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Sunk Cost

Sunk Cost Definition

Sunk Cost refers to the expenses or investments that have already been incurred and cannot be recovered. It is a term commonly used in economics and decision-making processes to describe costs that have already been paid and cannot be reversed.

What is a Sunk Cost?

A sunk cost is an expense or investment that has already been made and cannot be recovered. It is a cost that has been incurred in the past and is independent of any future decisions. Sunk costs are irrelevant to decision-making because they cannot be changed or recovered and therefore should not be considered when making rational choices.

Sunk Cost Method

The sunk cost method is a decision-making approach that involves disregarding sunk costs when evaluating future options. It recognizes that sunk costs are irrelevant to the decision at hand and should not influence the choice. By focusing on future costs and benefits, decision-makers can make more rational and efficient choices.

Sunk Cost Examples

To better understand the concept of sunk costs, let’s consider a few examples.

  1. Imagine a company that has invested a significant amount of money in developing a new product. However, during the testing phase, it becomes evident that the product is not viable and will not generate the expected profits. Despite the sunk costs associated with the development, the company decided to discontinue the project to avoid further losses. The initial investment is considered a sunk cost and should not influence the decision to abandon the project.
  2. Another example can be seen in personal finance. Suppose an individual purchases a non-refundable ticket for a concert but later realizes they have a conflicting commitment. Even though the ticket has already been paid for, attending the concert would require sacrificing the other commitment. In this case, the cost of the ticket is a sunk cost, and the decision should be based on the value of the conflicting commitment rather than the money already spent.

Why is Sunk Cost a Fallacy?

Sunk cost is considered a fallacy because it leads individuals and organizations to make irrational decisions. People often feel compelled to continue investing time, money, or resources into a project or endeavor simply because they have already invested a significant amount. This fallacy can result in further losses and missed opportunities.

The Opposite of Sunk Cost

The opposite of a sunk cost is a prospective cost. Prospective costs are future expenses or investments that have not yet been incurred. Unlike sunk costs, prospective costs can be influenced by current decisions and should be considered when evaluating options. By focusing on prospective costs and benefits, decision-makers can make more informed choices that maximize future outcomes.

Wrap Up

A sunk cost refers to expenses or investments that have already been made and cannot be recovered. It is a term used in economics and decision-making processes to describe costs that are irrelevant to future choices. By understanding the concept of sunk costs and applying the sunk cost method, individuals and organizations can make more rational and efficient decisions.

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