Suppose a builder constructs a house that he hopes to sell to a prospective future buyer before he finishes building it.After spending six months and $300,000 in acquiring the land and constructing the house,market conditions change and the builder fails to find a buyer willing to pay his asking price of $360,000.The builder further realizes that by investing $300,000 in a bank deposit he would have been able to earn $4,500 as interest.Which of the following is the economically efficient way for the builder to view his investment?
A)The $300,000 is a sunk cost and should be ignored when negotiating a price for the home.
B)The $300,000 is the builder's opportunity cost and he should not accept any offer below that.
C)He should advertise more heavily in an attempt to sell the home for at least $300,000.
D)He should raise the price even further to better reflect the additional opportunity costs of his time and capital expenditures.

Question

Quizplus · Accepted Answer

The $300,000 spent on acquiring the land and constructing the house is a sunk cost, meaning that it has already been incurred and cannot be recovered. Therefore, it should be ignored when negotiating a price for the home. Instead, the builder should focus on the current market value of the house and the potential future costs and benefits of holding onto it. Option B is incorrect because the opportunity cost of the investment (i.e. the interest that could have been earned in a bank deposit) is not relevant to the current situation. Options C and D are also incorrect as they do not take into account the current market conditions and the value of the house.

Suppose a Builder Constructs a House That He Hopes to Sell