Thugs of Hindostan, Sunk Cost and Behavioral Economics/ Finance

Much anticipated Hindi movie “Thugs of Hindostan” has released today across the world. Based on Philip Meadows Taylor’s 1839 novel Confessions of a Thug, the movie tells us about a thug named Ameer Ali and his gang, whose nefarious ways posed a serious challenge to the British Empire in India between 1790 and 1805.

The movie had created tremendous buzz because of the people associated with it. Aamir Khan – one of the three Khans (Aami, Salman and Shah Rukh) – and one of India’s most talented star actors is working for the first time with India’s most famous film star (the Star of the Millenium) – Amitabh Bachchan. Amitabh had worked with the other two Khans long back, and several times. But in the 30 years that Amir Khan has been in the film industry (50 for Amitabh) they never worked together. This was enough to create the sensation! Plus, the movie is produced by Yash Raj Films – undoubtedly the biggest production house in India. The movie also stars ravishing Katrina Kaif!

So I was curious to see first reviews by critics and movie fans.

And surprisingly, the movie has been thrashed royally by the critics as well as movie fans! Very harsh words used…here are few examples:

Another reason I was curious to see the reviews was – I have already booked tickets for this movie – the night show – along with couple of my friends. And the worse still…I insisted that we must watch the movie on the first day 😦

This brings me to the second half of this blog post i.e. concept of Sunk Cost and my tryst with behavioral economics/ finance.

For the uninitiated, Sunk Cost is one of the most important concepts in Economics.

A sunk cost is a cost that has already been incurred and cannot be recovered. The concept states that your business decisions should not be based on sunk cost (or retrospective costs). A typical example given is as follows:

You have booked tickets in advance for a movie which you are going to watch, let’s say tomorrow. You hear reviews of the movie and they are terrible. It is one of the worst movies ever made and the experience is sheer torture! Should you still go and watch the movie, just because you have purchased tickets?

The rational decision-making asserts that your future decision should not be based on the sunk cost. i.e. if you know the movie is a disaster, you should not subject you to the torture. The decision should be based on “what is the alternative for the time you would waste watching movie?”.

By now you must have realized that it is the exact predicament I am subjected to. I have booked tickets of the night show and now I know that the movie is a disaster. So ideally I should skip the movie and do something else. Because I am not going to get back the money spent on tickets; and anything that I do would be a better option than sitting through 3 hrs of torture.

And yet, I am going to go and watch the movie. Why is it so difficult for me to take the rational decision, in spite of knowing the concept?

That leads us to the last part of this article i.e. my encounter with behavioral economics/ finance.

Since the time when Adam Smith published in 1776 his book “The Wealth of Nations”, the field of Economics had advanced a lot! However, there was a basic assumption in all economic theories – that the man is a rational animal.

This foundation itself was found to be questionable by the turn of second half of the 20th century.

It was found and proven via many psychological, cognitive, cultural, and social experiments that man is not a (perfectly) rational animal. Man works in what they call as bounded rationality i.e. the idea that when individuals make decisions, their rationality is limited by the tractability of the decision problem, their cognitive limitations and the time available.

So that explains why I am still going to watch Thugs of Hindostan! I am not a rational animal…I am just a victim of Bounded Rationality.

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