These two ideas… well, they’re English words, but their meaning isn’t really the English we’re used to. And that’s what makes them hard.
We define them in certain ways; sunk cost is any kind of cost that affects the entire decision tree (not just a specific branch) with equal magnitude. In other words, any cost that makes every branch of the tree lower by the same amount is a sunk cost. The fizzie example in class was good -- we’ll cover this in person as well.
A fixed cost is generally used for cost allocation; it’s constant, regardless of the amount produced. An example of fixed cost is an ATM fee; the bank charges $4 no matter if you take out $50 or $500.
The point of these costs… the big picture idea is that the decision tree has to be written correctly, and fixed costs / sunk costs are a way to classify costs to help us do that. Many people get caught up in whether costs are sunk / fixed… although that can be useful to do, the main point is to be able to correctly map out a decision tree. As long as we can do that, we’ll be ok.
^_^
Thursday, February 12, 2009
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Is variable cost = marginal cost?
ReplyDeleteThis comment has been removed by the author.
ReplyDeleteTo be exact: Is the following statement true?
ReplyDeletetotal variable cost = sum of marginal cost
variable cost per unit = marginal cost
Hi Bowen --
ReplyDeleteYou're on the right track EXCEPT... Marginal costs often change based on output produced. In other words, the marginal cost of the first unit might be 2, the MC of the second unit might be four, etc. Saying that variable cost / unit = marginal cost implies that the marginal cost is constant over every unit produced... sometimes it is (see Sven's last midterm, problem 1), but often it isn't, especially on a firm-specific scale (problem 1 in the last homework set).
But I think you've got the idea down; variable costs are the costs above and beyond the fixed costs that we pay. Total variable cost DOES equal the sum of all the marginal costs.
Hope that helps, and i hope this does NOT come up on the midterm :)
Ronjon,
ReplyDeleteYes it helps. You explained this explicitly, as always. :)
Reviewing these basics is an enjoyable thing - not merely for the midterm, but also for my interests in turning them into the real-life application. That's why I go to MBA, learning from mistakes in this safe place, not struggling for a high score. :)
Appreciate your dedication to helping us in this course! Have a nice weekend.