Abstract. That sunk costs are not relevant to rational decision-making is often presented as one of the basic principles of economics. When people are influenced by sunk costs in their decision-making, they are said to be committing the “sunk cost fallacy.” Contrary to conventional wisdom, we argue that, in a broad range of situations, it is rational for people to condition behavior on sunk costs, because of informational content, reputational concerns, or financial and time constraints. Once all the elements of the decision-making environment are taken into account, reacting to sunk costs can often be understood as rational behavior. JEL Codes: D0, D01, D8, D81, D83, D9, D90.
Keywords: Sunk Costs, Rationality, Information, Reputation, Constraints. * R. Preston McAfee, Humanities and Social Sciences, California Institute of Technology, Pasadena, CA 91125 (Email: firstname.lastname@example.org, Phone: 626-395-3476, Fax: 626-793-4681); Hugo M. Mialon, Department of Economics, Emory University, Atlanta, GA 30322-2240 (E-mail: email@example.com, Phone: 404-408-8333, Fax: 404-727- 4639); Sue H. Mialon, Department of Economics, University of North Dakota, Grand Forks, ND 58202 (E-mail: firstname.lastname@example.org, Phone: 701-777-3349, Fax: 701-777-3365). 1
“Let Bygones Be Bygones.”
Khieu Samphan, former head of state of the Khmer Rouge government, asking Cambodians to forget the more than one million people who died under his government’s rule.
Sunk costs are costs that have already been incurred and cannot be recovered. Sunk costs do not change regardless of which action is presently chosen. Therefore, an individual should ignore sunk costs to make a rational choice. Introductory textbooks in economics present this as a basic principle and a deep truth of rational decision-making (Frank and Bernanke, 2006, p. 10, and Mankiw, 2004, p. 297).
Nonetheless, people are apparently often influenced by sunk costs in their decisionmaking. Once individuals have made a large sunk...
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