Lecture 04丨Sunk cost is not a cost

There is a cost if there is a choice, and there is no cost if there is no choice. When we can no longer make choices, there is no cost, which is the meaning of the phrase "sunk costs are not costs". Many people say this phrase, and everyone seems to understand what it means, but the real difficulty of this phrase is not in understanding what it means, but in making a decision and putting it into practice.

Let's say we go to the movies, we sit inside the cinema for 15 or 20 minutes, and we know if the movie is good or not. If the movie is not good, the best thing you can do is to leave it on the spot. Because the money to buy movie tickets has been sunk and is no longer the cost.

But look, if a bad movie is shown in the cinema, how many people will stand up and leave when the movie is 10 minutes and 20 minutes old? It's hard to do.

Most college students, after studying their major for a year and a half or two, actually already know very clearly whether this major is suitable for them, but how many of them can change their major on the spur of the moment?

The same is true for falling in love. Most people fall in love, six months after the blind period of love. This time they have been able to rational judgment, the relationship is not suitable for them, but how many people can decisively break up? A lot of people are dragging and dragging.

So, the phrase "sunk costs are not costs" is easy to know and difficult to implement. Since sunk costs are not costs, what do we use as a guide to our actions?

2. Marginal costs determine behavioral options

Let me tell you another very important concept, that is, marginal cost.

We should always keep an eye on marginal costs and marginal benefits as a guide for our future actions. Whenever we have to make a decision, we always have to ask the pertinent question of how much more we have to invest to get the expected return.

For example, we have two options on hand, option A and option B. Option A says that if we invest 100, we will get a return of 150. Option B says that if we invest 100, we will get a return of 200.

At this point, if scenario A doesn't start putting in, and scenario B doesn't start putting in. Which of these two options is better? Option B is better, of course.

If the situation changes and we have already invested 50 in Scenario A and 50 in Scenario B, which scenario would you continue to invest in? In Scenario A, you can get 150 for another 50, and in Scenario B, you can get 200 for the same 50. At this point, of course, you would choose option B.

However, if this is not the case, if you have invested 90 in the A program, that is, you only need to invest another 10 to get 150 returns; while the B program you have not started to invest at all, that is, you have to invest 100 to get 200 returns. At this point, Scenario A is more attractive than Scenario B. That's because the marginal return of option A is higher than the marginal return of option B.

So the comparison between Scenario A and Scenario B is not absolute. It depends on how much more we have to invest in Scenario A and Scenario B before we can get the return. It can be seen that what can guide our decision is the future return on investment at the current point in time.

3. It may be more efficient to settle for the wrong decision

The figures above also tell us that sometimes we make the wrong decision at the beginning, and we may be right to settle for the wrong decision.

Let me give you an example. Many years ago I bought an air conditioner. It was summer, so I was all about cooling, and I paid $3,000 for an air conditioner that only cooled, not considering that in winter I would also need the heating function.

In fact, at that time, I only had to pay an extra 1,000 yuan to be able to buy an air conditioner that could both cool and heat. But I made the wrong decision at that time, I paid $3000 for an air conditioner that could only cool, and I realized the problem in the winter. How should I choose this point?

Sunk costs are not costs, and at $3,000, the money for this cooling-only air conditioner has already been paid for, and the cost for me to continue to enjoy it is almost zero. If I want to heat, I have to buy a new air conditioner with a heating function, and I have to pay another 4,000 yuan. And now this air conditioner that only cools, even if I sell it, I will only get $1,000. That means, at the margin, I have to pay an extra $3,000 to get the air conditioner with a heating function.

You see, the marginal cost is different at different decision points. When I buy an air conditioner in the summer, if I want the heating function, I only have to pay an extra $1,000. But I realize the problem in the winter when I have to sell the original air conditioner and buy a new one, and the marginal cost of getting the heating function goes from $1,000 to $3,000.

For me, that's too expensive. So my choice is to settle for an air conditioner that only cools, and spend another $300 on a heater. Just get by. It's not ideal, of course, but the wrong decision has already been made, so it's a more economical decision to live with it. This is the meaning of always focusing on marginal costs and marginal benefits. 4.

4. The use of the marginal concept in industrial policy

Let's apply this example to industrial policy. Let's say there is a 3G and 4G wireless communication infrastructure, and if we start from scratch, 4G is certainly better than 3G. However, if 3G has already been launched and built, should 4G be introduced at this time? This becomes an economic question worth thinking about.

In other words, should we just settle for 3G?

Let's say that the original provider of 3G will threaten a 4G provider who wants to enter the market. He says, our sunk cost is not a cost, we have already invested, the equipment is already here, so we can reduce the service cost to very low, so low that you can't make money coming in with 4G, so low that users don't want to buy your service.

So, if we stand in a neutral position to look at industrial policy, should we support 3G providers, or support 4G providers who want to enter the market?

At this point, we have to use the concept of marginal cost and marginal revenue, if the service provided by 4G is not cost-effective enough, then it may be more efficient for users to temporarily settle for cheaper 3G services that have zero sunk costs.