Logical Reasoning

PT103 · S1 · Q23 Construction contractors working

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Construction contractors working on the cutting edge of technology nearly always work on a “cost-plus” basis only.

Given that ...

Method 1 (contractor gets paid a fixed % of costs) would lead to higher profits for the contractor the higher the costs, whereas Method 2 (contractors gets paid fixed amount on top of costs) would not.

Why is it that ...

It's more likely that final costs exceed initial estimates with Method 2 more than with Method 1.

Evaluate

Since % of costs gives contractors an incentive to add more costs, we would think that they might initially estimate a job would cost $2000 (and their 20% fee would be $400), but then later they'd tell the client, .

But instead, it's more likely that a contractor who is going to be paid $500 on top of costs, whatever the costs, will initially estimate $2000 and later tell the client the costs will be more like $3000.

Goal

We need some difference between these two types of payment plans (what sort of jobs they're used on / what sort of people use them / what sort of clients agree to them) that allows us to explain why the final cost is higher than the estimate more often for the fixed-amount method, than for the fixed-percentage method.

23.

Which one of the following, if true, most helps to resolve the apparent paradox in the situation described above?

  1. Clients are much less likely

    Deepens Paradox

    The idea of "certain conditions under which a project will be scuttled" is saying, "If X occurs, we'll just call the whole thing off". Let's say someone wants to rebuild their closets, but they tell the contractor, "I have a $2000 budget for this. If the job starts to cost more than that, then I will just cancel the whole project." That would prevent cost overruns from occurring, because the job just gets scuttled rather than completed at the higher cost. For our purposes, we would want to know that this trait that would prevent cost overruns from occurring is more often associated with the fixed-percentage method, since that is the method that less often has cost overruns. But this answer is saying it's more often associated with the fixed-profit method. So this goes the opposite way of what we want.

    5% picked this

  2. On long-term contracts, cost projections

    No Distinction

    This emphasizes long-term (vs. short-term) contracts, but we have no reason to think that long-term contracts are more often associated with one payment method vs. the other. Thus, this answer will provide us with no distinction between fixed-% and fixed-profit methods of payment. If it doesn't provide us with a distinction, then it can't do the work of explaining the difference in why one method is more likely than the other to have cost overruns.

    7% picked this

  3. On any sizable construction project,

    No Distinction

    This emphasizes sizable projects (vs. smaller projects), but we have no reason to think that sizable projects are more often associated with one payment method vs. the other. Thus, this answer will provide us with no distinction between fixed-% and fixed-profit methods of payment. If it doesn't provide us with a distinction, then it can't do the work of explaining the difference in why one method is more likely than the other to have cost overruns.

    6% picked this

  4. Correct

    Clients billed under a cost-plus

    Why this is right

    This provides a clear distinction between the two methods. With fixed-% (where profit varies with cost), clients can review individual billings to uncover wasteful expenditures. With fixed-profit (profit does not vary with cost), clients do not get to review individual billings to uncover wasteful expenditures. We would think that if clients can review individual billings to uncover wasteful expenditures, they will have more power to notice and thwart cost overruns. So we would think that with fixed-% contracts, they will have more power to notice and thwart cost overruns. Thus, cost overruns would be more likely with fixed-profit contracts.

    Skill tested: Paradox · how this choice captures the argument's function is the move to repeat next time.

    44% picked this

  5. The practice of submitting deliberately

    Deepens Paradox

    This goes the opposite direction of what we want. With fixed-profit, the contractor deliberately exaggerates the cost estimate (they say it will cost more than it will actually end up costing). That means that the final costs are actually lower than the estimated costs, so there are not going to be cost overruns. Thus, this is showing why fixed-profit would be associated with fewer cost-overruns, but the paradox is that fixed-profit is associated with more cost-overruns.

    38% picked this

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