The sunk cost fallacy occurs when individuals continue investing in a project based on past expenditures rather than rationally evaluating future costs and benefits. A common example is a mechanic purchasing a write-off car and pouring money into repairs in the hope of selling it to another buyer.
The initial purchase of the damaged vehicle is a sunk cost—money that cannot be recovered. Yet, the mechanic may continue spending on parts and labor, reasoning that abandoning the car would waste the investment. Each additional expense compounds the original loss, often exceeding the car’s market value once repaired.
For example, a mechanic buys a write-off for $2,000 and spends $5,000 on repairs, while the car’s post-repair value is only $4,000. Rationally, further investment is unjustified, but the mechanic’s decisions are clouded by the desire to “save” prior expenditures. Hope of selling the car serves as a false justification, masking the irrationality of continuing to invest.
This scenario illustrates the sunk cost fallacy clearly: decisions driven by irrecoverable past expenses, rather than future potential, almost always increase losses. Recognizing this bias is crucial in business and personal finance, ensuring resources are allocated to ventures that truly offer value.