Hyper-Correcting for the Sunk-Cost Fallacy

Tuesday, June 23, 2009
By dreeves

Here’s a classic litmus test for the sunk cost fallacy:

You bought a ticket for a show.  The night arrives and you just don’t feel like going. Do you go anyway, so as not to have wasted the money on the ticket? Probably you shouldn’t. Your current decisions should not be influenced by money that is spent and unrecoverable.

There are, of course, some exceptions:

1. Going to the show lets you avoid some painful cognitive dissonance — though this one doesn’t really accord with my notion of rationality.
2. Going to the show preserves your reputation for making prudent choices (somewhat deceptively), and for following through on commitments.  Fair enough.
3. You might not remember what all persuaded you to buy the ticket but the more you spent the better reasons you must have had.
4. If you have a fixed budget for entertainment then the more you spent on the ticket the less you can afford alternative entertainment, increasing your value for the paid-for ticket.

But mostly those are rationalizations and, rationally, you shouldn’t go. The last one in particular is dangerous — what you need to consider is how much money you have left, not how much you spent on the ticket.

The lesson here is:  Don’t throw good money (or effort/energy) after bad.

Here’s another classic litmus test for the sunk cost fallacy:

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!

The lesson here is:  Do throw good money after bad.

The general lesson of the sunk cost fallacy is to not be influenced in either direction by money/effort that is spent and unrecoverable. In examples like the case of no longer feeling like going to the show, I will ask myself “would I go to see this show (or whatever) right now if it were free?”. I’ve actually seen people hyper-correct for the sunk cost fallacy. They might blow off a hundred dollar ticket because, given their current preferences, they’d only be willing to pay ten dollars for it! The point is to make your decision now as if the cost had never happened, hence “sunk cost”.

Quiz

To make sure you’re neither falling prey to the sunk cost fallacy nor hyper-correcting for it, here are some more sunk cost quiz questions. Feel free to leave your answers in the comments.  (When I floated this quiz among friends, family, and colleagues, only 8 of 19 people got them all right.  Those wrong on more than one included fancypants PhDs.)

Scene:  You have a non-refundable flight but now the opportunity to road trip with some friends to your destination has come up. Which of the following are rational and which are irrational:

1. “I might do that much driving to save the flight costs but since the flight is paid for I’d rather take it.”
2. “That flight was so expensive that I had to forgo another part of my vacation, so not using the flight is not really an option.”
3. “I’m willing to blow off the flight if it was cheap enough.”
4. “I’m going to drive because that’s what I would’ve done if I had considered the driving option in the first place; what’s happened since then is irrelevant.”
5. “I’m going to fly because that’s what I would’ve done even if I had known about the driving option in the first place.”

And the last one has no right answer but I’ll throw it in anyway:

1. “I need to use this flight otherwise I’ll be forced to admit to myself how dumb I was to book it too soon.”