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Sunday, February 17, 2013

Sunk Costs and Subjectivism

As I have mentioned, I am using Heyne, Boettke, and Prychitko as my textbook for Micro I. I was just reading the section on sunk costs, and I sensed some tension between the way these are treated and methodological subjectivism. And, frankly, I believe the same tension is present in Economics for Real People, so don't think I am pointing fingers!

The problem is that the discussions of sunk cost often seem to become normative: the reader is being told he ought not to worry about sunk costs. But how does one fit that in with subjectivism? Imagine this conversation between a subjectivist economist and a student:

ECON [Handing back a quiz.]: Son, you ain't doing so well on these here tests. Perhaps you oughtta be considering dropping this here course. [I don't know why the economist talks like Foghorn Leghorn: I'm just listening to him and writing down what he says.]

STUDENT: No, I'm determined to finish the course: otherwise the $3000 I spent to enroll is wasted.

ECON: Now, son, you listen here: thems is what we eeconomists call "sunk costs," and you ought not be worrying your head 'bout them.

STUDENT: But didn't you tell me value, and costs, are all subjective?

ECON: Sure enough, son.

STUDENT: So how can you tell me I shouldn't worry about that cost? I am worrying about it. To me, it is an important thing. Why does whether you think I should worry about it matter?

ECON: But, but, son, I got this big ole book of eeconomic theory right here, and on page 61 it says clear as day, "Bygones is bygones." You gonna tell me you smarter than this book?

STUDENT: Ah, so I guess we actually are practicing methodological textbookism.

Now, I think the two points of view can be reconciled: Foghorn can tell the student the actual cost the student is concerned about is not the $3000, which is already spent and can't be recovered, but the feeling of guilt he will have if he drops the course, knowing he spent $3000 to take it, and that is a future cost. OK, but this is a rather fine distinction: after all, the student wouldn't feel that guilt if not for the past cost, would he?

My overall point here is that it often seems unclear whether economists are telling people that they don't concern themselves with sunk costs, or that they shouldn't concern themselves with sunk costs. If the first, that seems empirically false. If the second, that is hard to reconcile with methodological subjectivism.

Any thoughts?

14 comments:

  1. Well, but...

    DAMN YOU GENE CALLAHAN!!!

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  2. I think the student that you are describing above would be Henery Hawk.

    Maybe in a far more unlikely scenario, "Henery" is someone working a lucrative company and wants to improve his potential earnings by trying to acquire a master's degree or a Ph.D. The company is paying him to take courses at whatever university or college that he chooses as long as it doesn't break the bank. To be frugal and save himself some time, since the job itself might be very strenuous like in an electrical engineering or technological field, Henery decides to complete his degree at an online university like the University of Phoenix or DeVry University, or in the case of some educators that I've met, take courses at Walden University. I believe that in some cases, one could take courses on campus even at the University of Phoenix, so I'm thinking of that kind of a situation or even at a normal state college. He ends up failing many tests not because he hasn't studied hard enough, but the instructor is grading tests on a curve and the majority of the other students are choosing not to study and so forth. Another factor that I'm thinking of is when the school makes their process of adding or dropping courses very difficult whether it is due to outdated technology or a bug in the system. The instructor himself could be someone whose very incompetent and doesn't have an entry on a website like Rate my Professors, so the student doesn't exactly know the exact quality of the professor.

    Would it really be a waste of $3000 dollars if this student notified the company and the unviversity about the poor quality of the course he was taking and went from there? Perhaps there would be a degree of relief, anger, disappointment, and satisfaction if the student had found legitimate reasons to declare the school he was attending as one of those degree mill scams and sued them in court, especially if he found out that more unfortunate students were being ripped off through student loans? I'm assuming that Henery didn't know any of this and had found out about these colleges legitimately.

    Hopefully I'm not over-analyzing what you wrote above, but these are thoughts and questions that came to mind.

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  3. Yeah I'm glad you caught that. It's definitely a tricky point. In this article I did the standard finger-wagging in the main text but said in a footnote:

    "In commenting on examples such as this, the philosopher Roderick Long points out that there is nothing "irrational" in considering "sunk costs." If that's what someone's values are, then that's what they are. (To give a silly example, if someone had strong religious beliefs that he would be damned for ignoring sunk costs, then it would be perfectly sensible to eat the entrée.) But in this case, the costs wouldn't really be sunk, because one's present decision (whether or not to eat the dish) would entail future feelings of anguish, guilt, etc. Despite complications such as these, I still feel that a discussion of sunk costs is useful at the introductory level. Under normal circumstances, the economist would urge people to stop feeling anguish or guilt over costs that are truly sunk."

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    1. "But in this case, the costs wouldn't really be sunk, because one's present decision (whether or not to eat the dish) would entail future feelings of anguish, guilt, etc."

      Yes.

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  4. "after all, the student wouldn't feel that guilt if not for the past cost, would he?"

    "Past" costs dont exist...

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    1. The past certainly "exists" as present memories!

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  5. Bob's piece is good. Maybe the other harmonization is to think of the Sunk Cost Fallacy as being about recognition: for a lot of us, before being introduced to the concept of sunk costs as such, we don't genuinely recognize that those expenditures are gone regardless. Also, can't there be a non-normative lesson on sunk costs which simply says, "If you do choose not to abandon a goal because of the effort you've already made to it, that is an emotional or ethical decision rather than a strictly financial one. You may still wish to proceed on that basis. Just don't confuse it with maximizing return on investment as such."

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    1. Yes, I think that is right.

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  6. Thanks for writing about this topic. I was precisely thinking of it, from the point of the antitrust law.

    In this context, the concept of (objective) sunk cost is slightly less absurd. The idea is that "sunk costs", i.e. costs which are not retrievable, constitute a "barrier to entry".

    Now, in this perspective, I think only "sunk" costs are genuine costs ; if you can buy factors of production, enter a market and easily sell the factors back if the business is bad, you don't really incur any cost (except the interest).

    So, from the antitrust point of view, the only costs should be the "sunk" ones. But even these real costs don't constitute "barriers to entry", because they are discounted in order to take into account the risk.

    Am I right/wrong/beside the point?

    - Raoul

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    1. Interesting, Raoul. I am contemplating your point.

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  7. Gene: So much the worse for subjectivism. We have good reasons for ignoring sunk costs, whether or not we recognize these reasons. I thought that you were a fellow opponent of normative nihilism!

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    1. Yes, I am, Kevin. Here I am just noting the often unacknowledeged tension between two ideas that often sit side-by-side in the same text.

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  8. Hey, Gene. I think I can see the sunk cost fallacy interfering with decision-making in the opposite direction. Most examples show the problem with continuing a project because, "Look how much I've already spent." But here's an attempt at an example of bailing when you shouldn't because of sunk costs.

    I raise and finish cattle on grass. This is a low-margin business: all in, I expect to spend $1,000 raising a beeve to maturity and sell it for $1,040, posting a 4% profit. These numbers are not exact, but not too far off the actual numbers I saw in a worked example from a grass-farmer a couple years ago.

    The night before I'm to load Beefy on the truck to the slaughterhouse, she slips the fence and gets into Deacon Smith's yard. Deacon Smith hates me because he thinks humane treatment of animals "threatens the uniqueness of human beings" or some such hoo-hah. So he declares that it will cost me $100 to ransom the trespasser, Beefy. I do a quick, faulty reckoning that tells me if I pay the ransom, I'll now be upside-down on Beefy to the tune of ($60). I love my cattle, but I'm not in business to sell them at a loss, so I tell him, "Hey, keep her, she's yours."

    What I've just done, because of sunk costs, is turn down an opportunity to make $1,040 on a hundred-dollar expense. Cause the other $1,000 is gone already.

    I doubt a single real farmer would make this miscalculation, but it might do for an illustration.

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  9. This is a great point. A lot of people forget that guilt is a cost. So when certain people chastise game show contestants for not taking a chance to double their money, they're not considering the fact that those contestant could be remorseful for the rest of their lives: they had one chance to get $20,000, and they blew it by being greedy! That could be something that could haunt them for years.

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