By: Grzegorz Janota
“I hate this course but since I already did a semester I don’t want it to go to waste”. The above statement is common among university students – apart from those who study economics. Why? The answer lies in our knowledge of costs.
Understanding costs is essential to making a rational decision in any context. When you think of costs, you most likely think of accounting costs – costs that are directly attributable to the activity you are conducting. If you were running a coffee shop this would include the cost of the coffee, milk, rent and utilities. Analogously, when you take a module that you dislike, the accounting costs, expressed in monetary terms, would be the boredom that you experience during lectures and the effort that you must exert to finish the course work.
Perhaps a far more important cost, specific to economics, is the opportunity cost. This is the cost of foregoing the second best alternative. Instead of selling coffee, you could invest your money on the stock exchange or into starting a different business. In the student example, this is the cost of you not benefiting from taking a different, more stimulating, class.
To conclude, your accounting cost plus your opportunity cost is your economic cost – the cost that you would weigh against the benefits to make a decision. What then was the flaw in the student’s statement at the beginning of this article? It contained the sunk cost fallacy. Sunk costs are costs that you have already incurred and that you will never get back. They should thus never affect your decision. The student will not get her semester back and will only lose another one by continuing.