Sunk Cost
What is Sunk Cost?
A sunk cost is a cost that has already been incurred and cannot be recovered.
Sunk costs should not influence future economic decisions because they are irreversible. Rational firms ignore sunk costs when deciding whether to continue production or shut down, focusing instead on marginal costs and revenues.
Sunk Cost: a worked example
A toy company pays $40,000 for a custom injection mold that no other firm can use and nobody will buy back. Partway through the production run, demand disappoints. Finishing the batch will take another $12,000 of labor, plastic, and packaging, and the finished toys will sell for $18,000. The correct comparison ignores the mold completely: $18,000 of revenue against $12,000 of additional cost leaves a $6,000 gain, so the firm finishes the batch. The venture is still a disaster overall, since $40,000 plus $12,000 means $52,000 went out against $18,000 coming in, a $34,000 loss. Both statements hold at once. The $40,000 is gone under either choice, so it cannot tip a decision that only changes what happens from here.
The mistake students make with sunk cost
Students argue that a firm has already spent too much to quit now, and the move feels like avoiding waste rather than creating it. Money already gone is identical whichever option gets picked, so it cannot make one option better than another. Compare only the revenue ahead against the costs still avoidable. The same discipline drives the short-run shutdown rule: a firm keeps producing whenever price covers average variable cost, because committed fixed costs will be owed even with the machines sitting still.
Sunk Cost questions
Are all fixed costs sunk costs?
Fixed costs and sunk costs overlap without being identical. A non-refundable payment for custom equipment is both fixed and sunk. Rent on a lease the firm can cancel with notice stays fixed while production continues yet remains recoverable by walking away, so it is not sunk. AP problems usually treat short-run fixed costs as sunk, which is why they are excluded from the shutdown decision.
What is the sunk cost fallacy?
The sunk cost fallacy describes sticking with a losing project because of money already spent rather than because of what the project will earn going forward. A driver facing a $2,500 repair bill who pays it only because $3,000 has already gone into the same car, when a $2,000 replacement would serve just as well, has fallen for it. Sound decisions weigh future benefits against future avoidable costs and treat past spending as irrelevant.
Why do economists say to ignore sunk costs?
Sunk costs are identical across every option on the table, so they cannot change which option ranks best. Only costs that differ between the choices carry any information. A firm deciding whether to run its plant this month should weigh this month's wages and materials against this month's revenue, since equipment already purchased costs the same whether the plant runs or sits idle.
Related terms
Common comparisons
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