What are sunk costs?

Sunk costs refer to expenses that have already been incurred and cannot be recovered. This concept is crucial in decision-making, as it emphasizes that individuals and businesses should focus on future costs and benefits rather than past expenditures that cannot be altered. An example of a sunk cost might be money spent on research and development for a product that has since been abandoned; no matter what decisions are made moving forward, that cost remains irreversible.

Understanding sunk costs helps in making rational economic decisions because it encourages ignoring these past costs when evaluating the benefits and costs of future actions. By acknowledging that these costs are irretrievable, decision-makers can more effectively assess the potential returns from new investments or strategies without being influenced by prior expenditures that no longer have relevance.