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CA Foundation · Business Economics · Nature and Scope of Business Economics

A firm is considering a new product line. Which of the following uses the incremental principle correctly in deciding?

The incremental principle says to accept a decision when the additional revenue it brings exceeds the additional cost it causes. Only changes resulting from the decision matter, so total firm figures and sunk past expenditure such as earlier research spending should be ignored.

  1. AAccept it if total revenue of the firm exceeds total cost of the firm
  2. BAccept it if the addition to revenue is greater than the addition to cost caused by the decisionCorrect
  3. CAccept it if the average cost of the new line is the lowest in the industry
  4. DAccept it if past expenditure on research has been large

Explanation

The incremental principle says a decision is profitable if it raises revenue by more than it raises cost, or lowers cost by more than it reduces revenue. Total firm figures in option A include unaffected items. Option D relies on past research spending, which is a sunk cost and is irrelevant.

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