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Gittins_Econ irrationalism_SMH_19990424

Gittins_Econ irrationalism_SMH_19990424 - aesandpriceiafls...

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Unformatted text preview: aesandpriceiafls. sports seeking new depths in pes— pondering their earrnngs fore- dtnan Fielder. he chooirs—"and—chaff group S sieve even the lower end of pro-___ wwwsmncomen SATURBAY, APRli, 24, 3.999 GlTTINS ON SATURDAY ROSS GETTINS ECONOMICS EDHOR ' Economic irrationalism --— it can sink the investor. If you own shares in a company whose value over the years has gone down while your other shares have gone up, what’s the smart thing to do? Sell the burn shares to out your losses and try your luck elsewhere, or hang on in the hope they’ll come good and you'll avoid making a loss? If you’d avoid "the loss, i‘m sorry, but you‘re wrong ~— though you’d be in good com- pany. That’s what most people would do. if you know the right answer is to cut your losses and try again, the likelihood is you’re a well-educated investor who‘s been schooled in one of the basic lessons of conven- tional, “rational” economics. But l‘m prepared to bet that, faced with similar choices that didn’t invoive investments, you’d be no more rational than the next guy. Why is it ta’donai — that is, acting in clear-headed self—interw est —— to sell the shares and try again? Because the loss suffered when the market value of the shares fell below the price you paid for them is water under the bridge and there’s nothing you can do to get it back. it’s what economists call a “sunk cost” and one of the golden rules of economics is: when making decisions, always ignore sunk costs. Another way'to put it is: never worry about the past, aiways look to the future. It doesn’t make sense to try to recover past losses, but it does make sense to try to make future gains. . And diat‘s the key, The question you should be asking is: which company’s shares do i helievc are most likely to rise in value in the future? Because that’s where your best chance of gain lies. Oniy in the (unlikely) event that you have good _ reason to believe your present waiter brings you as many slices of pizza as you like. The question is, if the pizza house gave you a refund of your $5 — perhaps because it was running some kind of promotion — would that influ- ence how much pizza you ate? in experiments conducted by the economist Richard Thaler —— in which a phoney waiter distributed refunds at random to half the people in the restaurant d it turned out that those who didn‘t get a refund are far more pizza than those who did. For both groups, the addl‘ tional monetary cost of eating another slice was the same: zero. _So the only factors that should have influenced them about how many slices to eat were howghungry they were and how ranch they liked pizza. And since there was no reason to believe the two groups differed in hunger or taste, each should have eaten roughly the same amount Presumably, the people without a refund ate more because they were trying to recover their sunk cost of $5 ~ trying to “get their money‘s worth”. But those with a refund felt they had a sunk cost of zero, so they had no money’s worth to get and they ate no more than they feit like. It does make sense to seelt your money’s worth at a restau- rant, b it makes sense only before :iodfilfe decided which testament to go to. Once you’ve spent the money, the only question is: how much am I enjoying this? (Remember this invaluable insight next time you’re on a plane and are tempted to eat an unappetising meal merely because “live paid for it, haven’t iii”) Now imagine you’ve bought a pair of very fashionable shoes Kahneman and Amos Tversky. Say that, having eariier pub chased your ticket for $10, you arrive at the moviesto discover you’ve lost it Do you fork-out another 10 bucks, or do you turn around and go home? Now say you don’t haves -- propurchased ticket, but you arrive at the pictures and discover you’ve lost a $10 note on the way there. Do you fork out or give up? You know the drill bynow. The two situations are identical; in both cases you’ve lost $10 of value. In any case, the $10 is a sunk cost and shouldn’t influ- ence your decision. The reievant issue is whether you can afford to spend another $10. _ But most people presented with the lost-ticket case said they’d give up and go home, whereas 88 per cent of those presented with the lost—$10~n_ote case said they’d shell Joni another $10. .- _, So there isn’t any doubt that, contrary to good sense (and contrary to the assumption of conventional economics), many people fail to ignore sunk costs in their everyday decisions. Just think of all the people stuffing themselves with food and wearing uncomfortable shoes when there’s no good reason they should. They’re failing to maximise their per- sonal welfare because they’re not thinking clearly about the choices they face. , But don’t Eet homely exam— ples convince you this is no more than an endearing quirk of human nature with trivial consequences. When you fail to ignore sunk costs in your decisions about hoases and investments, the price you pay can be significant When oasi- nesses fail to ignore thorn it affects dreir bottom line and, in extreme cases. can send thorn l g ...
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