The Economics of Sunk Costs

by Andy Hough on April 4, 2007

According to to Wikipedia, sunk costs are those costs which have already been incurred and cannot be recovered to any significant degree. The example they use is the purchase of a non-refundable movie ticket. If you later decide you don’t want to see the movie an economist would argue that the fact you already paid for the movie ticket should not be part of a rational decision of whether or not you decide to see the movie. This is a condensed version of the explanation, if it doesn’t make sense refer to the Wikipedia entry.

Anyway, there is a reason I’m talking about the economics of sunk cost. I’m somewhat apathetic about going on to my third year of law school and finishing my J.D.  According to the theory of sunk costs the fact that I’ve spent two years in law school and accumulated $57,000 in debt shouldn’t be part of my decision of whether to finish law school. The accumulated debt and time spent are a major part of my decision process though. If I don’t finish law school it would seem like they were wasted.

Maybe the idea of sunk cost isn’t applicable to this situation. If I were to finish my degree I would have a much higher earning potential. To achieve that earning potential via other means would most likely require a further investment of time and money. Also, if I were later to decide I would like to get my J.D. I would have to start all over again. (Assuming I return more than one year after quitting.)  Then I would have to pay for my first two years again and have two years of limited earnings. Tuition would most likely be higher as well. It seems to me that the time and money I’ve already invested have to be considered.

Maybe I’m not thinking this through correctly. I would be interested in anyone’s insights or ideas of how I shoud evaluate this decision. If you have any suggestions please leave a comment.

1 KMull April 9, 2007 at 6:39 am

Naturally, I would recommend finishing the J.D. It depends on why you are apathetic. Do you hate law now? What do you want to do with your life?

My advice: finish the JD, get a solid job in your field, and pay off the debt. Then feel free to do whatever you want. The missed value of not finishing 2/3rds of the way through seems odd. Will you be able to achieve the same income if you walk away today?

2 John Hunter April 9, 2007 at 9:05 am

Sunk cost just means that you don’t include them in the calculation in determining what to do now. If going to school for one more year costs you $25,000 and it is worth $40,000 to you then it makes sense to go. The previous costs are ignored. Deciding to go for the next year does not effect how much money has already been spent. The decision for this year only effects what you will spend next.

The accumulated debt can be a factor (sunk costs does not rule that out). Factoring in not that you spent that much in the past but that today you have debt that must be paid off. If you have that debt today it might be that an option to earn less is not as practical given your accumulated debt (the situation today) and therefor providing incentive to finish so that you can earn more and pay off the debt.

3 Tight Fisted Miser April 9, 2007 at 9:20 am

Thanks for the comments. I believe I better understand the concept now. I most likely will complete my J.D., although I might use it in an alternative career.

4 EA April 9, 2007 at 1:26 pm

Another thing to consider is whether you’re ever going to want to finish the degree. It’s probably cheaper to finish now (including both costs and time) than to re-start later.

5 Super Saver April 9, 2007 at 3:26 pm

TFM,

I will comment with a couple of questions:

What will you do instead of finishing your J.D.?

Is the alternative a “better return” than your current path? If yes, then sunk costs should be ignored.

No need to answer me. Just wanted to provide some helpful elements to consider 🙂

Good luck on your decision.

6 shadox April 9, 2007 at 10:55 pm

John Hunter has it exactly right. Sunk cost simply means that the money you have already spent and cannot recoup should not be used in the financial cost-benefit analysis of deciding whether or not a third year of law school makes sense.

However, as you describe in the post, there are other factors that have nothing to do with the amount of debt you have accumulated or the tuition you already paid that are relevant in that decision – such as your increased earnings power after the JD, as well as the cost of obtaining alternative professional training.

DO NOT LOSE HEART! I am a recovered lawyer. After getting my law degree and practicing law for three years in a law firm, I left law in the distant past and found new challenges in corporate high-tech marketing. Your JD will come-in handy in whatever you decide to do. Stick it out and it will pay off.

7 plonkee April 10, 2007 at 4:17 am

Its true that you shouldn’t include the fact that you have already spent x amount on your degree in deciding whether to continue or not.

But you should be comparing your true financial position if you don’t finish it, with that if you do. And that includes student loans, if you have them.

For example, suppose you have $40,000 in debt now and can get a job that pays $40,000 per year if you don’t finish your JD, compared to $60,000 in debt in a years time and a job that pays $50,000 per year. Financially speaking, it would make more sense not to finish.

8 Juan Millon April 12, 2007 at 11:25 am

Quitting anything that you’re already knee deep in has infinite, but non-discrete costs. Stick to your guns!!

Juan

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