What is meant by the term "sunk cost"?

The term "sunk cost" refers to money that has already been spent and cannot be recovered, regardless of future decisions. This concept is important in decision-making because it highlights the need to focus on potential future costs and benefits rather than past expenditures that have no bearing on current or future circumstances.

In business and economics, recognizing a sunk cost helps individuals and organizations avoid the common fallacy of allowing past investments to unduly influence future decisions. For example, if a company has spent a significant amount of money on a project that is failing, that expenditure is a sunk cost. The rational decision would involve evaluating the project's future profitability rather than trying to justify continuing it based solely on the money already invested.

Understanding sunk costs is crucial to making informed business decisions, emphasizing a forward-looking approach rather than one entangled with past financial commitments.