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The company that you manage has invested $5 million in developing a new product, but the development is not quite finished. At a recent meeting, your salespeople report that the introduction of competing products has reduced the expected sales of your new product to $3 million. If it would cost $1 million to finish development and make the product, should you go ahead and do so? What is the most that you should pay to complete development?

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Principles of Macroeconomics (Mind...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781305971509

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Section
BuyFindarrow_forward

Principles of Macroeconomics (Mind...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781305971509
Chapter 1, Problem 5PA
Textbook Problem
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The company that you manage has invested $5 million in developing a new product, but the development is not quite finished. At a recent meeting, your salespeople report that the introduction of competing products has reduced the expected sales of your new product to $3 million. If it would cost $1 million to finish development and make the product, should you go ahead and do so? What is the most that you should pay to complete development?

To determine
Applying the concept: Rational people think at the margin.

Explanation of Solution

For example, suppose you are considering total cost as $5 million and total revenue as $3 million. Then cost is greater than benefit and there is a loss of $ 3 million (36) which implies that you should not have started it. But this conclusion is wrong. It is because, what one needs now is to consider reducing the loss. So the sunk cost of $5 million should no longer be under consideration. A person should consider the chance to earn profits at the margin

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