PACC6007 Economics For Rational Actor Paradigm Assignment

based on (Iannaccone 2016). Some important assumptions are:

1. i) All actions in the economy must be considered under individual choices
2. ii) Agents in the economy should be able to distinguish between means and ends.

iii) Economic actors take their decision to satisfy pre-set goals.

1. iv) Before taking decision actors should be well informed about possible outcome.
2. v) Preferences of human also matter while taking decision.

The interpretation of RAP is related to economic theory and establishes rationality as an important means of making efficient choice to attain some pre-designed goals.

However, there are circumstances where rational actor paradigm cannot hold. In times of collective action, people take decision above individualism. Collective action addresses selfless behavior, which is contrasting to rational choice theory. According to rational choice, theory people always take optimal decision (Jaeger et al. 2013). Sometime people take acceptable decision rather than the optimal one.  In the presence of bounded rationality, rational actor paradigm cannot hold. 

Net Present Value

Net present value analyzes the aspect of profitability while deciding on future investment project. Net present value is computed as a difference between present values of cash inflows and cash outflows of capital.

Advantages and disadvantages of net present value

The main advantage of NPV method is that it is a realistic measure of assessment of net value of invested capital (Asquith and Weiss 2016). NPV incorporates the basic idea that future capital value less than present investment. With every passing year, capital values are discounted with capital cost. Another advantage of NPV method is that cost of capital is taken into consideration and this includes risk associated with the project while making investment decision.

Sometimes there are computational difficulties in using NPV method. Calculation of NPV methods need right information about cost of capital.  However, this information is not always available. Using any assumed value for this purpose leads to inefficient decision choice. A very high value used for this purpose results in loss of some valuable investment (Bell 2017). In times o choice of low capital cost results in investment below the optimum.  Another shortcoming of this method is that it is unable to make choice between two projects having unequal size.

Break Even analysis

Break even analysis is based on evaluation of cost and profit at different level of production and business activities. Break-even point is defined as a point where price is set at minimum point of average total cost. It allows the investors to know not only about the return of investment but also gives time of realization of the return. Investors often require knowledge of break-even point before taking investment decision.

Advantages and Disadvantages of Break- even analysis

There are several advantages of break-even analysis. It provides producers an idea about the time of reaching the point of profitability. Prediction about future sales and prices can also be made using break-even analysis. The relation between variable and fixed cost in business decision become more prominent after knowing break-even point (Badiru 2016).  Knowledge about break-even point allows entrepreneurs to calculate the risk involved in business operation. This information becomes more crucial in case of start-up companies. The ease of calculation is another major advantage of the analysis.

In computing break-even points, sale prices are taken as constant for all output levels. This is not always the case in reality. The method considers no difference between sales and production. This assumption is not a realistic assumption (Anderson et al. 2015). Break-even analysis is particularly applicable in times of a single product or for a product mix. In real world most of the business firms engaged in multiple operation of selling more than one goods. Then, the analysis cannot help much. 

Sunk Cost fallacy

In production process, initial costs are generally recovered with passes of time. However, there are costs that cannot be recovered once made. These costs are known as sunk cost (Augenblick 2015). Sunk costs cannot be classified either under fixed cost or under variable. These are onetime costs incurred for production operation. For example, suppose the company purchases software. Before application of the software installation charges are given for properly installing it. The installation charge is Sunk cost that cannot be recovered.  Since, Sunk cost generates no additional gain for the company it is considered as a fallacy.

The ice cream factory has made an investment of $200k for land and $100k for machinery. These two costs come under the classification of Sunk cost. Neither the land cost nor the machinery cost can be recovered. Even when the business operation changes location, neither land nor custom machinery can be shifted. Therefore, total sunk cost for the factory is $200k+$100k = $300k. 

Optimum quantity is determined at a point where profit is maximized. In the table, profit is calculated as a difference between total revenue and total cost. From the table it is clear that profit is maximized when volume is 500000 litres. Thus, optimum quantity is 500000 litres.  

At the optimum quantity firm will make a profit of $500000. 

Reference

Anderson, D.R., Sweeney, D.J., Williams, T.A., Camm, J.D. and Cochran, J.J., 2015. An introduction to management science: quantitative approaches to decision making. Cengage learning.

Asquith, P. and Weiss, L.A., 2016. The Time Value of Money: Discounting and Net Present Values. Lessons in Corporate Finance: A Case Studies Approach to Financial Tools, Financial Policies, and Valuation, pp.287-302.

Augenblick, N., 2015. The sunk-cost fallacy in penny auctions. The Review of Economic Studies, 83(1), pp.58-86.

Badiru, A.B., 2016. Visualising the cost of quality investment using equity breakeven point. International Journal of Quality Engineering and Technology, 6(1-2), pp.40-53.

Bell, P., 2017. Introducing the Net Present Value Profile.

Hindess, B., 2014. Choice, Rationality and Social Theory (RLE Social Theory). Routledge.

Iannaccone, L.R., 2016. Rational choice. Rational choice theory and religion: summary and assessment.

Jaeger, C.C., Webler, T., Rosa, E.A. and Renn, O., 2013. Risk, uncertainty and rational action. Routledge.