Question

2. Two months ago, your five-year-old car suddenly required serious repairs. Faced with spending $2,500 on the engine work or junking the car and buying a different one, you chose the repairs. Now, however, your transmission’s shot, and fixing it will cost you another $500. Alternatively, you could sell the car as is for $1,000 and buy a different one. You know that the car will likely require further repairs in the future, though you hope it won’t happen soon.

   (a) Give an answer that clearly spells out the kind of reasoning we describe as the “sunk cost fallacy”. (Include numbers in your answer)

   (b) Now give an answer that avoids the sunk-cost fallacy.

Answer 1

(a) My five-year-old car requires an additional cost of repairing = $2,500 + $500 = $3,000

  Selling it will give $ 1,000

I chose to repair the car over buying a different one because I have already invested a lot of money, time, or effort into it. That is why I have made this decision to repair it even though I know that it will likely require further repairs in the future.

Individuals commit the sunk cost fallacy when they continue a behavior or endeavor as a result of previously invested resources (time, money, or effort) even when continuing is not the best thing to do.

(b) Sunk cost fallacy is irrational and could be described as "throwing good money after bad".

Although selling the car will only pay $1000, but it will be a rational decision to sell it. The reason is that investing money in repairing the car which most likely will need further repairs in the future is not a rational investment instead, the amount that will be spent can be used to buy a new car in the future.

If the costs outweigh the benefits, the extra costs incurred (inconvenience, time, or even money), the investment should not be continued rationally.