Peter Hollings wrote: > Whether or not costs are “sunk,” meaning irrelevant, depends on the nature > of the decision being made. For example, if a landlord owns an apartment > building, it does not matter what it cost him to construct it: he should > maximize marginal revenues less marginal costs. The market dictates the > price he can rent it at. His construction costs may determine what he would > like to rent it at, but they are sunk once he has built it. However, if he > is deciding whether to build an apartment building, i.e., making a long-term > investment decision, not a short-term pricing decision, the costs of > construction are certainly not sunk, they are quite relevant.
While I'm checking my e-mail, I might as well contradict myself. Though I agree with Peter (and with orthodox micro) on the issue of sunk costs, it's possible that the treatment of sunk costs by accountants may affect the behavior of a business. Ideally, a company would increase output as long as MR > MC in order to maximize profits. But it may be that the role of sunk costs in the accounting could make the company _appear_ to be unprofitable, which would affect the price of its stock shares, which in turn would affect the behavior of the CEO, who prefers higher stock prices. That's one example I could think of. By the way, in the preliminary edition of Goodwin, Nelson, Ackerman, and Weisskopf's MICROECONOMICS IN CONTEXT (ch. 5, pp. 17-19), they tried to see a clear role for sunk costs in determining business behavior: their solution is (1) that even though they shouldn't care about sunk costs, real-world people do care about such (because of information-processing problems); and (2) the external costs of ignoring sunk costs. The first point seems valid (and fits with my accounting example above), though neoclassical economics is trying to talk about what's rational from a business perspective (actual profit maximization) rather than what businesses actually do; neoclassicals see the former as a center of gravitation for the latter, with competition driving firms toward that center. The absence of competition would allow persistence of irrationality of this sort. The second is valid, but profit-seeking businesses don't care about external costs unless they're constrained by government regulations or care about their PR images. Even then, it's not the external costs that count as much as the regulations and images. Are the benefits of dumping toxic wastes on the community greater than the expected costs of the hit to the company's PR image and the fines imposed by the government? If so, profit-maximization says that those wastes should be dumped, even it lots of people die. To understand capitalist behavior, ask the question: what would a sociopath do? (WWSD?) -- Jim Devine / "laugh if you want to / really is kinda funny / cause the world is a car / and you're the crash test dummy" -- Devil Makes Three. _______________________________________________ pen-l mailing list [email protected] https://lists.csuchico.edu/mailman/listinfo/pen-l
