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American Economic Journal: Microeconomics: Vol. 3 No. 4 (November 2011)

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Mnemonomics: The Sunk Cost Fallacy as a Memory Kludge

Article Citation

Baliga, Sandeep, and Jeffrey C. Ely. 2011. "Mnemonomics: The Sunk Cost Fallacy as a Memory Kludge." American Economic Journal: Microeconomics, 3(4): 35-67.

DOI: 10.1257/mic.3.4.35

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. (JEL D24, D83, G31)

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Authors

Baliga, Sandeep (Northwestern U)
Ely, Jeffrey C. (Northwestern U)

JEL Classifications

D24: Production; Cost; Capital, Total Factor, and Multifactor Productivity; Capacity
D83: Search; Learning; Information and Knowledge; Communication; Belief
G31: Capital Budgeting; Fixed Investment and Inventory Studies; Capacity

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American Economic Journal: Microeconomics


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