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September 20, 2007

Sunk Costs Fallacy
Posted by Ilan Goldenberg

Via AJ at Americablog. A great piece on the irrationality of this war.

Economics professors have a standard game they use to demonstrate how apparently rational decisions can create a disastrous result. They call it a "dollar auction." The rules are simple. The professor offers a dollar for sale to the highest bidder, with only one wrinkle: the second-highest bidder has to pay up on their losing bid as well. Several students almost always get sucked in. The first bids a penny, looking to make 99 cents. The second bids 2 cents, the third 3 cents, and so on, each feeling they have a chance at something good on the cheap. The early stages are fun, and the bidders wonder what possessed the professor to be willing to lose some money.

The problem surfaces when the bidders get up close to a dollar. After 99 cents the last vestige of profitability disappears, but the bidding continues between the two highest players. They now realize that they stand to lose no matter what, but that they can still buffer their losses by winning the dollar. They just have to outlast the other player. Following this strategy, the two hapless students usually run the bid up several dollars, turning the apparent shot at easy money into a ghastly battle of spiraling disaster.

Theoretically, there is no stable outcome once the dynamic gets going. The only clear limit is the exhaustion of one of the player's total funds. In the classroom, the auction generally ends with the grudging decision of one player to "irrationally" accept the larger loss and get out of the terrible spiral. Economists call the dollar auction pattern an irrational escalation of commitment. We might also call it the war in Iraq.

America is long past the possibility of some kind of profitable outcome in Iraq. Neo-con dreams of a quick, cheap victory, delivering democracy and peace and self-financed from Iraq's own oil revenue, got us started on this misadventure. Like the students, the early bidding seemed like a fun adventure to the boys in the Bush administration. "Bring 'em on," the chief boy said about the other bidders. And like the economics class, suddenly we were in the thing up to our necks, with only bad choices available at an ever-escalating cost.

We can cut our losses now and take our lumps, or we can keep throwing good money after bad until maybe we wear the other side out, but in the process raising our own ultimate losses substantially. And in Iraq, the losses are already desperately high, on both sides, in blood, in money, and in the erosion of institutions like law and national cohesion.


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The problem with this example is where the ninety-nine cent point lies. Until we have a better way sense of how much would be lost by both the Iraqi's and ourselves if we left, we won't know when our sunk costs will exceed our possible benefits.

Oh, and comparing Bush and his coterie to freshmen in college probably isn't furthering the discussion (even if he did do poorly in economics as a freshmen in college).

Chris, the American people have clearly reached a consensus that we're over a dollar right now. Since the American people are the ones that have to pay the bids, the course seems clear.

My friends taught me that game - or something very similar - but they called it poker.

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