Rationality and opportunity cost.

Rationality and opportunity cost.

Ford Motor Co has just fired their longtime CEO Mark Fields and replaced him with James Hackett. Mr. Hackett now considers two strategies: he can (1) continue making 5 sedans and 5 trucks a year at the cost of $800 like Mark Fields did, or (2) make 7 trucks and zero sedans a year at the cost of $650.

A sedan sells at $100, a truck sells at $120.

(a) Calculate the payoff of the strategy (1). Use the formula

Payoff = benefit – direct_cost

(b) Calculate the payoff of the strategy (2)

(c) Calculate the full economic cost of switching to strategy (2). Use the formula Full_econ_cost = direct_cost + payoff_of_best_alternative


(d) Perform cost-benefit analysis of strategy (2) to determine if it is rational to switch to producing trucks only. Remember that it is rational to take the action if its benefit outweighs its full economic cost.

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