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Sunk Cost Fallacy

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    ECA5101 Presentation:

    Do people drive more because they paid

    their cars??

    Literature Review on Sunk ost Fallacy

    the Worlds ostliest ars

    Presented by:Fan YiJun

    Cao WanZhong

    Zhou BaiQi

    Jonathan Chan

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    Presentation Outline

    Introduction to:Economy Theory

    & Singapores Car Policy

    YiJun

    Main Findings

    & Model Specification

    WanZhong

    Empirical Design,Econometrics Interpretation,

    Alternative explanation

    BaiQi

    Robustness testing

    Policy Implications

    & Opinion on paper

    Jonathan

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    Introduction to underlying econom

    Key Microeconomic Concept:

    Sunk Cost Fallacy: To continue doing something if substantial amoueffort have already been invested, even when continuing is not the best th

    Appropriate setting to test theory?

    Buying a car is a big ticket item in Singapore, where there is substantiapurchase prices over time due to COE policies

    2 Possible effects of higher sunk cost:

    More effort invested to correct irrational bias

    Irrational bias still exist (Proven in this paper)

    Introduction to:Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

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    Introduction to Singapores ar

    = 1

    OMV, Open Market Value: Import price of a car, may flumanufacturers pricing strategy

    ARF, Additional Registration Fee: Fee for new car registra100% of OMW

    Therefore ARF=f(OMV)

    COE, Certificate of Entitlement AKA Quota Premium:

    Right to own a car for 10 years from day of purchase

    cannot be detached from original car of registration

    Floating price is determined by a bi-monthly auction

    Supply is fixed by a monthly quota based on:

    i.Specific growth rate of car population

    ii.Number of de-registration in preceding time period

    Main cause of variations of car retail prices

    Introduction to:Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

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    Introduction to Singapores ar

    Introduction to:Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

    Note the large swings in COE prices, highly volatile

    Rapid over the years due to quotasreleased coupled with

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    Introduction to Singapores ar

    Introduction to:Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

    Note the immediate 20% in COE value the moment the new car owner

    Linear of 8% yearly for the next 10 years

    0 1 2 3 4 5 6 7 8

    % COE Remaining 80% 72% 64% 56% 48% 40% 32% 24% 16

    0%

    10%20%

    30%

    40%

    50%

    60%

    70%

    80%

    90%

    100% % COE Value remaining after x no of years

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    Introduction to Singapores ar

    Introduction to:Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

    Note the immediate 25% in ARF value the moment the new car iowner

    No further decline for the 1st 5 years, after which there is a step-down

    1 2 3 4 5 6 7 8

    % ARF Remaining 75% 75% 75% 75% 75% 60% 45% 30% 1

    0%

    10%

    20%

    30%

    40%

    50%

    60%70%

    80%

    90%

    100%% ARF Value remaining after x no of years

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    Main Findings

    Proposition 1: Sunk CostUsage:

    Notice the correlation between Policy-related Sunk Cost & Average mo

    Robust evidence of sunk cost fallacy (Irrational Behaviour)

    1

    st

    4 years: S$1,000sunk cost

    142.666km annual usage (3.4%

    Introduction to:Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

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    Main Findings

    Proposition 2: Attenuation

    Age of carsunk cost

    > Sunk Cost

    > (Rate of Sunk Cost over time)

    Introduction to:Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

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    Model Specification

    2 Proposed Behaviour Models:

    Conventionally Rational Behaviour

    Mental Accounting for Sunk Cost

    Introduction to:Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

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    Model Specification

    Conventionally Rational Behaviour (CRB):

    , = (, ) (, )

    , = f (Novelty, breakdown frequency)

    , = ( / , / )

    = ( +++

    Find Optimal usage by maximising utility

    Introduction to:Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

    *

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    Model Specification

    Mental accounting for sunk cost (MASC): , | = , Sunk Cost A , | > = ,

    Where Sunk Cost(SC) Adjustment

    = 0 SC sensitivity factor 1

    Introduction to:Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

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    Model Specification

    Mental accounting for sunk cost (MASC):

    , | = , SunkCostA

    Find Optimal usage by maximising utility

    Introduction to:Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

    inoptimal usagedue Sun

    *

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    Model Specification

    =

    = [0.2 0.25 ] [ 1

    Introduction to:Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

    Policy-related Sunk Cost Parameters from Jun 2001-May 2009:

    Mean: S$16,364

    Standard Deviation: S$3400

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    Empirical Design

    Data Sources:

    Car Retail price & Usage: Car servicing records from a authorised dealer for middle class brand of cars in Singapo

    Monthly OMW, ARF, Retail Price & COE: Land TranspoSingapore

    Fuel Cost:Consumer Price Index (CPI) of 98 Octane Petrol

    Key features of sample set:

    Panel data

    Exclusion of resold cars

    Exclusion of outliers (> 2 Standard Deviations of average m

    Introduction to:

    Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

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    Econometrics Interpretatio

    Proposition 1: Sunk CostUsage:

    OLS Regression with Robust Standard Errors:

    = 2.395 0.013 1.674 0.00

    (2.362) (0.009) (0.068***) (0.00 = 0.541

    = Cumulative usage

    = Price (S$000)= Age in months

    *** Level of significant effort: p

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    Econometrics Interpretatio

    Proposition 1: Sunk CostUsage:

    Re-specified OLS Regression with Robust Standard Errors:

    = 8.549 1.409 0.001 1.775

    (2.153***) (0.169***) (0.121) (0.071*** = 0.545

    = Cumulative usage

    = Sunk Cost Proportion of COE Premium

    = Sunk Cost Proportion of ARF

    = Age in months

    *** Level of significant effort: p

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    Econometrics Interpretatio

    Proposition 2: Attenuation

    Age ofcarsunk cost

    > Sunk Cost > (Rate of Sunk Cost over time)

    Mental amortizing sunk cost relative to some target cumulativ

    Introduction to:

    Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

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    Econometrics Interpretatio

    Proposition 2: Attenuation

    i) Maximum Simulated Likelihood(MSL) of Mental Accoun(MASC) model:

    Introduction to:

    Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

    Notice how all the Sunk Costs,

    horizons are +ve & significantly

    Consistent with Attenuation

    *4 Year Horizon preferred as it h

    likelihood value of -20736.6, ind

    the 3 time horizons

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    Econometrics Interpretatio

    Introduction to:

    Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

    i) Maximum Likelihood Estimate(MLE) of Conventionally R(CRB) model:

    *

    Can reject the Conventionally Rational Beh

    favour of the 4 year horizon specific model a

    Likelihood with more variable coefficients

    from 0, hence yielding a better fit.

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    Alternative Explanation

    Bias Selection:

    Higher prices (Higher sunk cost) would be more likely to attare planning to drive more.

    Shown that there is correlation between prices and usageIntroduction to:

    Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

    Pay more Sunk Cost Drive

    Mental Accounting of Sunk Cost (MASC)

    Bias Selection

    Establishing Causation

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    Alternative Explanation

    Why Bias Selection cannot hold:

    If the people who were planning to drive more were thhigher sunk cost, then there should not be attenuation

    usage should remain constant in accordance with their initIntroduction to:

    Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

    Pay more Sunk Cost Drive

    Mental Accounting of Sunk Cost (MASC)

    Bias Selection

    Establishing Causation

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    Robustness Testing

    Check the sensitivity of initial model by running multiple MSL model vaother factors (Car Size, Sunk Cost as % of retail price, COE Salience, Hetero

    Benchmark model is the 4 Year Time Horizon MSL equation as specified on

    Notice how the Sunk Cost Elasticity of Usage stays relatively constant

    =

    %

    % Where = Sunk Cost sensitivity fa

    Introduction to:

    Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

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    Policy Implication

    COE & ARF were introduced to control the Singapore Car p

    & Cost

    (-1.96 Million Km/ M

    Contradictory effect as highlighted by paper:

    & Cost

    (+0.14 Million Km/Month)

    Effectiveness of Policy:

    Net -1.82 Million km/ Month of Total Road UsageHighly effective still (~

    Introduction to:

    Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

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    Policy Implication Beyond C

    Pricing strategy of durable goods:

    Common practice: cheap durables, expensive complementary con

    usage of durable good hence purchase complementary consu

    Implication of sunk cost fallacy: expensive durables, cheaper coconsumables

    usage of durable good hence purchase complementary consu

    Introduction to:

    Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

  • 8/11/2019 Sunk Cost Fallacy

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    Policy Implication Beyond C

    Escalationofcommitmentto rationalise the decision-makersearlier inv

    Introduction to:

    Economy Theory

    & Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

    Gambling

    Further gambling to

    War Casualties/ resources spent

    Commitment even

    with no successful outcome foreseen

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    Opinions on paper?

    Extensively comprehensive with ample Robustngiven the data constraints:

    Exclusion of 2nd hand cars Income Selection bias with poor exclu

    Study can be further expanded on in the future if the relavailable:

    Different brands of cars

    Separation of discretionary & non-discretionary usage

    Income of owner:

    Sunk cost sensitivity may vary across income levels

    Income Effect: SunkcostDiscretionary Incomefuels

    Introduction to:

    Economy Theory& Singapores Car Policy

    Main Findings

    & Model Specification

    Empirical Design,

    Econometrics Interpretation

    & Alternative explanation

    Robustness testing

    Policy Implications

    & Opinion on paper

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    The EndThank you for your attention.

    Questions?


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