Housing Adventures: The Pre-Sunk Cost Fallacy
In behavioural economics, the Sunk Cost Fallacy illustrates the tendency of individuals to follow through on an endeavour once they have invested money into it. In other words, once money has been spent, we will make use of all means to continue with what we spent on, whether a good or bad decision.
However, in my recent adventures looking for a new house with my parents, I realised a subtle yet somewhat distinct variation of the sunk cost fallacy that my parents fell into — one that involved other people’s money spent and yet they want to go through with it. Long story short, my parents decided that if they were to pay for a house that is already furnished, even if it is cheaper than similar alternatives on the market, they still would not want to touch the renovation, even if it doesn’t fit our theme and they do not particularly like it. I immediately thought: this is the sunk cost fallacy at work isn’t it? They were going to spend the money on the house and even if it is not to their liking, they were willing to go through with it because they feel it is a waste to redo all the new renovations — even though they did not pay for those renovations!
This seems to be a weird variation of the sunk cost fallacy, where even if you are not the one who spent the money on it, it feels like you are, since the money spent on the renovations is factored into the price of the house. And yes, some may argue that well technically, you are paying for the renovations as part of the house. However, I think there is a clear distinction to make. Firstly, the money has not been spent on the house yet, and all this are in presupposed terms. Secondly, even with the renovations, the house is still relatively cheaper as compared to similar houses and thus more money could be factored in for renovation, based on a fixed budget for the house and renovations.
So, why does this “pre-sunk cost fallacy” arise? I am by no means a professor in behaviourial economics or any sort of behavioural sciences (in fact, I am still in High School). However, I have some thoughts on why this arises.
Firstly, there seems to be some sort bias based on possible endowment. Imagine you walk into a newly renovated house with the perfect layout, floor level and checks whatever boxes you for an ideal house. Except, you think that the industrial style renovation is not suited to the minimalist theme. Because of the fact that the house checks all your boxes, you are likely to feel amazing to be able to buy this house, especially at a cheaper price. But there lies the problem: would you be willing to let go of the new renovations and spend money to overhaul the house to suit your preferred theme or would you feel very sorry for all the new renovations done up and just live with it. It seems like by experience, you would just buy the house and not renovate it, because it makes your heart ache to see the renovations gone. This is likely because you feel that getting the house has already endowed you with something that is almost perfect, and something that others may think to be perfect and so you are not willing to give up this opportunity and would rather just leave with the renovations.
Secondly, there seems to be a hint of unwillingness to spend money on something that is not ideal but not extremely sore to the eye. As humans, it is rational to want to spend less money on something than spend more on something. In fact, budgeting (what Thaler subsumes under “mental accounting”) is something that impedes rational human thinking as you are fixed on spending this amount of money, say $8000000, and the anchoring effect would mean you would spend somewhere close. As such, it seems rational to want to spend less on something. However, based on the Marginalist Principle, if the renovation is not to your liking, you should not even have committed to the house as the marginal cost likely outweighs the marginal benefit. I mean, just imagine seeing a renovation that makes you feel dull and empty everyday, even if not a sore to the eye. Surely the impact on your everyday life is larger than the originally good layout of the house and other factors that factored into buying the house. As such, there seems to be an unwillingness to spend on something that we can “live with” and thus leads to this “pre-sunk cost fallacy” that prevents one from rationally thinking and going ahead with renovating a house that is recently renovated.
Lastly, there is probably some shortsightedness in making this decision. At the point of purchasing the house, you would look at factors such as good layout, high floor, recently built, etc. However, in the long run, these may not be the factors that are most important to you. I’m sure that the fact that your cabinet was poorly done up and cannot fully open is more frustrating to you than the fact that the layout of your house is funny and has a weird v-shaped balcony. In this sense, the renovation of the house can make or break how livable the house is. As such, in selecting the house, there seems a under weighing of factors that would only come into play in the medium to long term. Coupled with the fact that the renovation was newly done up, many would overestimate how comfortable they would be living in the house for the long term. Thus, this leads to the “pre-sunk cost fallacy” I observed.
With all that I have said, what do you think about this “pre-sunk cost fallacy” that I observed. Is this even a variation of the sunk-cost fallacy? Are there any other factors that contribute to this fallacy/bias?
