Question

In: Economics

a) Define and compare the following types of cost: i. Sunk cost versus incremental cost ii....

a) Define and compare the following types of cost:

i. Sunk cost versus incremental cost

ii. Fixed cost versus variable cost

iii. Incremental cost versus marginal cost

iv. Opportunity cost versus out-of-pocket cost

b) Point out which costs in the preceding question are considered “relevant” and which are considered “irrelevant” to a business decision. Explain why.

Solutions

Expert Solution

1. Sunk cost versus incremental cost = Sunk costs are previous irrevesersible expenditure. It is incurred in past and is irrelevant in current business decisions. Whereas incremental cost change with business decisions. It is the additional cost incurred in adding a new product, machinery or allocating resource in the business.

2. Fixed cost is the cost spend on fixed inputs and it is independent of the output, It is constant and irrelevant. VAriable cost is the cost that increases with increase in the use of input as well as changes with the level of output. It is relevant.

3. Incremental cost change with business decisions. It is the additional cost incurred in adding a new product, machinery or allocating resource in the business. It can involve multiple units of output. Marginal cost is the change in total cost per unit change in total output. It is the additional cost incurred on adding 1 unit of output. Both are relevant.

4. opportunity cost is the cost of next best alternative that has been forgone. It is relevant. Out of pocket cost means immediate present or future cash expenditure regarding a certain decision. It is also relevant.


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