Have you ever spent more money trying to get the worth out of already sunken costs? Sometimes we keep investing more to keep an investment afloat. Constantly pumping money into a loss-making company to keep it running is such an example.
Many times we incur a sunk cost, and to justify it, we add a future cost to it. Take an example of a movie ticket you have purchased. You go for it. The movie turns out to be a disaster. Yet you sit through it because you have paid for the ticket. You justify wasting time on a movie that you are not enjoying even a bit because you have already wasted an amount on the ticket.
Another example can be a cricket match you might have bought a ticket for. On the day of the match, it rains. You are sure the match will be interrupted, yet you drive an hour to the stadium to watch it because a ticket has been bought. The pain of losing the money paid for the ticket is more than the trouble taken to drive to the match and watch the rain-interrupted match. Why? You believe in this way you have used at least part of the ticket's worth.
This rationale prompts us to take an action which we know is not worth the effort, but based on the past cost or efforts invested in something, we add more to them, to take as much benefit out of it as we can. This is not the way an economist would think. We know it. But it is a psychological trait to disassociate ourselves from the pain of loss. It prevents us from thinking logically. This phenomenon was nicely explained by Richard Nisbett in his Op-Ed titled 'Do you think like an economist? published in Los Angeles Times in 2015.
People spend more money on repairing a faulty machine they have bought by mistake. Since not repairing the machine would be a complete waste of invested money, so they think it is wise to add some money and get whatever best they could out of it.
To have a logical approach, Nisbett says, we need to distinguish between the past cost and the future cost. The past cost is already sunk, but if it's not really worth it, you can save the future cost. Most of the time, the future cost is based on the emotional decision, to make value out of the past cost. This is an avoidable loss. In absence of such a logical approach, most people end up making a double loss - of the past and that of the future. If one learns to objectively distinguish between the two, at least one cost can be saved. So, next time, dare skip the movie that you are not enjoying, stay home instead of going to the rain-interrupted match or discard the faulty machine demanding a huge cost of repair.
