Two days ago you bought a used car from a former roommate for $3,000. The sale i

Question

Two days ago you bought a used car from a former roommate for $3,000. The sale is final. Today it broke down. You find that the car requires repairs of $1,200 in order to get it to run. Once it is repaired, it will definitely not break down again. Assuming that the car is worth $3,500 after it is repaired, should you get it fixed?

Explanation / Answer

Yes. In order to maximize profit (minimize loss), you must make decisions on the margin. The $3,000 originally paid for the car is what economists call a "sunk cost." As such, it is completely irrelevant to whether or not one should repair the car. $3,500>$1,200. Therefore, you should repair the car. Here's an easy way to think about this. If you don't get the car repaired, you will lose $3,000, which is the price paid for the car. If you do get the car repaired, you will still lose the original $3,000 plus the repair bill of $1,200. But you will gain a functioning car worth $3,500. So, your total loss from repairing the car is only $700. 3500-1200-3000= $700. Since you would rather lose $700 rather than $3,000, you should choose to repair the car.

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