Hyper-Correcting for the Sunk-Cost Fallacy | Messy Matters

]]>2. Rational,

3. Irrational, I’m not at the point where blowing off money is an option

4. Irrational, if I had planned on driving then why would I buy tickets? Rational, if money was not already spent so i guess my decisions are based on money.

5. Rational

6. Rational ]]>

It’s as if a nineteenth century physicist who wasn’t blasted by x-rays when he opened an oven (this was a prediction of classical physics, the erroneous nature of which pointed the way to quantum theory) berated the oven.

The problem is that the concept of rationality is short hand for “making the most money or obtaining the most goods’.

Traditional economic concepts don’t capture some important aspects of human behaviour.

I think Hersh Shefrin’s work on behavioural asset pricing is an indication of future ways forward. ]]>

the relevant variables are:

u(d) – utility of driving, including cost

u(f) – utility of flying

c(f) – cost of flying

c(d) – cost of driving

b – budget constraint

Given that the flight is paid for, it’s rational to drive if:

u(d) > u(f) and c(d)+c(f) < b
and fly if:
u(d) < u(f) or c(d)+c(f) > b.

You could also consider a soft budget constraint, with the cost of the flight eliminating increasingly “good” alternative activities as the price goes up, and the cost of driving competing with those alternatives. I use the hard constraint below to simplify the logic.

Keeping that in mind . . .

1. “I might do that much driving to save the flight costs but since the flight is paid for I’d rather take it.”

RATIONAL: it’s saying u(d) > u(f) – c(f) and u(d) < u(f), which is possible. 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.” RATIONAL (but semi-ambiguous) it’s rational if it’s saying c(f)+c(d) > b, which seems to be the implication by “had to forgo …”, but imho it’s poor wording: does “not really an option” mean “can’t afford to drive”? Why not just come out and say “I can’t afford to drive”?

3. “I’m willing to blow off the flight if it was cheap enough.”

RATIONAL (and more ambiguous) this is the inverse of (2), but the wording is more misleading: Can we assume “if it was cheap enough” to mean c(f)+c(d) < b? Or does “blow off the flight” somehow imply the budget constraint isn’t an issue? Surely the inverse of (2) is rational if (2) itself is rational. 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.” IRRATIONAL: deciding based on u(d) > u(f)-c(f), which doesn’t imply u(d) > u(f).

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.”

RATIONAL, saying u(d) < u(f)-c(f), which implies u(d) < u(f)

]]>With those in mind,

(1) is rational based on the consideration that the road trip will cost money, but irrational if time with friends is valued more than the cost of the road trip.

(2) is rational if my budget can’t stand the cost of the road trip even though I value time with my friends.

(3) is irrational under all circumstances.

(4)is irrational, mere mule-headed inability to go with the flow.

(5) is rational. I clearly value a quick flight more than I value the cost to spend time with friends.

(6) is rational if I value saving face over making rational considerations, and so is clearly irrational.

]]>2. Way irrational — basically typical sunk cost fallacy

3. Ambiguous. If the cost of the plane ticket is insignificant relative to disposable funds available for the trip, then this is irrational, and is similar to #2. However, if the plane ticket cost enough that now the choice to take the plane is decided by the desire to save the gas money + other road trip expenses, *but that wouldn’t have been the case had the ticket been a lot cheaper*, then this could be a rational statement.

4. Irrational. The original decision would have been influenced by an expensive plane ticket, but now that is a sunk cost so the present decision should be made considering the ticket free.

5. Rational. If you would have bought the ticket and taken the flight knowing the road trip was available, it’s certainly rational to take the flight after having sunk the money into the ticket.

6. Ridiculous ]]>

1. Rational – I view this as a choice between the flight (no additional cost) and the roadtrip (gas money, snacks, maybe hotel/camping)

2. Rational – this situation seems to indicate that the budget is tight, so it seems like spending additional money to take the road trip would further stretch the tight travel budget

3. Irrational

4. Irrational – my thinking is that I might have driven since it would have (presumably) saved money. Now instead of saving money, driving would cost additional money, so what has happened since the decision was made does matter.

5. Rational – since you would have flown even if you’d known about the road trip, knowing about the road trip shouldn’t change the decision (although I feel like this one might be a trick question) :)

6. Rational :)

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