"Fixed costs,"
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You drive 5000 miles a year and buy gasoline at the price of $2/gal. Except for differences in annual costs, you are indifferent between driving a 10 year old Buick ($400/yr, 20 miles per gal) or a 10 year old Toyota ($800/yr, 50 miles per gal).
(a) Which one do you choose to drive?
The yearly expense on the Buick = 400 + (5000/20)*2 = 900
The yearly expense on the Toyota = 800 + (5000/50)*2 = 1000
I would choose the Buick, since it is the one with lower expenses.
(b) How does your decision change if the price of gas is $1.75 per gallon?
When gas price goes to $1.75
The yearly expense on the Buick = 400 + (5000/20)*1.75 = 837.5
The yearly expense on the Toyota = 800 + (5000/50)* 1.75 = 975
I would choose the Buick, since it is the one with lower expenses.
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Solution Summary
A discussion ensues in the case for fixed and variable costs.
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You drive 5000 miles a year and buy gasoline at the price of $2/gal. Except for differences in annual costs, you are indifferent between driving a 10 year old Buick ($400/yr, 20 miles per gal) or a 10 year old Toyota ($800/yr, 50 miles per gal).
(a) Which one do you choose to drive?
The yearly expense on the Buick = 400 + (5000/20)*2 = 900
The yearly expense on the Toyota = 800 + (5000/50)*2 = 1000
I would choose the Buick, since it is the one with lower expenses.
(b) How does your decision change if the price of ...
Purchase this Solution
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