Thursday, December 13, 2007

Shut Down and Sunk Costs


In the notes for Class 11, it says that the "check shut down" test for short term is TR < TVC, only if all fixed costs are assumed to be sunk in short run. So if any of the fixed costs are not sunk in short run, how do we treat them? Should we assume we sell them off first, before doing the check shut down?


Again, I don't think you have to worry about this, but if a fixed cost is not sunk in the short run, then you can think about explicit tradeoff that you are making:
If you choose not to produce, you lose the SUNK costs
If you choose to produce, you get some revenue and you pay the SUNK costs, the other FIXED costs and the VARIABLE costs. The only difference is that this doesn't simplify into a pretty little condition, but you take the choice that gives you more profit (or less loss).

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