Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Tuesday, August 23, 2005

Is This a Good Classroom Example for
Economics and "Sunk Costs"?

In nearly every introductory economics course, we teach that for profit-maximizing firms, sunk costs do not enter into a decision. We teach that profit maximizers are forward-looking and consider only the expected future costs and future benefits of their decisions, without regard to their sunk costs.

Then we quote a few nice cliches:

"Let bygones be bygones."

"Don't cry over spilled milk."

Or the New Testament admonition, "Leave the dead to bury the dead."

But you know what? Sunk costs play an important role in our decision-making.

Sometimes they are a short-hand way of saying something. For example when person A breaks up with person B, person B sometimes responds, "But think of all we have built up together. Do you really want to throw all that away?"

Person B could mistakenly be relying on sunk costs to make an argument. Alternatively, B could be arguing that both A and B will have to make large new investments in other relationships and it might be more efficient to work on the present one.

It is probably an irrational mental defect on my part, but I know I sometimes dwell for too long on past decisions about which I can do nothing now. I know I'm not the only one to do this. Past actions affect us now, even if they are of the form "sunk costs."

And now to the point of all this. From the New York Times quote of the day (August 23rd, reg. req.),
"We owe them something. We will finish the task that they gave their lives for."PRESIDENT BUSH, on the American soldiers killed in Iraq and Afghanistan.
Can dead soldiers be viewed as a sunk cost? Can a politician rationally say, "We have had many deaths, but looking forward, we believe the expected costs of this operation outweigh the expected benefits, so we're wrapping it up now."?

Let me make clear, I am not advocating that the U.S. withdraw from Iraq. I have had mixed but positive feelings about the U.S. actions there.

Rather, I take note of this quotation because I often use a similar example in the classroom, "We had to take the hill so that all the boys who died there will not have died in vain." which captured some of the inanity in Vietnam so many years ago.

So is President Bush being irrational in raising what are, from this perspective, sunk costs? Is he playing on the irrationalities of U.S. voters? And/or are humans hard-wired to consider sunk costs and dwell on regrets?
Who Links Here