Sunk Cost Fallacy in Driving the World's Costliest Cars
43 Pages Posted: 11 May 2013 Last revised: 22 Jan 2014
Date Written: January 15, 2014
Does the sunk cost fallacy affect decision-makers in high-stakes situations? We develop a behavioral model of usage of a durable good with mental accounting for sunk costs. It predicts that usage increases in the sunk cost, and attenuates with time at a rate that increases in the sunk cost. The model nests conventionally rational behavior as a special case.
We take the model to a panel of 7,398 cars between 2001-2011 in Singapore. During that period, the sunk cost involved in a new car purchase varied substantially with the continuing government policy. We found robust evidence of a sunk cost fallacy. The elasticity of usage with respect to the sunk cost was 0.124(±0.015). An increase in the sunk cost by S$4,500 (the outcome of government policy between 2009 and 2010) would have been associated with an increase in monthly usage by 53.5 kilometers or 3.4% in the first four years of purchase. Our results were robust to various checks including alternative controls for selection, differences in model and specification, and allowing for heterogeneous effects by car size.
Keywords: automobile, sunk costs, mental accounting, behavioral economics
JEL Classification: D03, D12, Q41, R48
Suggested Citation: Suggested Citation