Thursday, April 30, 2009

My Favorite Lesson in Economics

One of my favorite lessons from the economics courses that I took at Mizzou is that of a sunk cost. It makes complete sense but 9 times out of 10, people will not act rationally and will consider the sunk cost - to their detriment - when making a decision. In other words, this is a perfect example of how people are irrational. They worry about sunk costs.

According to Wikipedia, this is the definition of a sunk cost:

In economics and business decision-making, sunk costs are costs that cannot be recovered once they have been incurred.

Traditional microeconomic theory proposes that an economic actor does not let sunk costs influence one's decisions, because doing so would not be rationally assessing a decision exclusively on its own merits.

So, let's put this is laymen's terms. You go out to dinner and spend $100 on a fabulous meal. Everything is delicious and you have practically licked your plate clean in enjoyment after each course. Now, though, you are starting to feel uncomfortably full and more food is on it's way. You consider lying down on the floor to let your food "spread out" so that you can force down the dessert. You would un-button your pants but they are already unbuttoned.

What can you do? You've already ordered and (essentially) paid for the meal. Your options are to (1) shove the food down your throat and feel miserable all night long or (2) realize that you have thoroughly enjoyed yourself and your meal and get a "doggie bag" for tomorrow. Your problem is obvious: food is never as good when it is re-heated and you want to get your money's worth from the meal.

Judging by the waist lines of America, I would venture to say that most people gobble down the food in this situation. Making this decision based on the theory of a sunk cost, though, you should take the extra food home in your "doggie bag". You ordered your food already and cannot change the cost of the meal to you so it's a...(say it with me, now...) sunk cost. The price should not factor into your decision of whether or not to eat the dessert because you cannot change it now. And, I'm saying that this is true EVEN IF the dessert on your plate is icing, pancakes, and pecan pie. The concept still applies.

Ok, so on to my real point: It's painfully obvious that the Obama administration needs to learn about sunk costs. The government should not have bailed out any of the auto companies to begin with and I completely disapprove of the insane amount of tax-payer money that has been "given" to these failing companies. We live in America and good companies should succeed and poorly run (eh-hem, heavily unionized) companies should fail. Our socialist government, who has no reason to be meddling around in the auto industry (or any industry), decided today that Chrysler could file for bankruptcy. The proceedings will be quick, as Obama said today, and the company will re-emerge. To no one's surprise, Chrysler is also set to receive up to $8 billion MORE in tax payer money.

I was nauseated (this time is wasn't attributable to my acid reflux) as I heard his speech on the radio today. I heard a man's voice say, "go out and buy an American car. Buy a Chrysler. All warranties will be backed by the federal government". I wasn't sure if it was still Mr. Obama speaking or a car salesman.

Turns out it was both.

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