Sunk cost

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In economic and business decision making, the cost of burned is the cost incurred and can not be recovered (also known as retrospective cost).

The charred cost is sometimes contrasted with the prospective cost , which is the future cost that may arise or change if an action is taken. In that case, both retrospective and prospective costs can be fixed costs (continuously as long as the business operates and are not affected by output volumes) or variable costs (depending on volume). However, many economists consider it a mistake to classify charred expenses as "fixed" or "variable." For example, if a company drowns $ 400 million in enterprise software installations, the fee is "forfeited" because it is a one-time cost and can not be recovered after it has been spent. A "fixed" fee is a monthly payment made as part of a service contract or licensing agreement with the company that governs the software. Non-refundable payments for installation should be not perceived as a "fixed" fee, with expenses spread over time. Burn costs should be kept separate. The "variable costs" for this project may include the use of data center power, for example.

In traditional microeconomic theory, only prospective (future) costs are relevant to investment decisions. The traditional economic field proposes that economic actors do not let charred costs affect their decisions. Doing so will not rationally judge a decision exclusively on its own merits. Or, decision makers can make rational decisions according to their own incentives, beyond efficiency or profitability. This is considered an incentive issue and is different from the problem of burned costs. Evidence from behavioral economics suggests this theory may fail to predict real-world behavior. The cost of sunk does, in fact, affect the decision of the perpetrators because humans are vulnerable to loss of aversion and framing effects.

The charred cost does not affect the best choice of rational decision makers. However, until the irrevocable decision maker makes the resources, the prospective cost is a future cost that can be avoided and incorporated correctly in every decision-making process.

For example, if someone is considering booking a movie ticket, but has not actually bought it, the cost can still be avoided. However, if the ticket price goes up to the amount that requires him to pay more than the value he places on them, they should figure out the changes in terms of the prospective cost that goes into the decision-making process and re-evaluate his decision.

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The charred cost is different from the economic loss. For example, when a new car is purchased, the car is then resold; however, it may not be resold for the original purchase price. Economic losses are the difference (including transaction costs). The amount originally paid will not affect the rational future decision making of the car, regardless of the value of the sale: if the owner can get more value than selling the car than not selling it, then it should be sold, regardless of the price paid. In this sense, the charred cost is not an appropriate quantity, but an economic term for the amount paid, in the past, which is no longer relevant to the decision about the future; this may be used inconsistently in quantitative terms as the original cost or expected economic loss. It can also be used as an abbreviation for errors in analysis due to sinking cost errors, irrational decision making or, simply, irrelevant data.

Economists argue that charred costs are not taken into account when making rational decisions. In the case of a baseball game ticket that has been purchased, the ticket buyer can choose between the following two outcomes if he realizes that he does not like the game:

1. After paying the ticket price and suffering from watching a match he does not want to see, or;
2. After paying the ticket price and have used the time to do something more fun.

In both cases, the ticket buyer has paid the ticket price so that that part of the decision no longer affects the future. If ticket buyers lament buying tickets, the current decision should be based on whether he wants to see the game at all, regardless of the price, as if he is going to a free baseball game. The economist will suggest that, because the second option involves suffering in only one way (spending money), while the former involves suffering in two (spending money plus wasted time), the second option is definitely better.

A charred cost can cause the cost to be overrun. In business, the example of a charred cost may be an investment to a factory or research that now has a lower value or no value at all. For example, $ 20 million has been spent on building power plants; the current value is zero because it is incomplete (and no sales or restoration is feasible). This plant can be completed for an additional $ 10 million, or abandoned and different but equally valuable facility built for $ 5 million. It should be clear that the abandonment and construction of alternative facilities is a more rational decision, even though it is a total loss of initial expenditure - the initial amount invested is a charred cost. If the decision maker is not rational or has the wrong incentive, the completion of the project can be selected. For example, politicians or managers may have more incentives to avoid total loss. In practice, there is considerable ambiguity and uncertainty in such cases, and possible decisions in retrospect seem irrational which, at that time, makes sense for the economic actors involved and in the context of their own incentives.

The behavioral economy recognizes that charred costs often affect economic decisions because of the reluctance to lose: the price paid becomes a benchmark for value, while the price paid should be irrelevant. This is considered irrational behavior (because rationality is defined by classical economics). Economic experiments have shown that falling cost mistakes and loss of aversion are common; then economic rationality - as assumed by many economies - is limited. This has enormous implications for financial, economic, and securities markets in particular. Daniel Kahneman won the Nobel Prize in Economics as part of his extensive work in this field with his collaborator, Amos Tversky.

Maps Sunk cost

Features that characterize the heuristic of burned costs

Two specific features that characterize the heuristic costs worth mentioning are:

1. Overoptimistic probability bias, which after investment dividend evaluation of the acquisition of a person's investment increases.
2. Terms of personal liability. Sunk costs seem to operate primarily on those who feel personal responsibility for the investment that should be seen as a charred expense.

Predicted overoptimistic possibilities

In 1968, Knox and Inkster, in what might be a classic sinking cost experiment, approached 141 horse buckets: 72 have just finished betting $ 2.00 in the last 30 seconds, and 69 will place a $ 2.00 bet in 30 next second. Their hypothesis is that people who have just committed to action ($ 2.00 bet) will reduce post-decision discrepancies by believing stronger than ever that they have chosen the winner. Knox and Inkster asked the bettors to assess their horse's likelihood of winning on a 7-point scale. What they found was that people who would place bets assessed the odds that their horse would win on an average of 3.48 relating to a "fair chance of winning" whereas people who just finished betting gave the average score 4.81 relating to "a good chance of winning". Their hypothesis is confirmed: after making a $ 2.00 commitment, people become more confident that their bets will pay off. Knox and Inkster perform additional tests on the horse's own customers and succeed (after normalization) to repeat their almost identical findings.

Additional evidence of estimated inflation probabilities can be found in Arkes and Blumer (1985) and Arkes and Hutzel (2000).

Personal liability requirements

In a study of 96 business students in 1976, Staw and Fox gave the subject of choice between making good R & D investments in poorly performing corporate departments, or in other parts of hypothetical companies. Staw and Fox divide the participants into two groups: conditions of low responsibility and high responsibility conditions. Under conditions of high responsibility, the participants were told that they, as managers, had made earlier and disappointing R & D investments. Under conditions of low responsibility, the subject was told that the former manager had made an earlier R & D investment in a poorly performing division and was given the same earnings data as the other group. In both cases, subjects were asked to make a new investment of $ 20 million. There is a significant interaction between assumed liability and average investment, with high average liability conditions of $ 12.97 million and low conditions averaging $ 9.43 million.

Similar results have been obtained in previous studies by Staw (1974, 1976) and by Arkes and Blumer (1985) and Whyte (1986).

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Missile loss and cost errors

Many people have strong doubts about "loss aversion" resources. In the above example involving non-refundable sports game tickets, many people, for example, would feel obliged to go to the event even though they did not really want it, because otherwise it would be a waste of ticket prices; they feel they have passed the point of no return. This is sometimes referred to as a charred cost error . Economists would label this behavior "irrational": it is inefficient because of misallocation of resources by relying on information irrelevant to the decision made.

This line of thinking, in turn, can reflect non-standard utility measures, which ultimately are subjective and unique to the consumer. Ticket buyers who buy tickets to events they do not like before make a semi-public commitment to watch them. Going early is to make this vague judgment manifest to a stranger, an appearance they might choose to avoid. Or, they may feel proud to have recognized the opportunity cost of alternative time use.

The idea of ​​charred costs is often used when analyzing business decisions. A common example of sunk costs for businesses is brand name promotion. This type of marketing incurs a cost that can not normally be recovered. It is usually not possible to then "lower" a person's brand name in exchange for cash. The second example is the cost of R & amp; D. After spending, such costs will sink and should not affect future pricing decisions. So the efforts of pharmaceutical companies to justify the high price because of the need to cover the cost of R & D is wrong. The company will charge the market price whether the R & D has a cost of one dollar or a million dollars. However, the cost of R & amp; D, and the ability to cover those costs, is a factor in deciding whether to spend money on R & D. While it is a mistake, however, raise the price to finance R & D future does not.

The lack of sinking costs is in game theory sometimes known as the "Concorde Error", referring to the fact that the governments of Britain and France continue to fund joint development of Concorde even after it becomes clear that there is no longer an economic case for aircraft. The project was considered privately by the British government as a "commercial disaster" that should never have started and was almost canceled, but political and legal issues ultimately made it impossible for the government to withdraw.

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The Bygones Principles

The bygones principle is the economic theory used in business. Economists emphasize the "extra" or "marginal" costs and benefits of each decision. This theory emphasizes the importance of ignoring past costs and only taking into account future costs and benefits when making decisions. It states that when making a decision, one must make a hard calculation of the additional costs that will be covered and weigh it with extra excess.

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See also

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References

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Further reading

• Amankwah-Amoah, J. (2014). "A unified explanation framework for strategic firmness behind the failure of others". Journal of Strategy and Management . 7 (4): 422-444. doi: 10.1108/JSMA-01-2014-0009.
• Arkes, H.R.; Ayton, P. (1999). "The effects of Sunk Cost and Concorde: are humans less rational than lower animals?". Psychological Bulletin . 125 (5): 591-600. doi: 10.1037/0033-2909.125.5.591.
• Variant, Hal R. Intermediate Microeconomics: A Modern Approach. Fifth Ed. New York, 1999. ISBNÃ, 0-393-97830-3
• N. Gregory Mankiw, Principles of Economics, Third Edition. (International Student Edition) page 297. ISBNÃ, 0-324-20309-8
• Schaub, Harald (1997) "Cost of Sunk, RationalitÃÆ'¤t und ÃÆ'¶konomische Theorie". SchÃÆ'¤ffer Poeschel, Stuttgart 1997. ISBNÃ, 3-7910-1244-4
• Sutton, J. Sunk Cost and Market Structure . The MIT Press, Cambridge, Massachusetts, 1991. ISBNÃ, 0-262-19305-1
• Kahneman, D. (2011) Think, Fast and Slow , Farrar, Straus and Giroux, ISBN 978-0374275631. (Reviewed by Freeman Dyson in New York Review of Books, December 22, 2011, pp.Ã, 40-44.)
• Klein, G. and Bauman, Y. Introduction Cartoons for Economy Volume One: Microeconomics Hill and Wang 2010 ISBNÃ, 978-0-8090-9481-3..
• Bernheim, D. and Whinston, M. "Microeconomics". McGraw-Hill Irwin, New York, NY, 2008. ISBNÃ, 978-0-07-290027-9.
• Bade, Robin; and Michael Parkin. Microeconomic Foundation. Addison Wesley Paperback Issue 1: 2001.
• Samuelson, Paul; and Nordhaus, William. Economy. McGraw-Hill International Edition: 1989.

Source of the article : Wikipedia