Economics for Baseball Fans 1: Sunk Costs

Okay, that does it.  I wasn't going to write about this now, but then someone had to go and make this comment at Fay's blog about a guy we all know well: Willy Taveras.

if he is closer to his career stats or near his best years, than it's better to have him as a fourth or fifth outfielder than to pay 4 mil for nothing --

simple economics

See, I could have ignored it...but then he had to go and call it "simple economics," and this just happens to be what I'm teaching this week.  So join me after the jump for my explanation of why this gets under my skin, and I promise I'll do my best not to put you to sleep...

In the textbook I'm using, Robert Frank phrases this as a common pitfall of decision-making, the failure to think at the margin.  Let me quote the textbook here:

The only costs that should influence a decision about whether to take an action are those that we can avoid by not taking the action.  Similarly, the only benefits we should consider are those that would not occur unless the action were taken.

As he continues,

[P]eople are often influenced by sunk costs--costs that are beyond recovery at the moment a decision is made.  For example, money spent on a nontransferable, nonrefundable airline ticket is a sunk cost.

To expand on that example: say I have such a ticket to a warm locale--but then the Reds make the World Series, and I am given a ticket to see them play the very same weekend I was planning on traveling.  Should I consider how much I paid for the plane ticket in deciding whether to go to the game?

 

The answer of course should be no--I should just figure out if I would benefit more from changing my plans than it would cost to change them--but this might be hard to do if I had planned a whole nonrefundable trip that cost thousands of dollars.  It might be hard for me to get over that decision (how could I have bet on the Reds not making the Series?), but I gain nothing by remaining stuck on the past.

 

Let's get back to contracts and Willy Taveras.  The point here is that that $4 million the Reds owe him in 2010 is a sunk cost.  If the team is acting rationally--and really, as a small market team the Reds are particularly bound by rationality, since they can't afford to make simple mistakes--then Willy should play if that's the best option, ignoring sunk costs.  We should consider the costs of replacing him: whatever we have to pay his replacement (a couple of hundred thousand dollars, presumably).  Then there are the benefits of replacing him: whatever that replacement produces, above what Willy would have.

 

I don't know if it's worth it to replace him, but I do know this: Those four million dollars?  If we're thinking this through like rational adults, those aren't remotely involved in this decision.  Sure, it's an easy mistake to make...but we're better than that, aren't we?

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