My wife and I are having a disagreement as to what it means. She says that it means the cost of something you purchased some time ago, and had you not purchased it the money would be gone anyway.
Basically, 3 years ago we decided to purchase something to hold onto and sell later on when the value goes up. She says that the purchase price can be considered as profit since it was so long ago. I disagreed. Anyway, she calls it “sunk cost”.
In: 59
I think you need to make a distinction between *decision making* and *accounting*. The term “sunk cost” is really only applicable in decision making.
In your situation, the money you spent on object X *in the past*is a sunk cost insofar as it informs what you choose to do with it X *in the future*. What that means is that you shouldn’t take the money you’ve already spent into account when you are deciding whether or not to keep or sell X, because that money isn’t recoverable. The only relevant factors are how much you can sell X for today, and how much upkeep cost and/or benefit you get from holding on to X (the economic “utility”).
Having said that, when calculating your profit, you absolutely need to factor in the amount you spent on X. You can’t just say “well it was long enough ago that we can consider it free”, because that’s just not true.
A concrete example: let’s say you bought a DVD rental store in 2005 for $1000. That $1000 is a sunk cost as far as your future decisions are concerned, because you can never go back to 2005 and undo that purchase. All you can do is decide to sell or keep the store today. You have an offer for $500 for the store. The sunk cost principle tells us you *should not* use the $1000 you paid initially as part of your decision, otherwise you will possibly end up losing more money. Let’s say, since it’s 2022 and no one rents DVDs, you lose $10/month on the store. You should just sell the store for $500, because the only alternative is to keep losing $10/month. It doesn’t matter that you paid $1000 for it initially, because if you insist on waiting until you can “make that $1000 back”, you’ll end up losing $10/month for eternity. The $1000 is the sunk cost. However, in calculating your profit, you don’t get to just say “Well I made $500 profit!”, because you didn’t, you paid $1000 + all the years of upkeep. So your profit is still negative (-$500 and all the months of running it), but it would have been even *more* negative if you had fallen victim to the sunk cost fallacy and not sold.
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