new discipline merging economics with psychology to examine human decision-making. Behavioral economics applies human judgement errors and biases to traditional economic models to more accurately reflect real-world behavior.
Thaler discussed the “sunk cost effect” in his pivotal 1980 paper, connecting the phenomenon to loss aversion and speculating about the thought processes that would lead an individual to honor sunk costs. Five years later, Hal Arkes and Catherine Blumer of Ohio University published their paper “The Psychology of Sunk Cost” that built upon Thaler’s work and provided ten experiments along with analysis to validate the sunk cost effect.
Nearly every academic paper on the sunk cost fallacy since the 1980’s has cited Arkes and Blumer. Research in the past several decades has focused on the effect in specific situations (such as education, military, medical, and financial), and correlations between specific traits and better decision-making (such as age or mindfulness).
Is it irrational to consider sunk costs in decisions?
Normally, yes.
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Economists generally assume that people make decisions based on weighing the incremental costs and benefits of the choice. If you value the utility of a car more than the cost you have to pay, you will buy the car. However, the sunk cost fallacy proposes that people often consider past investments of money, time and effort in their decisions. For example, if you had driven two hours to a car dealership, you may be more likely to purchase the car regardless of the price out of a fear of wasting your day. In this situation, you are taking the time you spent driving into account, when the rational move would be to only consider the value of the car compared to its cost.
Although the sunk cost fallacy generally leads people to make themselves unhappy and unsuccessful, honoring sunk costs in decisions is not always a bad thing. Imagine an unmotivated high school senior failing a class he needed to graduate. Although he may place a low value on studying for the class, the enormous investments of time and effort into his high school education could serve as motivation to pass the class and earn his diploma.
Similarly, irrationally honoring sunk costs could benefit the reputation of an individual or organization. Imagine a company that was 9/10 of the way done building a new company office. Then, a more spacious building in a more ideal location opened for rent at a cheaper average price than the company would need to pay for their new building. The rational thing to do would be to halt construction and go for the better, cheaper option. However, this decision may lead employees and citizens to view the company leadership as wasteful and unable to complete what they started. Therefore, the most prudent long-term choice may be to honor the sunk costs and finish the project, even though this would be irrational on strictly economic terms.
As SCU psychology professor Dr. Kathryn Bruchmann put it, “We prioritize seeing something through to the end; culturally we think that it’s a really good thing. Even if you get two thirds of the way through a task and know it will fail, we still culturally prioritize finishing the task.” If the reputation of an individual or company would be damaged by ignoring prior investments, honoring sunk costs could be the best decision.
Why does the sunk cost fallacy matter?
In addition to low-stakes situations like staying for a whole movie you hate or dragging yourself to an event you prepaid for, the sunk cost fallacy can also be related to more important decisions that specifically impact college students. You may feel pressure to prolong an unhealthy relationship or continue to spend time with a group of friends only because of the large amount of time you have already spent with them.
Academically, college students may feel pressure to continue pursuing a major, minor or class they dislike just because of the progress they have already made. Our culture looks down on being “wasteful” or being a “quitter,” but these pressures often lead us to make decisions that disregard what will make us most happy and successful in the long run.
The sunk cost fallacy can also manifest in much more consequential situations. Leaders of businesses must often choose between completing a failing project and being labeled as wasteful by critics. During the Vietnam War, United States leadership argued that the U.S. should continue to fight to honor the lives already lost. While this reasoning may appear noble, a purely rational decision would only take into account future costs and benefits of continuing the war.
By learning about the sunk cost fallacy, we can become more aware of our subconscious decision-making processes. Instead of allowing our decisions to be affected by the time and resources already invested in a course of action, we can more accurately weigh the consequences of our choices. Cultural norms against wastefulness and quitting often make us afraid to end failing projects and relationships, but learning about the sunk cost fallacy can help us overcome these tendencies, improve our decisions, and ultimately increase our happiness.
