Thursday, August 19, 2010

Had Your Cake

Economics is very much a study of opposites. There are positive incentives and negative incentives. Positive externalities and negative externalities. Gain and loss. Marginal benefit and marginal cost. But about a month ago, while doing some early preparations for my upcoming class this fall, something hit me: Is there a corollary to the sunk cost?

Sunk cost is probably best defined as something incurred in the past that an economist says doesn’t matter to the decision at hand, but any rational person is stubborn enough to consider it anyway. My suggestion is that, if there are retroactive and prospective costs and there are prospective benefits, (theoretically) there should be retroactive benefits. What would such a thing look like? I came up with two examples that might work:

Say a couple has dated and each half has to decide now whether or not to enter an official relationship. The sunk costs could be anything from the extra effort spent to shower right before the date to the overdraft fee on the credit card used to pay for a five-star meal. These costs have been incurred regardless of whether the couple decides to break up or “go steady.” So the sunk benefit, assumedly, would be the past benefits incurred (a pleasant evening with someone nice, the envy of everyone at school, an hour-long make-out session, etc.) Like the sunk costs, the couple would be told not to take these retroactive benefits into account.

Economics major best friend: “So what if he was a good kisser last night. Will he be a good kisser next weekend?”

My second example has to do with consuming free promotional items before choosing whether or not to buy anything, and it’s not nearly so interesting.