Consider the following statement from a wheat farmer to his workers: \"The price
ID: 1201507 • Letter: C
Question
Consider the following statement from a wheat farmer to his workers: "The price of wheat is very low this year, and the most I can get for the crop is $35,000. If I paid you the same amount as I paid you last year ($30,000) I would lose money because I also have to worry about the $20,000 I paid for seed and fertilizer three months ago. I would be crazy to pay $50,000 to harvest a crop I can sell only for $35,000. If you are willing to work for half as much as last year ($15,000), my total cost will be $35,000, so I will break even. If you do not take a pay cut, I won't harvest the wheat."
Is the farmer bluffing, or will the farm workers really lose their jobs if they reject the proposed pay cut ? Please give an explanation.
Explanation / Answer
The farmer is bluffing. The revenue from the wheat will still cover the farmer’s variable cost (hiring the workers). The $20,000 is a fixed (and sunk) cost, and thus cannot be recovered. The farmer will lose less by paying his workers the usual amount (loss of $15,000) than he would be not harvesting the crop (loss of $20,000).