Image credit: www.erecipeguide.com
Those of you, who read Tim Ferriss’s 4-Hour Workweek may remember Tim talking about a cheesecake he once made using stevia. I am going to use it as my first example to illustrate a concept economists call sunk costs.
Sunk costs are costs that aren’t recoverable. It’s important to recognise them because no matter how much you spent on something in terms of time and money, your decisions going forward should not be affected by sunk costs.
Back to Tim. Tim wanted to make a cheesecake, substituting sugar with natural sweetener, stevia, which has a lower glycemic index, and is therefore healthier than sugar. Stevia is also very sweet, so without a recipe at hand, Tim ended up using too much of it. The cake turned out so sweet, it was inedible.
However, since Tim put all that effort into making a cake and all that time into waiting for it to set, he ended up eating it anyway. In fact, he ate the entire cake just because he could not bare to walk away from everything he’s put into that cheesecake.
Tim made himself sick, but he learned a valuable lesson: regardless how much time and money something cost you, if such investment cannot be recovered, it is always better to cut losses and move on. Let bygones be bygones.
To put it differently, sunk costs are incurred in the past and do not affect marginal decisions. Think about a 6-session writing course you bought. The first session wasn’t great and the second was blatantly useless but you are still dragging yourself to classes, thinking of the money you’ve invested. In fact, the cost of the course is sunk (you cannot sell it on eBay or Gumtree), so your decision of whether to attend a class or do something more pleasant or useful should simply be weighing up a writing class against an alternative.
Now here is a thing. It’s all very well to talk fancy economics, but we all know that in reality we end up eating that hideous cake until it makes us sick, we end up feeling guilty for not wearing that dress we bought just because it was on sale and we end up stuck in jobs we’ve invested so much time in, gaining status.
“I’ve been in investment banking all my life - I cannot just leave it now!”
“I’ve spent the entire weekend building my website in WordPress, I don’t like it, it’s not user-friendly, but I cannot back off, now that I’ve invested all that time...”
“We’ve been together for years, we ought to get married...”
Am I exaggerating here? Not really. I happen to know someone who ended up walking down the aisle only to get separated a few months later. A crush course in microeconomics might have helped her to think more rationally...
Any other sunk costs that spring to mind? Share your inventory here.
Sunk costs are costs that aren’t recoverable. It’s important to recognise them because no matter how much you spent on something in terms of time and money, your decisions going forward should not be affected by sunk costs.
Back to Tim. Tim wanted to make a cheesecake, substituting sugar with natural sweetener, stevia, which has a lower glycemic index, and is therefore healthier than sugar. Stevia is also very sweet, so without a recipe at hand, Tim ended up using too much of it. The cake turned out so sweet, it was inedible.
However, since Tim put all that effort into making a cake and all that time into waiting for it to set, he ended up eating it anyway. In fact, he ate the entire cake just because he could not bare to walk away from everything he’s put into that cheesecake.
Tim made himself sick, but he learned a valuable lesson: regardless how much time and money something cost you, if such investment cannot be recovered, it is always better to cut losses and move on. Let bygones be bygones.
To put it differently, sunk costs are incurred in the past and do not affect marginal decisions. Think about a 6-session writing course you bought. The first session wasn’t great and the second was blatantly useless but you are still dragging yourself to classes, thinking of the money you’ve invested. In fact, the cost of the course is sunk (you cannot sell it on eBay or Gumtree), so your decision of whether to attend a class or do something more pleasant or useful should simply be weighing up a writing class against an alternative.
Now here is a thing. It’s all very well to talk fancy economics, but we all know that in reality we end up eating that hideous cake until it makes us sick, we end up feeling guilty for not wearing that dress we bought just because it was on sale and we end up stuck in jobs we’ve invested so much time in, gaining status.
“I’ve been in investment banking all my life - I cannot just leave it now!”
“I’ve spent the entire weekend building my website in WordPress, I don’t like it, it’s not user-friendly, but I cannot back off, now that I’ve invested all that time...”
“We’ve been together for years, we ought to get married...”
Am I exaggerating here? Not really. I happen to know someone who ended up walking down the aisle only to get separated a few months later. A crush course in microeconomics might have helped her to think more rationally...
Any other sunk costs that spring to mind? Share your inventory here.
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