Loss aversion - Sunk cost

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 Loss aversion - Sunk cost

We will be going over loss aversion and its effects on sunk costs. First thing we need to explain is
what these terms even mean. A sunk cost refers to a cost that can not be recovered, expenses that
should be ignored when it comes to future decisions. Loss aversion in terms of behavioural
economics, refers to people’s preferences to avoid losing compared to gaining the equivalent
amount (Pettinger n.d.) e.g. people would rather not lose $100 than to gain $100.
 Sunk cost fallacy

What happens if you keep investing resources because you already invested those sunk costs.
This is called the sunk cost fallacy. Sunk cost fallacy occurs when an entity continues to invest
in something due to the previous invested resources and not wanting to let those resources
"go to waste." This is not a good metric to base resources on. This should be decided based
on present value and whether future benefits are greater than future costs not on already
invested resources.
 Basic Example of Sunk Cost Fallacy

An example would be if you decide to open up a lemonade

stand. You would need to acquire all of the necessary items to
run the lemonade stand. Those would be sunk costs. After
running the lemonade stand for some time, you see that you
are running the business at a loss. Rather than shutting down
the lemonade stand, you continue to invest into it, hoping that
things will turn around, even though it may be a better
decision to just shut it down. The act of throwing more
resources at the lemonade stand because you already
invested into it is the fallacy.
 Example of loss aversion - Concorde Fallacy

The Concorde was the first supersonic passenger commercial airplane. The project was worked on jointly by aircraft manufacturers
in both Great Britain and France. Both the British and French governments funded a large portion of the project. While in
development it became clear to designers and engineers that the development costs of the Concorde were so great that they
would never be fully recovered during its lifespan. Nevertheless at this point lots of money and time had been put into the project
as well as it gaining a lot of publicity, so the British and French governments continued funding. The Concorde was barely even
physically possible, requiring the engineers to come up with many workarounds to get it flying. One example of this is the “droop
snoot”. In order to be stable at the over Mach 2 speeds the designers wanted, they needed to make the nose cone of the Concorde
very long. This however, proved to cause more issues since when a plane is landing it tilts upward and with the nose cone being so
long, the pilots were unable to see the runway. This meant even more money had to be poured into the project and engineers
developed a complicated system of tilting the nose cone down during the landing process. This was just one of the design
challenges that should have been a red flag to engineers and investors that the Concorde wouldn’t be viable and that they were
stuck in a sunk cost fallacy.
 Engineering Interpretation Loss Aversion and sunk cost
fallacy and intro to relation of Concorde

As we all know, the Concorde was a huge failure economically for all parties that took part in the project. In a well
mannered and organized team, everybody has a say including the engineers. With loss aversion and sunk cost
fallacy, the engineers play the role of soldier as the economic decision of whether to continue spending resources
on a failing project to try and create successes out of it because the resources spent/used will go to waste (Sunk
Cost Fallacy) or to Quit the project, forget about the money lost and accept the losses because you do not see the
outcome favouring profit (Loss Aversion).
What was wrong with Concorde and how much money was
invested to try and fix the issues (Relating to economics).

The team at Airbus had limited time to innovate, design, test, build, and implement the first ever supersonic
passenger jet in existence. The engineers at Airbus encountered many design flaws such as Wing Shape and
aerodynamics (“Allowing supersonic speed, but unstable at lower speeds, causing landing and takeoff issues”),
Nose length (“causing pilots to encounter difficulties while taking off and landing due to departure and arrival
angles”), and even ethical engineering issues later on in the life of the project due to design flaws causing crashes
and deaths. Sticking to loss aversion and skunk cost fallacy, the design failures of the Concorde prior to the global
unveiling led the engineering team at Airbus to make the overall design more complicated by finding specific
solutions to fix a bad design
 Topic definitions and comparing examples

These two examples may seem very different, however they are made up of the same concept, the
sunk cost fallacy.
-Sunk cost: A cost of which has been incurred that is not able to be recovered, these are
treated as a bygone which a company or an individual would not consider while deciding the
future of the investment.
-Sunk cost Fallacy: continuing an investment due to previously invested resources to prevent
loosing the resources which have been put into the project already.
-loss aversion: Tends to describe why psychologically the pain of loosing is stronger than the
pleasure gained from success.
All three of these terms help to explain why the company or the individuals made the decision to
keep throwing resources into the project which has no evident future.
 Overall conclusions

Sunk cost can be seen in various examples across the economy and in the marketplace while
also relating to engineering in the sense that engineers must also understand this concept
and act accordingly to make the best decisions. Sunk cost fallacy is the continuation of
behavior which is driven by costs that can no longer be recovered, these costs are deemed as
sunk costs. loss aversion is the definition as to why companies and individuals follow the suck
cost fallacy. Finally the definitions of sunk cost and the terms aligned with it, as well as the
ability to identify real world examples of where these topics are apparent have been stated.
 Citations
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divesting/. ---(Page 1)
“Sunk Cost Fallacy.” Doctor In Progress, May 2018, doctorinprogress.com/wp-content/uploads/2018/05/sunk-cost-fallacy1.jpg. --- (Page 2)
Mead, T. (2019). [Digital image]. Retrieved 2020, from https://www.delish.com/food/a28118328/lemonade-stands-illegal-in-most-us-states/. -
-- (Page 3)
“Concorde #4.” Wallpapers Vista, vistapointe.net/concorde.html. --- (Page 4)
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engineering-meeting-four-engineer-machine-improvement-plan-room-image92165637. --- (page 5)
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