Thursday, December 9, 2010

Sunk cost

Just because you have something, doesnt mean you have to use it even if it decreases productivity.

It is a common trap humans tend to fall into. 

The question is, given r0 resources and utility function f(x) [measures the amount of benefit you derive from x resources], what is utility that can be derived? The key point to note is that f(x) is NOT always increasing.. which means, the answer is not f(r0) but the maximum of all f(x) where x <= r and then find the maximum. It is likely that this is achieved at r1 < r0. This would especially be true when there are say N resources x1,x2,x3...xN. These could refer to internet, phone, number of chairs, food, lights, furniture whatever. And in this case, the utility function would be f(x1,x2,x3...xN). And f(r0,a2,a3...aN) is not necessarily > f(r1,a2,x3..xN) (where x2, x3 etc are kept constant at a2 a3 unless they vary with x0) if r0 > r1. So we get the feeling that r1-r0 is "wasted". But no! We care about f not x, ie. the output is more important than the input. If you are getting more out of less, we should use less, even if more is available. Even if we paid for the more. The cost of r0 is a "Sunk cost" and it should have no part to play in how the resources are utilized.


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