Questions: Sunk Cost Fallacy

Question 1

A company has spent $10 million developing a product that market research now shows will fail. A manager argues, 'We can't stop now — we've already invested $10 million.' This reasoning commits the sunk cost fallacy because...

• A. The manager is correctly considering all relevant costs
• B. The $10 million is already spent and unrecoverable — the decision should be based only on future costs and benefits of continuing versus stopping
• C. The manager should spend more to protect the investment
• D. Market research is unreliable and should be ignored

Answer: (B)

The $10 million is a sunk cost — it is gone regardless of whether the project continues or stops. The rational decision compares only the future costs of continuing (additional development, marketing, opportunity cost) against the future benefits (expected revenue if the product is launched). If future costs exceed future benefits, the project should be stopped — the past $10 million is irrelevant because it cannot be recovered. The manager's reasoning confuses past investment (sunk) with future value (relevant).

Question 2

A person who has already eaten enough food at a buffet continues eating to 'get their money's worth.' This is an example of the sunk cost fallacy.

• T. True
• F. False

Answer: True

The buffet price is a sunk cost — it was paid upon entry and cannot be recovered regardless of how much food is consumed. The rational decision is to eat until marginal utility becomes zero or negative (you are full or uncomfortable). Eating beyond this point to 'justify' the entry fee makes the person worse off (discomfort, health costs) while recovering nothing. The mental accounting desire to close the 'buffet account' in the positive — by consuming enough to feel the price was worthwhile — drives the behavior.

Question 3

Why does the sunk cost fallacy persist even among experienced decision-makers who understand the concept intellectually?

Model answer: The fallacy persists because it is driven by powerful emotional and psychological mechanisms — loss aversion (stopping makes the loss feel real and final), self-justification (admitting failure threatens ego and reputation), organizational incentives (managers who kill projects are seen as having 'wasted' resources), and mental accounting (the desire to close accounts positively). Intellectual understanding of the fallacy does not eliminate these emotional and social pressures, especially when the decision is public and reputational stakes are high.

In organizational settings, the problem is compounded by agency dynamics: the manager who started the project has a personal stake in its continuation (their judgment is on trial), and other managers may be reluctant to kill a colleague's project. This creates an organizational sunk cost effect where failing projects persist because no individual has the incentive and authority to cut losses. External audits, pre-commitment to decision criteria, and separating the decision to continue from the person who made the initial investment can mitigate this.