hey Internet this is Jacob Clifford and welcome to my youtube channel this week the US automaker General Motors said they're gonna close five of their factories in the US and Canada and lay off more than 14,000 employees and everyone freaked out in this video I'm going to talk about what goes into a firm's decision to close down and more importantly give you some strategies that will make you a better decision maker let's start off with a pop quiz assume that you own a toy company and you're considering developing a new set of action figures based
on famous economists you do some market research in the total revenue you expect to earn is $100,000 in the total cost is $60,000 obviously you can earn some profit so you decide to move forward with the project but after you spend $40,000 on development Yury evaluate things and you find out some things have changed you still expect to earn $100,000 but it turns out your costs are a lot higher than you expected instead of costing you $60,000 the total cost of the project is gonna be a hundred and twenty thousand dollars here's the question should
you move forward and produce the toys or should you stop production and walk away from the project seriously stop the video think about it and come up with an answer it's clear that had you known from the beginning that the total cost to be 120 thousand dollars you never would have actually started the project that's true but what do you do now now that you've already spent a whole lot of money well the forty thousand dollars that you spent is something the economists call a sunk cost you can't get it back so you have to
ignore it and just move forward to make good decisions you need to only look at future benefits and future cost so you should definitely ignore the sunk costs and move forward with a project let me explain why remember thinking like an economist means thinking on the margin looking at the additional benefits and the additional costs of your decisions the additional cost of moving forward with the project is not a hundred and twenty thousand dollars since you already spent forty thousand dollars the additional cost is only eighty thousand dollars and how much is the additional benefit
well it's the hundred thousand dollars you expect to earn in revenue and since that additional benefit is greater than the additional cost the best choice the smart choice moving forward is to continue with the project sure you're gonna lose $20,000 but that's better than the alternative think about it what happens if you stop production and produce no toys well you make a loss of $40,000 because that's the money that you already spent obviously you'd prefer to make profit but given this information you're gonna make a loss anyways so should you stop production and have a
$40,000 loss or should you keep producing and have a $20,000 loss does that make sense do you understand the idea that sunk costs need to be ignored okay new question with the same scenario you're expecting to make $100,000 on selling the toys except now when you really ate the project you find out that it's not gonna cost you a hundred and twenty thousand dollars it's gonna cost you a hundred and fifty thousand dollars so you spent 40 thousand dollars and now you realize that it's actually gonna cost me a total of a hundred and fifty
thousand dollars so should you continue to produce or stop production again ignore the forty thousand dollars sunk cost and just look at the additional cost an additional benefit moving forward right the additional cost is gonna be a hundred and ten thousand dollars which is more than the additional revenue which is a hundred thousand dollars so you should definitely stop production it would be better to lose forty thousand dollars rather than lose fifty thousand dollars it's this second example that you really need to understand remember and apply many people they won't ignore that forty thousand dollar
sunk cost most people will continue to produce because they think you know what I already spent forty thousand dollars I'm I'll just keep going forward this economically irrational behavior happens more often than you might think and it's something you got to watch out for for example let's say you go buy some stock in a company and for valid reasons the value quickly decreases and you lose $2,000 so you're all upset and no one likes losing money and your first reaction might be to keep the stock and just hope that it goes up in the future
but that doesn't make any economic sense me should choose whatever option is the best moving forward but even people that understand the idea of sunk cost still don't do that they hold on the stock or sometimes they sell the stock but they adopt a more aggressive and risky investment strategy they start thinking oh man I lost that money I gotta get that money back but they can't get it back it's a sunk cost you gotta think like an economist if you don't you might end up making worse in the future think of Google glasses with
a Concord or the Microsoft Zune I mean probably never even heard of that and there's a reason for each of these examples these companies had to say you know what enough is enough let's just move forward don't worry about all that money that we spent in the past but don't think this concept only applies to money in business it also applies to other things like dating imagine you were dating someone for a year and although it was fun in the beginning they're starting to annoy you I mean do you say well we've got to stay
together I already invested a year in this relationship no right that time that money all that energy you spend the relationship is a sunk cost you have to ignore them and move forward let's go back and talk about General Motors closing those car factories now for the most part I try to keep politics out of my videos because my goal is to help you appreciate and understand economics not fan the flames of division but in this case I've got to say something because both the left and the right are just nuts I watched a lot
of news on this and most the time the news was completely missing the mark they weren't explaining what's going on and why it's happening but there's one guy in the news this GM executive out of Canada that explained it best we have about 75 plants around the world but we have far too many plants for the amount of demand in the marketplace if there is a surge in demand for electric vehicles then perhaps there's going to be a need for more production but you don't produce things unless there's a market demand for the products it's
heartbreaking to see all these people losing their jobs but who is to blame say it with me consumers people just don't want GM cars and if they do want a GM vehicle it's a truck an SUV a crossover an electric car and these factories aren't designed to produce those they're designed to produce sedans which are cars that no one really wants right now and those factories were losing money for years the decision to close them down was painful but who have been a whole lot worse if they continue to produce made a loss and eventually
went bankrupt I mean then all the factories would closed now I don't want to open up a big debate about GM that's not the point the point is losses they're inevitable you just can't expect to win every single time so when you do lose don't double down and make things worse you have to ignore your sunk costs and move forward I mean that's what GM did and someday that's what you have to do because that it's thinking like an economist now if you're enrolled in a microeconomics class there's a lot you still have to learn
about shutting down and this idea of cost curves and seeing it on the graph so make sure to watch the next video that talks about the shutdown rule and if you're just watching this video because you like economics and want to learn more then awesome thank you so much for watching please subscribe also let me know in the comments if you like this video and what other concepts you want me to help you understand okay thanks for watching until next time
