What defines sunk costs?

Sunk costs are defined as costs that have already been incurred and cannot be recovered. This concept is essential in decision-making as it emphasizes the importance of disregarding these costs when evaluating future expenditures or projects. Since sunk costs are past expenses, they should not influence current or future decisions. Decision-makers should focus only on relevant costs, which impact future cash flows and outcomes.

Understanding sunk costs helps prevent the "sunk cost fallacy," where individuals continue to invest in a project due to the amount already spent, rather than considering the future benefits and costs. By recognizing that these costs are irretrievable, decision-makers can make more rational and objective choices based on the prospective value of their options instead of being swayed by past expenditures.