Module7 - LearningModule7 SunkCostvs.RelevantCost

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Learning Module 7 Sunk Cost vs. Relevant Cost Interpretation of Dual Price for Sunk Cost vs. Relevant Cost Duality Economic Interpretation of the Dual Problem/Variables Learning Objectives Module 7 Understand within the context of an LPM the distinction between a sunk cost and a relevant cost Interpret the meaning of the dual price associated with a resource/constraint when the resource costs are sunk costs and when they are relevant costs Understand the concept of duality and the relationship between the primal and dual linear programming models. Given the primal of an LPM write down its dual and vice versa. Know the economic interpretation of the dual variables. Be able to convert any maximization or minimization problem into its associated canonical form. Be able to obtain the primal solution/value from the software solution output of the dual and vice versa. Sunk Costs And Relevant Costs A sunk cost is a cost that has already been incurred. It is not affected by the value of the decision variables and is not relevant to decision making. Sunk costs are not reflected in the objective function for profit or costs. A relevant cost is a cost that is not incurred until products are actually made. The total amount of a relevant cost depends on the values of the decision variables. All relevant costs should be included in calculation of the D.V. coefficients in the objective function The correct interpretation of the dual prices in the solution output depends on whether a resource represents a sunk cost or a relevant cost.
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Example 1: If one has workers on roll that must be paid regardless of how many items are produced then the cost associated with the labor hrs of those workers is a sunk cost that is not relevant to decisions or values of the decision variables Example 2: If one has raw materials that have already been contracted for each month then the cost of those raw materials would be a sunk cost because you have to pay for them regardless of what is produced . Toy Gun Production LPM Cosmos Corporation makes toy space ray guns that are marketed to national discount chain stores. Two of its primary products are the Disintegrator and the Lazer Tazer . Although both models cost the same to manufacture, the demand for the Lazer Tazer is at least 40% higher than that for the Disintegrator . The profit
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This note was uploaded on 03/06/2012 for the course BIOL 2107 taught by Professor J.louten during the Spring '10 term at SPSU.

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Module7 - LearningModule7 SunkCostvs.RelevantCost

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