In my younger years, I had always seen economics, the subject, with disdain because I considered it not a science but a topic of “personal opinions and interpretations.” Nowadays I have reached the conclusion that most of our believes are a product of our own personal opinions and interpretations, although it seems we are not very aware of that.
I questioned a friend of mine, who is a very well-respected economist, if he could give me an example of economics theory applied on our daily life, and while I was not expecting a great answer, his example made a profound impression on me.
He looked at me with a relaxed look in his eyes and said: “One of the things that I had applied in my life very often is the law of the sunk costs.”
I looked at him perplexed waiting for a clearer explanation.
When he saw the puzzling expression in my face he proceeded to elucidate:
“In the budget constraint framework, all decisions involve what will happen next. These decisions do not look back to past choices.”
He stopped when he realised I was not understanding a word he was saying.
“Imagine you go to a restaurant, a very fancy one.” He said with a calmed voice.
“You order a very expensive dish, because you think that you will enjoy a wonderful taste, but as soon as you begin to eat your palate dislikes the flavour and you just cannot keep eating it, but because of the price, you force yourself to keep eating some more, to see if you find something likable about it.”
I imagined the scene and felt the frustration in my stomach.
He continued, “But despite the cost of the food, you begin to wonder if you should live that place and go to eat somewhere else, maybe something you like and that is cheaper and yummier than this, or probably you could just go back home and watch a movie with your plate of popcorn and forget about this unpleasant incident.”
“In the end you opt for the last choice and then you promise yourself never to go back to that restaurant again, or at least, never to ask for that particular dish ever again.”
“That same frustration and bitter taste is experienced by small and big companies when they have to admit that they made an earlier error in judgment by spending too much money in creating and launching a product or service and in economics this is called: Sunk Costs.” He made a long pause this time.
“The main lesson of sunk costs is to ignore them, admit the mistake, never expect to recover that money and make decisions based on what will happen in the future.”
I was beginning to understand where he was going from here.
“These sunk costs cannot be recovered, and you have to be very aware of that. But the lesson learnt is invaluable. I have applied this concept many times in my life, and I can tell you that it has taught me a lot about how to live a better life. How to grow faster and better.”
I was very impressed with his “class”. He was right, if we could avoid suffering over and over with our past mistakes and stop searching how to blame others, or even ourselves for those faults, and those things we did not do at the time, we could profit more on the lesson and our decisions would be much more confident in the future.
I thanked my friend for this lesson and yes, I am now considering my “sunk costs” as unrecoverable but extremely valuable for my future steps towards my goals.
Thank you, Economics!