Andrew has decided to open an online store that sells home and garden products.
ID: 1217120 • Letter: A
Question
Andrew has decided to open an online store that sells home and garden products. After searching around, he chooses the software company Initech to provide the software for his website since their product required the least amount of specialized investments for him to use it. They agreed upon price of $6,000. To use Initech’s software, Andrew makes $3,200 in sunk capital investments and spends 60 hours learning how to use Initech’s software, which is very different from other software packages. Both Andrew and Initech view Andrew’s time as worth $24 per hour and Initech is fully aware of the investments Andrew must make to use their product. After Andrew’s investments were made, Initech came to Andrew and asked for more money. How much do you think they asked for?
Explanation / Answer
Since Initech knows the investment Andrew made in terms of hours and the implicit cost of this investment, Initech must have asked for $24 x 60 = $1,440 extra, in addition to originally agreed price of $6,000. Note that Andrew's sunk cost of $3,200 cannot be recovered whether or not he purchases Initech's software, therefore Initech will not consider this sunk cost while charging an additional price.