Mnemonomics: The sunk cost fallacy as a memory kludge

Sandeep Baliga*, Jeffrey C. Ely

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

16 Scopus citations

Abstract

We offer a theory of the sunk cost fallacy as an optimal response to limited memory. As new information arrives, a decision-maker may not remember all the reasons he began a project. The sunk cost gives additional information about future profits and informs subsequent decisions. The Concorde effect makes the investor more eager to complete projects when sunk costs are high and the pro-rata effect makes the investor less eager. In a controlled experiment we had subjects play a simple version of the model. In a baseline treatment subjects exhibit the pro-rata bias. When we induce memory constraints the effect reverses and the subjects exhibit the Concorde bias.

Original languageEnglish (US)
Pages (from-to)35-67
Number of pages33
JournalAmerican Economic Journal: Microeconomics
Volume3
Issue number4
DOIs
StatePublished - Nov 2011

ASJC Scopus subject areas

  • Economics, Econometrics and Finance(all)

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