Posted by: erichosemann | October 24, 2009

Sunk Costs, And Then What?

In economics, the term “sunk costs” refers to costs incurred in the past that have no chance of being recovered and thus have no bearing on present decisions.  A good example of a sunk cost is the price of a movie ticket.  If you purchase a movie ticket, and it turns out the movie is terrible, it makes no sense for you to see it through to the end.  If you do, you merely pile the opportunity cost of your lost time onto the ticket price.  You’d be better off leaving the theatre and doing something you enjoy rather than forcing yourself to “recoup” the price of the ticket.  You can’t do that anyway.  The price of the ticket has gone from a concrete medium of exchange to a figment of imagination tricking you into believing there’s honor in sticking around until the movie is over.  There isn’t.

“And then what?” is the idea that decisions have consequences.  Russ Roberts attributes “And then what?” to Thomas Sowell.  He’s probably right–Sowell wrote an entire book called Applied Economics: Thinking Beyond Stage One. Thinking beyond stage one is the same as asking “And then what?”  By asking “And then what?” one considers the effects of decisions in later stages.  Politicians might decide rent control is a good way to make housing affordable.  And then what?  What might landlords skimp on if they can’t generate revenue at rent-controlled prices?  Maintenance?  Painting?  Thermostat settings?  Maybe they’ll make purchase of an apartment full of crummy furniture at an inflated price a precondition for agreeing to rent the apartment out.  Compiling such a list for any public policy decision is to ask “And then what?”

Sunk costs are in the past.  “And then what?” looks to the future.  Thinking about both concepts can inform daily, routine decisions like what to eat, or infrequent, large-scale decisions like whether to buy a car or remodel your house.  Firms and entrepreneurs do their best to ignore sunk costs and focus on present-day decisions and their implication for future growth and earnings.

The spirituality and creativity of economics—yes, you read that correctly—lies in things like “And then what” and sunk costs.  These aren’t merely koans bean counters use to lower their blood pressure.  They have deep implications for the way we live our lives.  Sunk costs can be a major drag on an individual’s achievement in life.  Imagine if you had to account for every mistake or accident in your life before you made a decision.  Each opportunity would mean cataloguing all sunk costs to that point.  Think about the psychological and spiritual implications of such a process.  A person would wither away and die just trying to pick a tie and shirt combination.  For a small scale manufacturer, obsessing about a new machine or production line well after it has proven itself a loss could mean the death of the enterprise.  Forgetting sunk costs means moving on; doing the best with what you’ve got; looking towards tomorrow rather than dwelling in the past.  Understanding that sunk costs are sunk is also the beginning of a creative process.  Rather than being hang-dog about leaving a theatre a quarter of the way through a crummy movie, you should be happy—you’ve taken responsibility for the rest of your afternoon or evening and opened a window on a world of possibility.  “What do we do now?” isn’t just for asking when the ammo runs out or the house is burning down.  It’s a question for the beginning of every day.

Asking “And then what?” is also the beginning of a creative process.  Empirical knowledge is only a small part of the answer to that question.  Imagination is the larger part, coupled with a little courage.  One must be courageous to claim to see connections ignored or unnoticed by others, and pausing to ask such questions is usually frowned upon.  Steely-eyed decision makers and brave revolutionaries get press.  Thoughtful consideration and contemplation usually don’t.  Will rent control hurt retailers of latex interior paint?  What will this tariff do to the price of substitutes or compliments for the imported good?  Could it be possible that minimum wages increase unemployment among unskilled workers?  These are some of the basic questions.  Broader, grander ruminations go thusly: are there enough atoms in the universe to accommodate a standard of living increasing at current rates?

Asking “And then what?” is to take one’s social responsibility seriously.  I’m not a big fan of the question applied to modes of consumption like veganism.  I’m generally confident that the lowest priced good is also the most efficiently produced, and thus least environmentally impactful, good.  But I am sympathetic to environmentalists for whom asking the question is a high priority.  They shop at places like Whole Foods because they trust the assertions of Whole Foods that what is sold there is produced in an environmentally friendly way.  This is a great thing, if pursued without relying on the big guys with the guns, as Elinor Ostrom puts it.

Critics of the “And then what?” process will say we can be bogged down by it, that flights of fancy in the “And then what?” realm can have costs of their own.  That is true.  No one wants to sit at a green light trying to decide whether to go right, left or straight ahead.  No one–without proper compensation, that is–wants to be the CEO weighing the fate of his company against the livelihood of his employees.  But there are always alternatives to consumption or action.  Just as doctors must “first do no harm” we can keep from piling up costs if we keep sunk costs and “And then what?” in mind.

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