Business Administration Essay on Sunk Costs

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Definition of Sunk Costs

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If a company spends money, that money is reflected as a sunk cost. Irrespective of what money is spent on, sunk costs are amounts of money already spent and forever lost. Sunk costs cannot be reimbursed. In economics, a sunk cost is a cost that has already been acquired and cannot be recovered.

Examples of sunk costs

Let us say construction company Wilson & sons has begun the enlargement of a new housing sub-division. The first construction materials have been procured, and mounting has initiated. A total of $ 400 million has been put in. Abruptly, a disaster in the banking industry causes depression, and then the bottom falls out of the housing market. The sub-division land is now worth much less than the construction company paid for it. If the company leaves the project, it will take a $ 400 million loss. If the company directors want to finish the houses and sell them to recover at least a share of the costs already spent - sunk costs. But it will cost an extra $ 600 million to finish the venture. Some directors might say that they have used $ 400 million and so they should as well complete the venture. Other directors might say that it doesn't matter that they already spent $400 million since that's a sunk cost.

They need to agree if spending on a housing expansion is a sound choice, given the present housing and banking atmosphere. Making the judgment without bearing in mind the sunk costs will cause the directors to abandon the venture and limit their losses to $400 million. The extra $600 million can be used for another venture better suited to the present business atmosphere. In this case the marginal cost will exceed the marginal benefits since they will lose more money trying to finish the venture.

Characteristics of private and public goods

Private good, a product or service produced by a privately owned business. Examples of private goods include food, clothing, and an ice cream cone. The owner does not have to allow anyone else to use the product or service. Private goods are bought to rise the usefulness, or gratification, of the consumer. Their prices are determined to some degree by the market forces of supply and demand. Private goods are rival and excludable. Pure private goods are both excludable and rivalrous, where excludability means that manufacturers can stop some people from using the good or service based on their ability or willingness to pay and rivalrous indicates that one person's consumption of a product reduces the amount available for consumption by another.

The lack of excludability and competition introduces market disappointments that ensure that some goods and services cannot be well delivered to the markets. Excludable is a good for which it is possible to prevent consumers who have not paid for it from having access to it. Rivalrous is a good whose consumption by one consumer prevents simultaneous consumption by other consumers. The owners or sellers of private goods exercise private property rights over them. A consumer generally has to pay for a private good. Generally, the market will efficiently allocate resources for the production of private goods.

Public Goods, such as streetlights, clean air, public fireworks, defense, have non-excludable and non-rivalry characteristics. Non-rival means that my consumption does not affect your consumption of a good; I do not consume it up. Non-excludable means that I cannot stop you from consuming a good. Another way of accepting this concept is saying that adding an extra person to the public goods market has a marginal cost of $0. In other words, even those who do not actually pay for the good can benefit from the good. In a private market economy, such goods lead to a free-rider problem, in which consumers enjoy the benefits of the good or service without paying for it. These goods are thus unbeneficial and wasteful to produce in a private market and must be provided by the government.

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