Define Opportunity Cost
the opportunity cost of an action is what you give up (forgone profit) to pursue it.
- Costs imply decision-making rules and vice-versa
- The goal is to make decisions that increase profit
- If the profit of an action is greater than the alternative, pursue it.
What do you consider WRT Costs and Benefits
In computing costs and benefits, consider
- all costs and benefits that vary with the consequences of a decision
- and only those costs and benefits that vary with the consequences of the decision.
These are the relevant costs and benefits of a decision.
Define Fixed and Variable Costs
Fixed costs do not vary with the amount of output.
Variable costs change as output changes.
Decisions that change output will change only variable costs.
What is the “fixed cost” or “sunk cost” fallacy
The fixed-cost fallacy or sunk-cost fallacy means that you consider irrelevant costs. A common fixed-cost fallacy is to let overhead or depreciation costs influence short-run decisions.
What is the hidden cost fallacy
The hidden-cost fallacy occurs when you ignore relevant costs. A common hidden-cost fallacy is to ignore the opportunity cost of capital when making investment or shutdown decisions.
Identifying Costs
“What decision am I trying to make?”
- If you start with costs, you will always get confused
- If you start with a decision, you will never get confused
Define EVA
Economic Value Added
- EVA®= net operating profit after taxes minus the cost of capital times the amount of capital utilized
- Makes visible the hidden cost of capital
- The major benefit of EVA is identifying costs.
If you cannot measure something, you cannot control it.
Define the Endowment Effect
the endowment effect means that taking ownership of item causes owner to increase value she places on the item.
Define Loss Aversion
Define Confirmation Bias
confirmation bias – a tendency to gather information that confirms your prior beliefs, and to ignore information that contradicts them.
Define Anchoring Bias
anchoring bias – relates the effects of how information is presented or “framed”
Define Overconfidence Bias
overconfidence bias – the tendency to place too much confidence in the accuracy of your analysis
