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Sunk costs are the historical costs of past decisions that cannot be reversed. Sunk costs give managers hindsight when it comes to making current decisions, but the specific costs themselves are no longer relevant. When past choices cannot be reversed – no refund is available, for example – money that has been spent is gone for good. Today’s choices must be based on the costs and benefits expected under current and future market conditions, if mistakes are to be avoided (see the accompanying Myths of Economics feature). To minimize costs, business decision makers need to realize that sunk costs are, indeed, sunk. A simple example will emphasize this point. Suppose that a firm pays $100,000 to purchase and install a roller blade- producing machine. The
machine is expected to last ten years. The company’s books record the cost of the machine as $10,000 each year under the heading of depreciation. The machine can be used only to make roller blades, though. Because dismantling and reinstallation costs are high, it cannot be leased or sold to another firm. Also, it has no scrap value. In other words, there are no alternative uses for the machine. The machine’? annual production of roller blades will generate $50,000 of revenues for the firm when it is employed with raw materials and other factors of production that cost $46,000. Thus, the net revenue generated by the machine is $4,000.
Should the firm continue to use the machine? Its depreciation figures suggest that the machine is costing the firm $10,000 annually, compared to the $4,000 net revenue it generates. Put another way, the machine is reducing the firm’s profit by $6,000 annually. The machine’s depreciation cost, however. is a sunk cost. It was incurred when the machine was purchased and installed. The current opportunity cost of the machine is therefore precisely zero. In other words, the firm is not giving up anything by continuing to use it today. Since using the machine generates $4,000 of additional net revenue, the firm can gain by continuing to use it. Of course, if market conditions are not expected to improve, the firm will not purchase a similar machine or replace the machine when it wears out, but this should not influence its decision whether to continue operating the one it already has. The irrelevance of sunk costs helps explain why it often makes sense to continue using older equipment (it has a low opportunity cost), even if it would not be wise to purchase similar equipment again.

Many investors start with less than $10,000 in their trading accounts. How- ever, it is important to realize that the less you have in your account, the more cautious you have to be. Perhaps the toughest problem is to establish a sufficient capital base to invest effectively. If you begin investing or trading with very little capital, you will assure yourself of failure. Making money in the markets requires a learning curve, and incurring loss is part of the trading process. When it comes to trading, “you have to pay to play.” You don’t need to be a millionaire, but trading does require a certain amount of capital to get started. In many cases, the brokerage firm you choose will determine how much is required to put you in the game. How- ever, no matter how much you begin with, it is a good idea to start out by trading conservatively. If you invest smartly, you can make very good returns and your financial goals will be realized.