Chapter 9: Decision Making

Explicit cost

Cost requiring monetary payment (e.g., rent, wages).

Implicit cost

Nonmonetary cost; forgone opportunities.

Opportunity cost

Sum of explicit and implicit costs.

Accounting profit

Total revenue – explicit costs.

Economic profit

Total revenue – (explicit + implicit costs).

Either-or decision rule

Choose option with positive economic profit.

Marginal analysis

Compare marginal benefit and marginal cost.

Marginal cost (MC)

Extra cost from one more unit.

Marginal benefit (MB)

Extra benefit from one more unit.

Optimal quantity

Where MB = MC.

Profit-maximizing principle

Continue until MB = MC.

Sunk cost

Cost already incurred; ignore for future decisions.

Rational decision maker

Chooses option maximizing satisfaction or profit.

Bounded rationality

“Good enough” choice due to limits in info/time.

Loss aversion

Preference to avoid losses over equal gains.

Framing bias

Decisions affected by how choices are presented.

Status quo bias

Preference for the current state.

Implicit cost of capital

Opportunity cost of using capital internally instead of elsewhere.

Q: What should a firm do if MB > MC?

Increase the activity.

Q: What’s the difference between accounting and economic profit?

Economic profit includes implicit costs.

Q: Why ignore sunk costs?

They can’t be recovered and don’t affect future outcomes.