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Please use this identifier to cite or link to this item: http://hdl.handle.net/2164/200

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Title: Experimental evidence of a sunk–cost paradox : a study of pricing behavior in Bertrand–Edgeworth duopoly
Authors: Buchheit, Steve
Feltovich, Nick
Keywords: oligopoly
posted prices
capacity constraints
loss avoidance
cost–based pricing
Issue Date: 16-Apr-2008
Series/Report no.: University of Aberdeen Business School
2008-04
Abstract: A well–known implication of microeconomic theory is that sunk costs should have no effect on decision making. We test this hypothesis with a human–subjects experiment. Students recruited from graduate business courses, with an average of over six years of work experience, played the role of firms in a repeated price–setting duopoly game in which both firms had identical capacity constraints and costs, including a sunk cost that varied across experimental sessions over six different values. We find, contrary to the prediction of microeconomic theory, that subjects’ pricing decisions show sizable differences across treatments. The effect of the sunk cost is non–monotonic: as it increases from low to medium levels, average prices decrease, but as it increases from medium to high levels, average prices increase. These effects are not apparent initially, but develop quickly and persist throughout the game. Cachon and Camerer’s (1996) loss avoidance is consistent with both effects, while cost–based pricing predicts only the latter effect, and is inconsistent with the former.
URI: http://hdl.handle.net/2164/200
ISSN: 0143-4543
Appears in Collections:Economics research
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