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Mnemonomics: The Sunk Cost Fallacy as a Memory Kludge

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  • Sandeep Baliga
  • Jeffrey C. Ely

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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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Journal: Microeconomics.

Volume (Year): 3 (2011)
Issue (Month): 4 (November)
Pages: 35-67

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Handle: RePEc:aea:aejmic:v:3:y:2011:i:4:p:35-67

Note: DOI: 10.1257/mic.3.4.35
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Cited by:
  1. Spiegler, Ran, 2011. "‘But Can'T We Get The Same Thing With A Standard Model?’ Rationalizing Bounded-Rationality Models," Economics and Philosophy, Cambridge University Press, vol. 27(01), pages 23-43, March.
  2. Cunningham, Thomas, 2013. "Biases and Implicit Knowledge," MPRA Paper 50292, University Library of Munich, Germany.
  3. Calzolari, Giacomo & Nardotto, Mattia, 2011. "Nudging with information: a randomized field experiment on reminders and feedback," CEPR Discussion Papers 8571, C.E.P.R. Discussion Papers.

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