Sunk Costs

Economics, Strategy

August 17, 2007

Sunk costs are a concept from economics that applies directly to poker. A “sunk” cost is a cost that has already been paid, and that you can’t get back. For example, if you ran a restaurant, your city licensing for the year is a sunk cost. Even if you stopped running the restaurant, you couldn’t get that money back.

The key economic idea related to sunk costs is that they shouldn’t affect future decisions. To continue the restaurant example, suppose you were losing money on the venture and have to decide whether to continuing operating or close up shop. Factors you would consider when making this decision include how much money you’re losing, how likely you think it is that business will improve, how much capital you have on hand, etc. But it would not matter what you paid for your restaurant license. It could be $1 or $1 million and it wouldn’t affect your decision one bit. This sort of thinking is counterintuitive to a lot of people, because it’s natural to value things you paid a lot for more than things you got cheaply. But of course you should pass on an opportunity to lose money, even one acquired at great cost.

Another key aspect of sunk costs is that it often becomes obvious in hindsight that paying a sunk cost was a mistake. With the benefit of hindsight, you would never have opened that money-losing restaurant in the first place. The fact that you made a previous mistake, however, should not influence current thinking. Determining the best future course of action is an independent problem. That said, often times sunk costs are recurring, and it may well be the case that you shouldn’t pay the cost again if the situation arises again.

What does this have to do with poker? Everything, it turns out. In particular, past bets in a hand are always sunk costs. You cannot undo them, and the amount of money you’ve already put into a hand should not by itself influence whether you continue. What matters the the current and future wagers available to you, the odds of winning them, and the payout you get if you win.

Poker, however, has an additional twist that makes it more complicated than a standard sunk costs problem. In particular, money from past wagers affects the payout on future wagers.  So in some sense, the past activity does influence future activity.  But the key concept is that all this thinking is about the present and future situation.  it doesn’t really matter if the money in the pot came from players betting, or a house promotion, or you somehow managed to put in all the money yourself.  It’s just money available to win.  it doesn’t belong to you any more, and your decisions need to be based solely on the likelihood that you’ll be able to get that money in the future.

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