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Also known as stranded costs, sunk costs are any expenses or costs that have been incurred in the past, and cannot be recovered or reversed. While sometimes confused with the concept of economic loss, sunk cost is more concerned with what was paid for an asset, and not with any losses that result from the difference between the original purchase price and the price that the asset is sold for at a later date. Sunk cost does not technically exist until a purchase is made, making it important to assess the potential of the purchase to deliver the satisfaction sought by the consumer.
One of the easiest ways to understand sunk cost is to consider the purchase of tickets to a sporting event. Each ticket carries a specific price that must be paid in order to attend the event. The prospective buyer considers the prospective cost in the form of the price of the tickets, then makes a decision on whether or not to actually make the purchase. If he or she proceeds with the purchase, the amount of money paid for those tickets represents a sunk cost.
Should circumstances arise where the ticket buyer is unable to attend the event, there is no way to reverse the purchase of those tickets; the sunk cost is not a historical fact and cannot be changed. While it may be possible to sell the tickets for some type of discounted rate, chances are that it will not be possible to recover the full price of the original purchase. In any event, the resale of the tickets is viewed as a transaction that is distinct from the sunk cost, since that original purchase was not canceled or voided.
The same general approach is applied to the purchase of a new car. Any amount paid to secure ownership of the vehicle represents the sunk cost of the transaction. Even if the owner subsequently sells the now used vehicle for a lesser amount and partially recovers the amount of the initial purchase, that transaction does not change, replace, or reverse that original purchase.
In terms of budgeting and general economics, the sunk cost does not really represent a factor that buyers consider. While a transaction is under consideration, the cost of the purchase is identified as a prospective cost. That prospective cost only becomes a sunk or stranded cost once the purchase is completed and any opportunity for reversing the purchase has passed. For this reason, financial planners tend to place more emphasis on the prospective cost when it comes to making decisions involving money management, and view stranded cost as simply one possible outcome of that decision making process.
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