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Homework answers / question archive / Andrew has decided to open an online store that sells home and garden products
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 its product required the least amount of specialized investements for him to use it. They agreed upon a price of $3,000.00. To use Initech's software, Andrew makes $1,000.00 in sunk capital investments and spends 40 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 $25 per hour, and Initech is fully aware of the investments Andrew must make to use its product. After Andrew's investments were made, Initech came to Andrew and asked for more money. How much do you think it asked for?
Answer: $5,000
Andrew's total sunk cost is $1,000+$25*40=$2,000. Thus, Initech knows Andrew must spend that much again in sunk costs if he wants to switch software. Therefore they know he would be willing to pay up to $5,000 for Initech. At such a price Andrew is indifferent to keeping Initech or switching software.
