The Hindu Business Line : Concorde Effect

Consider this. One of our neighbours recently moved to the east coast. The family donated most of their belongings to the Salvation Army. Our friend was, however, reluctant to buy gifts for his extended family. You may find this behaviour intriguing — donating to strangers but reluctant to buy gifts for family members. His behaviour seemed to be based on the principle of sunk cost, also called the "Concorde Effect". What is it?

Suppose you buy a movie ticket. You then realise that your favourite football team is playing that day. So, you decide to watch the match. You gift the ticket to a friend, as you are unable to find a buyer. The ticket is sunk cost. Your decision to give it away was not based on the price you paid for the ticket. Will you be just as willing to buy a ticket as a gift?

It was the same logic with our neighbours. They gave away most of their belongings. Giving things that you already own is not that difficult. Buying gifts results in cash outflow, which they were reluctant to incur.

We use sunk cost in a different way in the stock market. Suppose you buy 1,000 shares of MTNL at Rs 150. If the stock declines to Rs 130, you may buy another 1,000 shares to average your cost. Your decision to buy again is based on the sunk cost of Rs 150. You may, perhaps, not buy MTNL for the first time at Rs 130.

Sunk cost is also called the "Concorde Effect", named after the British and the French Governments' joint effort to build the Concorde even after the project was declared economically unviable.

(The author is based in Surrey, BC in Canada.)

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