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Sunk costs

In the budget constraint framework, all decisions involve what will happen next: that is, what quantities of goods will you consume, how many hours will you work, or how much will you save. These decisions do not look back to past choices. Thus, the budget constraint framework assumes that sunk costs    , which are costs that were incurred in the past and cannot be recovered, should not affect the current decision.

Consider the case of Selena, who pays $8 to see a movie, but after watching the film for 30 minutes, she knows that it is truly terrible. Should she stay and watch the rest of the movie because she paid for the ticket, or should she leave? The money she spent is a sunk cost, and unless the theater manager is feeling kindly, Selena will not get a refund. But staying in the movie still means paying an opportunity cost in time. Her choice is whether to spend the next 90 minutes suffering through a cinematic disaster or to do something—anything—else. The lesson of sunk costs is to forget about the money and time that is irretrievably gone and instead to focus on the marginal costs and benefits of current and future options.

For people and firms alike, dealing with sunk costs can be frustrating. It often means admitting an earlier error in judgment. Many firms, for example, find it hard to give up on a new product that is doing poorly because they spent so much money in creating and launching the product. But the lesson of sunk costs is to ignore them and make decisions based on what will happen in the future.

From a model with two goods to one of many goods

The budget constraint diagram containing just two goods, like most models used in this book, is not realistic. After all, in a modern economy people choose from thousands of goods. However, thinking about a model with many goods is a straightforward extension of what we discussed here. Instead of drawing just one budget constraint, showing the tradeoff between two goods, you can draw multiple budget constraints, showing the possible tradeoffs between many different pairs of goods. Or in more advanced classes in economics, you would use mathematical equations that include many possible goods and services that can be purchased, together with their quantities and prices, and show how the total spending on all goods and services is limited to the overall budget available. The graph with two goods that was presented here clearly illustrates that every choice has an opportunity cost, which is the point that does carry over to the real world.

Key concepts and summary

Economists see the real world as one of scarcity: that is, a world in which people’s desires exceed what is possible. As a result, economic behavior involves tradeoffs in which individuals, firms, and society must give up something that they desire to obtain things that they desire more. Individuals face the tradeoff of what quantities of goods and services to consume. The budget constraint, which is the frontier of the opportunity set, illustrates the range of choices available. The slope of the budget constraint is determined by the relative price of the choices. Choices beyond the budget constraint are not affordable.

Opportunity cost measures cost by what is given up in exchange. Sometimes opportunity cost can be measured in money, but it is often useful to consider time as well, or to measure it in terms of the actual resources that must be given up.

Most economic decisions and tradeoffs are not all-or-nothing. Instead, they involve marginal analysis, which means they are about decisions on the margin, involving a little more or a little less. The law of diminishing marginal utility points out that as a person receives more of something—whether it is a specific good or another resource—the additional marginal gains tend to become smaller. Because sunk costs occurred in the past and cannot be recovered, they should be disregarded in making current decisions.

Problems

Use this information to answer the following 4 questions: Marie has a weekly budget of $24, which she likes to spend on magazines and pies.

If the price of a magazine is $4 each, what is the maximum number of magazines she could buy in a week?

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If the price of a pie is $12, what is the maximum number of pies she could buy in a week?

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Draw Marie’s budget constraint with pies on the horizontal axis and magazines on the vertical axis. What is the slope of the budget constraint?

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What is Marie’s opportunity cost of purchasing a pie?

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References

Bureau of Labor Statistics, U.S. Department of Labor. 2015. “Median Weekly Earnings by Educational Attainment in 2014.” Accessed March 27, 2015. http://www.bls.gov/opub/ted/2015/median-weekly-earnings-by-education-gender-race-and-ethnicity-in-2014.htm.

Robbins, Lionel. An Essay on the Nature and Significance of Economic Science . London: Macmillan. 1932.

United States Department of Transportation. “Total Passengers on U.S Airlines and Foreign Airlines U.S. Flights Increased 1.3% in 2012 from 2011.” Accessed October 2013. http://www.rita.dot.gov/bts/press_releases/bts016_13

Questions & Answers

what is demand
Melissa Reply
demand is where the customer is willing and able to buy goods and services during a given period of time
idk
demand is the ability and willingness of an individual to buy goods and services at a given price in a particular period of time
Alpha
demand is the ability to buy a specific quantities of goods and services at a given price and at a specific period of time
rosemary
what are the rules of demand
rosemary
Rosemary Nsebon, Do you mean laws of demand?
Alpha
Suppose you have a team of two workers: one is a baker and one is a chef. Explain why the kitchen can produce more meals in a given period of time if each worker specializes in what they do best than if each worker tries to do everything from appetizer to dessert. please I need a urgent answer
Oladosu Reply
Enables individuals and countries to consume a variety of goods and services
Iddrisu
what is the meaning of competency
Oladosu Reply
competency is an ability and courage to do something perfectly
Abdullahi
ability to perform some task
Segun
rival
Ray
thanks 🙏 it is also the same with the core competency
Oladosu
A sufficient supply
Ebenezer
Ebenezer you mean the (core competency) right?
Oladosu
what is mean,median and mode
Ikeh Reply
mean is the average number of a given data
Gallant
median is the middle number of a given data
Gallant
in a given data sorry
Mitchel
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Sajib
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Physcal
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Physcal
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Adedigba
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Physcal
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Mumtaz
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Mumtaz
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Charm
Payroll and​ 4p
Wasuroj
Agriculture
Wasuroj
Export
Wasuroj
Transport
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Change management​ and​ cerrancy
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Empoyee
Wasuroj
Lawyer army and​ Lawyer​
Wasuroj
animal husbandry essay
Rakuane Reply
what's the primary location of capital and money market respectively
ALIMI
what is bank
Nyakeh Reply
A bank is an institution set up purposely for the save keeping of money and other valuables
Alpha
A bank is a financial institution which helps people to save their money
Cyprian
When a supply curve start from the origin price elasticity of supply is unitory. Provide a simple proof
Felix Reply
Oui
Bobbo
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Felix
ok
Anita
what is price
Divine Reply
the perchesing amount of something is called price
Nasir
OK pls tell me about economic elasticity of supply and demand
Mumtaz Reply
elasticity in economics is a measurement of the ratio of percentage change in quantity of a particular commodity to the percentage change in a factor that influence demand-price, consumer's income and price of another good
Epie
same with supply. How ever economics focus only on price elasticity of supply(PES)
Epie
using diagrams defferentiate between price ceiling and price floors
VIDELIS Reply
price ceiling lies below the equilibrium price and vice versa
Freeman
who is a broker
ALIMI Reply
a broker is a middle person between two other parties who makes all the arrangements required to conduct the the transaction.
rkesh
when do we apply contractiob
Emma Reply
make your statement clear
Freeman
Hi
Mumtaz
I am a student and studying BBA economic in university please help me in study of BBA
Mumtaz
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Wasuroj
Thanks
Mumtaz
what is BBA
Rosaline
Bachelor of the Business Administration
parheez
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what is comparative advantage
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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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