The Sunk Cost Fallacy: Why “We’ve Already Paid for It” Is Bad Economics

 

One of my favorite ways to start the semester is by introducing a concept many students are at least tangentially familiar with: opportunity cost.

Closely tied to opportunity cost, and to a core economic assumption about marginal decision-making to maximize well-being, is the sunk cost fallacy. While this fallacy shows up frequently in large public and private projects, I find it most effective to bring it down to a scale we’re all familiar with (and probably guilty of): sitting through a bad movie simply because “we’ve already paid for it.”

Before working through an example, one quick definition. In this post, I’ll refer to economic rent, which, following the CORE Microeconomics framework, means the extra benefit you receive from an action after accounting for all relevant economic costs, including opportunity costs. A positive economic rent means the choice improves your well-being relative to the next-best alternative.

The Initial Choice

Suppose you have two groups of friends asking you to hang out on the same evening:

• One group wants to go to the movie theatre
• The other wants to go to the pub

You can only attend one.

To keep things simple, let’s assume:

• Your time is the scarce resource, not money (Lucky you)
• You enjoy both groups of friends
• The movie starts earlier, and the pub hangout begins later

Economists often represent enjoyment or satisfaction in dollar terms, not because it’s literally money, but because it gives us a common unit to compare options.

Option A: The Movie Theatre

You’ve heard the movie is good, so you expect:

• Benefit: $50 (movie + time with friends)
• Explicit cost: $35 (ticket, popcorn, etc.)

That leaves you with a net explicit benefit of:

$50 − $35 = $15

Option B: The Pub

You know from experience the pub is always a good time:

• Benefit: $60
• Explicit cost: $50 (food, drinks, tip)

So, your net explicit benefit here is:

$60 − $50 = $10

Choosing Using Economic Rent

Using economic rent as the decision rule:

If you choose the movie:

• Net explicit benefit = $15
• Opportunity cost = forgone $10 from the pub
• Economic rent = +$5

If you choose the pub:

• Net explicit benefit = $10
• Opportunity cost = forgone $15 from the movie
• Economic rent = −$5

To maximize well-being, you choose the option with positive economic rent, in this case, the movie.

When Expectations Turn Out to Be Wrong

Now suppose you get into the theatre and quickly realize the movie is terrible.

Your original expectation of a $50 benefit was wrong. Going forward, the only enjoyment you expect to receive is about $5, purely from being with friends, not from the movie itself.

At this point, you face a new decision:

• Do you stay and finish the movie because you already paid for it?
• Or do you leave and head to the pub, which is just getting started?

This is where many of us fall into the sunk cost fallacy.

Why the Sunk Cost Shouldn’t Matter

The $35 you paid for the movie is sunk:

• It’s already been paid
• It’s irrecoverable
• It’s in the past

Because of that, it should not influence your decision going forward.

What matters now are the costs and benefits from this point onward.

The Decision Going Forward

Option A: Stay at the Theatre

• Benefit: $5 (time with friends)
• Explicit cost: $0 (the ticket is already paid)

Net explicit benefit = $5

The opportunity cost of staying is the forgone pub experience worth $10.

Economic rent = $5 − $10 = −$5

Option B: Go to the Pub

• Benefit: $60
• Explicit cost: $50

Net explicit benefit = $10

The opportunity cost is the $5 you would have received by staying.

Economic rent = $10 − $5 = +$5

The Rational Choice

The economically rational choice is to leave the movie and go to the pub.

Importantly, notice what doesn’t enter the calculation: The $35 already spent as that cost is sunk. It cannot be recovered, and including it in your decision would only lead you to make a worse choice going forward.

A Hiking Analogy

I find this analogy really helps drive the point home.

Suppose you’re on a hike and have already walked 5,000 steps. Ahead of you is a river you planned to cross, but when you arrive, the river is raging and the bridge is washed out. Crossing now would risk serious injury or death.

Should you continue just because you’ve already spent 5,000 steps getting there?

Of course not.

Those steps are sunk. The only relevant question is:

• Do you take a dangerous risk?
• Or do you turn back and choose a safer alternative for the day?

When the stakes are life and limb, the correct choice is obvious. The sunk cost fallacy feels tempting mainly when the costs are monetary or effort-based, but the logic is exactly the same.

Final Thought

What are your thoughts on the sunk cost fallacy?
Have you caught yourself thinking “I might as well finish, I’ve already paid for it or invested so much into it”?
Have you seen examples where sunk costs led to clearly worse outcomes?

Let me know in the comments.

 

Water and Wood: The Economic Trap of Common Resource Goods

 

We’re starting this post by looking at two recent articles by Stefan Labbe in BIV. The first, on October 23, 2025, highlighted the extremely low rates being charged for water use by industrial users. The second, on November 19, 2025, looked at a different but economically identical issue: unsustainable forestry harvesting rates. While water extraction and forestry might seem unrelated, from an economic perspective, they are both classic examples of the Common Resource Good trap.

This is a crucial concept because the trap threatens long-term environmental sustainability for short-term economic gain. To figure out what's happening in these sectors, let's start with the basic 100-level theory.

Key Concepts: What is a Common Resource Good?

A Common Resource Good is defined by two primary characteristics that, when combined, create a predictable market failure.

The first characteristic is that the good is Non-Excludable. This means it is difficult or costly to stop people from using the good, even if they don't pay for it. For example, trying to stop a homeowner from drilling a well or someone from filling a bucket from a lake often requires costly government intervention.

The second is that the good is Rivalrous. This means consumption by one person directly reduces the amount available for others. For instance, every tree cut down is one less for someone else, and every litre of water used is a litre that cannot then be used by another actor.

The Model of Collapse Over Time

When we first discover a common resource, the total supply, N (the total population), often seems vast, far more than the quantity demanded, Q_D, in any given year.

This initial abundance, combined with the non-excludable nature of the resource, is what leads to the Tragedy of the Commons. The short-term optimal strategy for every individual actor is to continue to extract the resource today, because an individual who cuts their own consumption is still hurt by everyone else extracting the resource anyway. This unchecked behavior leads to the resource shrinking year after year until it collapses below its reproduction threshold. You can see this process illustrated in the diagram below over five periods (N à N₅).

The Price Problem

So why doesn't a price naturally appear, even as the resource becomes scarce?

Think of a large lake with houses and businesses all around it, all using the water for various reasons. The only way a price would naturally appear is if a single actor could control access and charge money. But because the lake is non-excludable, it’s virtually impossible to enforce who is taking how much water, especially if they are drilling wells or using it for large-scale agriculture.

The cost of trying to set up a toll booth or a metering system for every single user far outweighs any potential profit. Because the good is non-excludable, the price mechanism, the force that usually balances supply and demand in a market, fails entirely.

Policy Solution 1: Property Rights

One way to overcome the common resource problem is to make the good excludable by establishing property rights.

Private Property

When we talk about shifting ownership to a single entity, or privatization, it fundamentally changes the incentives. Think about historical examples like communal grazing land or traditional agricultural plots. When everyone has access, no one has an incentive to limit their extraction or manage the land long-term. However, as soon as you fence the land and assign it to a private owner, that owner suddenly has a reason to maintain the resource's longevity. If they overgraze their cows, the cost (ruined pasture, lower land value) falls entirely on them. This incentive alignment is why privatization often solves the tragedy of the commons; the private owner internalizes the full long-term cost of their actions.

However, the way we privatize the resource can be fraught with peril and create new problems. If we simply sell off common land or resource rights to the highest bidder, it can exacerbate existing wealth inequality, turning a shared public good into a private monopoly. Furthermore, the process of privatization itself can be rife with corruption, leading to politically connected actors receiving valuable resource rights for cheap, benefiting from massive private profits while society loses out on its shared asset and shared wealth.

Nationalized Property

The other option is Nationalized Property, where the government (the Crown) retains ownership. This approach helps ensure that profits from the resource are shared by all of society and avoids the risks of exacerbating inequality by auctioning off public goods. The trade-off here is that the government now has to take on the management burden, which includes setting the laws and spending money to patrol and enforce against things like poaching or illegal extraction.

Policy Solution 2: Quotas vs. Price Controls

If the resource is nationalized and managed by the government, the objective shifts to limiting the harvest H to a sustainable level. We shouldn't think of supply as the total population N, but as the sustainable flow, the amount we can harvest in a given year while keeping the population stable. We can simplify the change in a resource population with the formula:

Change in Population = (Births - Deaths) - Harvest

The goal for Sustainable Harvesting is for the change to be zero. The government can target this sustainable level Q_H using either of two main methods:

1. Quota set at Q_H: The government sets a fixed harvest limit. This is generally the most effective "set it and forget it" tool, as the corresponding market price P_H will float based on demand for a fixed, sustainable quantity. The downside is that it requires revenue to enforce the quota.
2. Price Control set at P_H: The government sets a required price per unit extracted. This is less stable because if demand suddenly surges, the quantity harvested will automatically increase, leading to an over-harvesting of the resource unless the price is immediately adjusted.

The Policy Pitfalls and Trade-Off

Even with solid economic theory, policy implementation faces severe, very human challenges. First, estimating the exact sustainable quota (Q_H​) is complex, and the industry that stands to profit from extraction has every incentive to convince the government that Q_H​ is higher (and P_H​ is lower) than it should be, a problem known as regulatory capture.

Second, governments are often pressured to prioritize short-term economic growth (more jobs, higher GDP today) over long-term sustainability. This short-sighted goal can unfortunately be pursued for generations before the resource finally collapses.

The Real Cost of Collapse

This brings us back to the unavoidable trade-off. We have seen time and again what happens when a common resource fails. A dark Canadian Heritage Moment is the collapse of the Atlantic cod fisheries in the 1990s which didn't just hurt the economy; it created ghost towns along the coast, destroyed generational fishing cultures, and led to deep poverty and significant social issues. The ecological cost is equally devastating, often wiping out entire food webs.

The painful irony of this situation is that the very workers dependent on the industry, who are often the most vocal opponents against any government-imposed caps or quotas, were the ones who suffered the most in the end.

Restricting harvesting today causes direct, immediate pain by limiting their income, which makes a sustainable cap seem like an affront to their way of life and a gross government overstep. However, this short-termism sets them up for an even larger economic hardship in the future. By resisting the smaller, necessary economic cut today, they ensure a catastrophic, total collapse tomorrow, where the 50% hardship becomes a 100% loss of their industry.

When we enjoy the excess profits and resource extraction today, we are setting ourselves up for this type of collapse and undue future hardship.

To make matters worse, the ultimate issue of fairness and inequality is that the wealthy shareholders and corporate leaders who profit the most from excessive extraction today will likely not be the ones around to experience the pain decades from now. They take the profits, and the future generations, including the children and grandchildren of the now laid-off workers, are left to pay the cleanup bill and deal with the lost resource.

This is an ever-pressing reminder of the current state of the forestry sector in BC today. The painful question is whether we accept the immediate pain of reduced harvesting today, or wait for the complete economic and ecological devastation later.

P.S. Only hours after finishing this post, I came across the attached image - a letter from two current sitting MPs criticizing the government’s forestry policy. This post perfectly illustrates the political difficulty of the common resource problem in real time.

The issue we discussed in the blog, based on reports cited in the BIV articles, is that we are likely significantly over-harvesting our forests. However, this letter criticizes the government for reducing the harvest limits (the Allowable Annual Cut, or AAC). The MPs state that thousands of jobs are at stake and urge action to address harvest delays to protect the coastal forestry sector.

This is the unavoidable trade-off in action. While the data suggests the resource can't support the current extraction rate, political pressure demands more extraction to protect short-term jobs and avoid immediate economic hardship.

This situation is precisely why we need to be educated about the reality of the issues at hand and need to advocate for our future. If you choose to be silent, the industries and political forces who are trying to change the rules of the game in their favour, choosing short-term profits over long-term social welfare, are definitely advocating for their goals.