Give an example of sunk cost and explain the relevance of these costs in decision making.?

Answer 1

It usually applies to ongoing concerns and investment returns. Let's say you have a widget producer with one widget producing machine that cost you $1000 last year.
You are trying to see if you should buy a thingamajig that paints the widgets yellow, fetching $2 more per widget. You want to know if this is a good investment. In your evaluation of the investment, do you include the cost of the widget machine?
No. why? Because it is a "sunk cost". It is called a "sunk cost", because you "sunk" it into your widget factory last year. If you stop producing widgets, you loose that investment, so its cost is not relevant to the analysis of the purchase of the thingamajig today.

Answer 2

Sunk cost was explained to me in econ. class using an old car as an example. Say you have an old beater of a car and the brakes go out. The brakes cost $300 to fix, and you decide to pay this amount rather than buying another car because your car is worth $1300. However, two weeks after you pay for the brake job your transmission kicks it too, and we all know a transmission costs more like $1500 to fix. Keeping this in mind you decide to scrap the car completely and just buy a new one. That $300 is your sunk cost because you cannot get it back. It might not have aided you or been worth the fix, but the service has already been completed and the money exchanged. Therefore, you might say that sunk costs are not really relevant in decision making because the money has already been spent and since they cannot be changed they do not have any influence on the current or future choices. Hope this helps!

Answer 3

Sunk costs are not relevant in decision making once they have been incurred. What matters is the marginal cost of a decision, or the change in , extra, additional costs that may come about.