Bernheim and whinston microeconomics pdf

Unsourced material may be challenged and removed. However, many economists consider it a mistake to classify sunk costs as “fixed” or “variable. 400 million on an enterprise software installation, that cost is “sunk” because it was a one-time expense and cannot be recovered once spent. Bernheim and whinston microeconomics pdf “fixed” cost would be monthly payments made as part of a service contract or licensing deal with the company that set up the software.

Sunk costs should be kept separate. The “variable costs” for this project might include data centre power usage, for example. Traditional economics proposes that economic actors should not let sunk costs influence their decisions. Doing so would not be rationally assessing a decision exclusively on its own merits.

Alternatively, a decision-maker might make rational decisions according to their own incentives, outside of efficiency or profitability. In light of such cognitive quirks, it is unsurprising that people frequently fail to behave in ways that economists deem “rational”. Sunk costs should not affect the rational decision-maker’s best choice. For instance, if someone is considering preordering movie tickets, but has not actually purchased them yet, the cost remains avoidable.

However, if the price of the tickets rises to an amount that requires him or her to pay more than the value he or she places on them, they should figure out the change in terms of prospective cost that goes into the decision-making process and re-evaluate his decision hence. The sunk cost is distinct from economic loss. The sum originally paid should not affect any rational future decision-making about the car, regardless of the resale value: if the owner can derive more value from selling the car than not selling it, then it should be sold, regardless of the price paid. Having paid the price of the ticket and having used the time to do something more fun. If the ticket-buyer regrets buying the ticket, the current decision should be based on whether he wants to see the game at all, regardless of the price, just as if he were to go to a free baseball game. In business, an example of sunk costs may be investment into a factory or research that now has a lower value or no value whatsoever. It should be obvious that abandonment and construction of the alternative facility is the more rational decision, even though it represents a total loss of the original expenditure—the original sum invested is a sunk cost.

If decision-makers are irrational or have the wrong incentives, the completion of the project may be chosen. For example, politicians or managers may have more incentive to avoid the appearance of a total loss. In practice, there is considerable ambiguity and uncertainty in such cases, and decisions may in retrospect appear irrational that were, at the time, reasonable to the economic actors involved and in the context of their own incentives. Behavioral economics recognizes that sunk costs often affect economic decisions due to loss aversion: the price paid becomes a benchmark for the value, whereas the price paid should be irrelevant. An overoptimistic probability bias, whereby after an investment the evaluation of one’s investment-reaping dividends is increased. The requisite of personal responsibility.

Sunk cost appears to operate chiefly in those who feel personal responsibility for the investments that are to be viewed as sunk cost. 00 bet in the next 30 seconds. Knox and Inkster asked the bettors to rate their horse’s chances of winning on a 7-point scale. What they found was that people who were about to place a bet rated the chance that their horse would win at an average of 3. 48 which corresponded to a “fair chance of winning” whereas people who had just finished betting gave an average rating of 4. 81 which corresponded to a “good chance of winning”. 00 commitment, people became more confident their bet would pay off.

D investment either in an underperforming company department, or in other sections of the hypothetical company. Staw and Fox divided the participants into two groups: a low responsibility condition and a high responsibility condition. D investment in the underperforming division and were given the same profit data as the other group. Economists would label this behavior “irrational”: it is inefficient because it misallocates resources by depending on information that is irrelevant to the decision being made. A ticket-buyer who purchases a ticket to an event they won’t enjoy in advance makes a semi-public commitment to watching it. To leave early is to make this lapse of judgment manifest to strangers, an appearance they might otherwise choose to avoid. The idea of sunk costs is often employed when analyzing business decisions.