Types of CostSunk Costs and Ordinary Costs1. Sunk CostsExamplesImplicationSunk costs in HollywoodBut…The value of quitting2. Ordinary CostsSlide 10Application:Consider:If no second hand market:Implication:Variable and Fixed Costs3. Variable Costs (VC)4. Fixed Costs (FC)SummaryTypes of CostSunk, ordinary, variable and fixed costs.Sunk Costs and Ordinary CostsDifferent types of cost.1. Sunk Costs•Actions involving sacrifices that have no salvageable option•Costs that cannot be recoveredExamples-Rental payments-Advertising -Tickets-Movie-Concert -GameImplicationSunk costs should be irrelevant to decision makingSunk costs in HollywoodBut…•We often have an emotional problem with ignoring sunk costs… ignoring the past•Even though we should, we don’t know how to quit!The value of quittingJustin Humphries:“When you’re 25, playing in independent ball, making less than $2,000 a month. Living off your parents because you can’t financially sustain yourself like that. At some point you have to say to look…with no degree… you have to tell yourself, ‘I can’t do this to myself. I can’t do this to my parents. And I can’t continue …when I know that there’s untapped potential to do other things.”2. Ordinary Costs•Costs that are not sunkAny good that can be sold on a second hand marketExamples-Cars-Books-Houses-Clothes…-Music?Application:From a gamespot.com member:“While the general perception of piracy is that it is morally wrong, a lot of people perceive buying used games as perfectly reasonable. I shall not question the morality behind it, and I certainly know that buying used game is legal. However the end result is the same: developers and publishers don't get a cent out of either piracy or used games.”Consider:Willingness to pay reflects a stream of benefits. If one expects to have good for k months:MV = benefits (month 1) + benefits (month 2) + benefits (month 3) + … + benefits (month k) + resale value ordinary costIf no second hand market:Then resale value = 0Thus:MV’ = benefits (month 1) + benefits (month 2) + benefits (month 3) + … + benefits (month k)< MVWillingness to pay is reducedImplication:•Existence of second hand market likely serves to increase price of new goods because it increases a good’s resale value•Developers and publishers benefit by sales of used games in the form of higher prices for new goodsVariable and Fixed CostsCosts that relate to production.3. Variable Costs (VC)•Costs that change as output changes• Labor• Materials• Electricity4. Fixed Costs (FC) •Costs that don’t change as output changes•“Lump sum” costs• Factories• Warehouses• Machinery• AdvertisementsSummary•Some of our sacrifices cannot be recovered (sunk costs)•If we can’t recover our costs, then they shouldn’t impact our
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