Skip to main content

Apples and the sunk cost fallacy

   It is apple season for another year. The trees in the village where I live are packed full of tasty, fresh, organic apples. And, most of them are going to be left to fall to the ground and rot! Which I think is a great waste. I also think it is a great example of the sunk cost fallacy in action.
    Here's the issue: Consider someone called Mark who goes out to the supermarket and buys some apples. He will almost certainly eat those apples and go out of his way to not waste them. Mark, however, ignores the apples growing in his garden and does not think twice about letting them go to waste. Why does Mark save the apples he bought and not the apples  growing in his garden?
    You might say it is a difference in quality; but, the apples in my garden are easily as tasty as those in my local supermarket. You might say it is the difficulty of harvesting the apples; but, it takes seconds for me to harvest 20 apples from my garden. The difference, therefore, must be psychological. That is where the sunk cost fallacy comes in.
     A sunk cost is a cost that cannot be recovered. Given that it cannot be recovered it should not influence future choice. When Mark walks out of the supermarket (and throws away the receipt) the money he paid to buy the apples is a sunk cost. As such, the amount of money he paid for the apples should not influence whether or not he eats the apples.  We see, however, that it does: He is more likely to eat an apple he has bought than one growing in his garden. This looks like the sunk cost fallacy: Mark lets sunk costs influence his choice.
    Richard Thaler in his classic paper on mental accounting gives a slightly different example. In this case Mark has bought some expensive shoes that do not fit. The more expensive they are the more likely Mark will continue to try and wear them and the longer he will keep them in his cupboard. Note the subtle difference between these examples. In the shoe example the emphasis is on how Mark 'over-values' the shoes he has paid a large sunk cost for. In the apple example the emphasis is on how Mark 'under-values' the apples that he has got for free.
      The classic take on the sunk cost fallacy is that it is about mental accounting (see the paper by Richard Thaler). While buying this interpretation, I also think the fallacy is partly caused by people confusing the price they paid for something with the value it has for them. Mark, for instance, should focus on how much he values an apple and how much he values the shoes. For example, he might value a fresh apple at $2 and shoes that do not fit at $0. Instead, he will focus on how much he paid for the apple or shoes. If he got the apple for free he think it cannot be worth much, if he paid $1 for the apple it seems more valuable, and if he paid $300 for the shoes then they must be worth saving.
      The lesson, therefore, is to ignore how much something cost when deciding whether or not to use it. And, just because something is for free does not mean it is not valuable. So, let's get making some apple pie. 
 
 
 
 
 

Comments

Post a Comment

Popular posts from this blog

Revealed preference, WARP, SARP and GARP

The basic idea behind revealed preference is incredibly simple: we try to infer something useful about a person's preferences by observing the choices they make. The topic, however, confuses many a student and academic alike, particularly when we get on to WARP, SARP and GARP. So, let us see if we can make some sense of it all.           In trying to explain revealed preference I want to draw on a  study  by James Andreoni and John Miller published in Econometrica . They look at people's willingness to share money with another person. Specifically subjects were given questions like:  Q1. Divide 60 tokens: Hold _____ at $1 each and Pass _____ at $1 each.  In this case there were 60 tokens to split and each token was worth $1. So, for example, if they held 40 tokens and passed 20 then they would get $40 and the other person $20. Consider another question: Q2. Divide 40 tokens: Hold _____ at $1 each and Pass ______ at $3 each. In this case each token given to th
Post a Comment
Read more

Nash bargaining solution

Following the tragic death of John Nash in May I thought it would be good to explain some of his main contributions to game theory. Where better to start than the Nash bargaining solution. This is surely one of the most beautiful results in game theory and was completely unprecedented. All the more remarkable that Nash came up with the idea at the start of his graduate studies!          The Nash solution is a 'solution' to a two-person bargaining problem . To illustrate, suppose we have Adam and Beth bargaining over how to split some surplus. If they fail to reach agreement they get payoffs €a and €b respectively. The pair (a, b) is called the disagreement point . If they agree then they can achieve any pair of payoffs within some set F of feasible payoff points . I'll give some examples later. For the problem to be interesting we need there to be some point (A, B) in F such that A > a and B > b. In other words Adam and Beth should be able to gain from agreeing.
Post a Comment
Read more

Some estimates of price elasticity of demand

In the  textbook on Microeconomics and Behaviour with Bob Frank we have some tables giving examples of price, income and cross-price elasticities of demand. Given that most of the references are from the 70's I'm working on an update for the forthcoming 3rd edition. So, here is a brief overview of where the numbers come from for the table on price elasticity of demand. Suggestions for other good sources much appreciated. Before we get into the numbers - the disclaimer. Price elasticities are tricky things to tie down. Suppose you want the price elasticity of demand for cars. This elasticity is likely to be different for rich or poor people, people living in the city or the countryside, people in France or Germany etc.etc. You then have to think if you want the elasticity for buying a car or using a car (which includes petrol, insurance and so on). So, there is no such thing as the price elasticity of demand for cars. Moreover, the estimated price elasticity will depend o
Post a Comment
Read more