1 Opportunity and sunk costs (4 points) (a) What is the opportunity cost of an e
ID: 1148715 • Letter: 1
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1 Opportunity and sunk costs (4 points) (a) What is the opportunity cost of an extra 8h shift at work, if your alternatives are to spend a maximum of 4h with friends at a bar (valued at 258/h), doing problem sets for a maximum of 2h (valued at 108/h), and surfing for any amount of time (valued at 158/h) [You can combine activities as you wish.]? (2) (b) You have just purchased a house for S500,000, paid $13,000 for legal fees and $41,000 for renovations. The market price of the house does not change. If the sales tax on a house were 3% (to be paid by the seller), what is the sunk cost of this purchase? (2)Explanation / Answer
(a) The opportunity cost is the next best alternative forgone in order to select another alternative. Here, the best alternatives forgotten are 4h with friends at a bar and 4h of surfing. Note that surfing for any time gives me more value/h than doing problem sets. So, I will prefer surfing over doing problem sets. So, my opportunity cost of an extra 8h shift is = value of meeting friends at bar for 4h + surfing for 4h = $25 * 4 + $15 * 4 = $100 + $60 = $160
(b) Sunk cost is the cost which has been incurred. Here, the cost of the house, the legal fees and the cost of renovations has already been paid for. So, these are sunk costs. The total sunk cost here is = $500,000 + $13,000 + $41,000 = $554,000.
Note that the sales tax which is yet to be paid is not a sunk cost.
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