What is Sunk cost? and why you should get rid of it.

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Below is a scenario I envisioned; I will be using this scenario to analyze the concept. For this scenario, we would assume that both the well and borehole will provide the same quality of water. 

Scenario 

You are the chairman of your Local Government council and as part of a project to provide water for your community, you dug a well at the central square, at the time you dug the well, the cost was ₦10, and the good supplies 2,000 litres of water to your community on daily basis, but this amount is insufficient. Given its current population, the community needs at least 3,000 litres per day to become self-sufficient in the water supply. Meanwhile, after 5 years, the well starts to dry up as the population has almost doubled over the period thereby causing chronic water scarcity. It is a new fiscal year, and the state government has allocated the sum of ₦100 Naira to your local government. Driven by the plight of your community, you intend to take on an expansion project to boost the water supply. You have two options, you can either dig the initial well further which will grow the water capacity to 8,000 litres at ₦10 or you could drill a borehole for ₦25 which will provide over 15,000 litres of water. Both options will provide sufficient water to your community. The well would dry up after 10 years, but the borehole will last for up to 35 years.

Analysis 

As a layman, this decision would warrant you to put several factors into consideration. One of them is sunk cost. The fact that you have already invested ₦10 in drilling a well tends to influence your psychology to deepen the well instead of drilling a borehole. You are most likely to overlook all other benefits associated with drilling a borehole because you feel you have invested in the well already. That’s why economists advise that when taking a future decision concerning an investment project, the concept of sunk cost shouldn’t be taken into consideration, instead you should focus on the impact and benefits of the decisions you are taking. 

This applies to our day-to-day life, I have interacted with people who are currently in Toxic relationships, and when I ask them why they are still in those relationships despite what they go through, they respond by saying they have invested a lot. 

Unfortunately, what they have invested is irrecoverable, detaching your psychology from sunk cost requires critical analysis of the future impact of your decisions and the courage to break away from the past. Having understood this concept, I will like you to take your calculator and do the analysis yourself, don’t just take my word for it. what decision would you take as a local government chairman and why? Don’t just say the answer crunch the numbers until you are convinced your decision is the best.

Congratulations! you are now an economist.