Editing Sunk cost (section)

== Bygones principle ==

According to [[classical economics]] and standard [[microeconomic]] theory, only prospective (future) costs are relevant to a [[rationality|rational]] decision.<ref>{{Cite book| publisher = Cambridge University Press| isbn = 978-1-107-12366-3| last1 = Sharma| first1 = Sanjay| last2 = Sharma| first2 = Pramodita| title = Patient Capital| date = 2019}}</ref> At any moment in time, the best thing to do depends only on ''current'' alternatives.<ref name=Lipsey1992>{{Cite book| publisher = Oxford University Press| isbn = 978-0-297-82120-5| last1 = Lipsey| first1 = Richard G.| last2 = Harbury| first2 = Colin| title = First Principles of Economics| date = 1992| url = https://books.google.com/books?id=cV0EZuJxod8C| pages = 143}}</ref> The only things that matter are the ''future'' consequences.<ref name=Ryan2004>{{Cite book| publisher = Cengage Learning EMEA| isbn = 978-1-86152-993-0| last = Ryan| first = Bob| title = Finance and Accounting for Business| date = 2004| pages = 229–230}}</ref> Past mistakes are irrelevant.<ref name=Lipsey1992 /> Any costs incurred prior to making the decision have already been incurred no matter what decision is made. They may be described as "water under the bridge",<ref name=Bernheim2008>{{Cite book| publisher = McGraw-Hill Irwin| isbn = 978-0-07-721199-8| last1 = Bernheim| first1 = B. Douglas| last2 = Whinston| first2 = Michael Dennis| title = Microeconomics| date = 2008}}</ref> and making decisions on their basis may be described as "crying over spilt milk".<ref>{{Cite book| publisher = Tata McGraw-Hill Education| isbn = 978-0-07-040224-9| last = Jain| first = P. K.| title = Cost Accounting| date = 2000}}</ref> In other words, people should not let sunk costs influence their decisions; sunk costs are irrelevant to rational decisions. Thus, if a new factory was originally projected to cost $100 million, and yield $120 million in value, and after $30 million is spent on it the value projection falls to $65 million, the company should abandon the project rather than spending an additional $70 million to complete it. Conversely, if the value projection falls to $75 million, the company, as a rational actor, should continue the project.  This is known as the ''bygones principle''<ref name=Ryan2004 /><ref name=Gupta2009 /> or the ''marginal principle''.<ref>{{Cite book| publisher = Tata McGraw-Hill Education| isbn = 978-0-07-070071-0| last = Samuelson| first = Paul A.| title = Economics| date = 2010}}</ref>

The bygones principle is grounded in the branch of [[normative]] [[decision theory]] known as ''[[rational choice theory]]'', particularly in [[expected utility hypothesis]]. Expected utility theory relies on a property known as ''cancellation'', which says that it is rational in decision-making to disregard (cancel) any state of the world that yields the same outcome regardless of one's choice.<ref>{{Cite journal| issn = 0021-9398| volume = 59| issue = 4| pages =S251–S278| last1 = Tversky| first1 = Amos| last2 = Kahneman| first2 = Daniel| title = Rational choice and the framing of decisions| journal = The Journal of Business| date = 1986| jstor = 2352759| doi = 10.1086/296365}}</ref> Past decisions—including sunk costs—meet that criterion.

The bygones principle can also be formalised as the notion of "separability". Separability requires agents to take decisions by comparing the available options in eventualities that can still occur, uninfluenced by how the current situation was reached or by eventualities that are precluded by that history. In the language of decision trees, it requires the agent's choice at a particular choice node to be independent of unreachable parts of the tree. This formulation makes clear how central the principle is to standard economic theory by, for example, founding the folding-back algorithm for individual sequential decisions and game-theoretical concepts such as sub-game perfection.<ref>{{Cite journal| volume = 73| issue = 2| pages =S185–S202| last1 = Cubitt| first1 = Robin| last2 = Ruiz-Martos| first2 = Maria| last3 = Starmer| first3 = Chris| title = Are bygones bygones?| journal = Theory and Decision| date = 2012| doi = 10.1007/s11238-010-9233-4| s2cid = 5051889}}</ref>

Until a decision-maker irreversibly commits resources, the prospective cost is an [[relevant cost|avoidable future cost]] and is properly included in any decision-making process.<ref name=Gupta2009 /> For instance, if someone is considering pre-ordering movie tickets, but has not actually purchased them yet, the cost remains avoidable.

Both retrospective and prospective costs could be either [[fixed cost]]s (continuous for as long as the business is operating and unaffected by output volume) or [[variable cost]]s (dependent on volume).<ref name="Sherman2008">{{cite book|url=https://books.google.com/books?id=tbFHAAAAYAAJ|title=Market Regulation|last=Sherman|first=Roger|publisher=Pearson / Addison Wesley|year=2008|isbn=978-0-321-32232-6}}</ref> However, many economists consider it a mistake to classify sunk costs as "fixed" or "variable". For example, if a firm sinks $400 million on an enterprise software installation, that cost is "sunk" because it was a one-time expense and cannot be recovered once spent. A "fixed" cost would be monthly payments made as part of a service contract or licensing deal with the company that set up the software. The upfront irretrievable payment for the installation should ''not'' be deemed a "fixed" cost, with its cost spread out over time. Sunk costs should be kept separate. The "variable costs" for this project might include data centre power usage, for example.

There are cases in which taking sunk costs into account in decision-making, violating the bygones principle, is rational.<ref name=Parayre1995 /> For example, for a manager who wishes to be perceived as persevering in the face of adversity, or to avoid blame for earlier mistakes, it may be rational to persist with a project for personal reasons even if it is not the benefit of their company. Or, if they hold private information about the undesirability of abandoning a project, it is fully rational to persist with a project that outsiders think displays the fallacy of sunk cost.<ref>{{Cite news| issn = 0017-8012| issue = March 1987| last1 = Staw| first1 = Barry M.| last2 = Ross| first2 = Jerry| title = Knowing When to Pull the Plug| work = Harvard Business Review| access-date = 2019-08-09| date = 1987| url = https://hbr.org/1987/03/knowing-when-to-pull-the-plug}}</ref>