Sunk Costs


Economists talk about sunk costs as being irrecoverable, hence not
relevant to decision making. But it seems to me that a lot of sunk
costs are also investments, and investments really should be
considered in the budget. Say you bought a Matisse–not one of the
really good ones–for top dollar in 2007. Two years later you couldn’t
sell it for a wallpaper pattern and the painfully high number of
millions you spent was a sunk cost. But you bought it because you
liked it, and you still like it. Also, those Chinese will bounce back
one of these days, and when they’ve bought back all the trade goods
China has ever exported, they’ll start to buy Western again. However,
you still can’t get your money out of it, so the economists would tell
you to ignore the money you spent on it.

But should you? You’re figuring out your insurance costs for next
year. That Matisse, not even one of the really good ones: it costs a
bundle to insure it, and the insurer makes you have it appraised every
year, which also costs a bundle. It’s a sunk cost. Do you insure it?

Well, hell, yes, you do. You’ll pay for it in about 15 or 20 years
with the costs of appraisal and insurance, but in the meantime, you
get to look at it and show it off. And if something happened to it,
insurance would bring you at least some of those millions back. It has
never sunk to the ignominy of six figures, after all. And who is idiot
enough to bet against the Chinese (or someone else) bouncing back and
buying Western in the next 15 or 20 years?

Here’s my alternative description of a sunk cost: It’s a past
expenditure used as a false justification of future expenditure.

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