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Are Sunk Costs a Barrier to Entry?

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  • Luís Cabral

    (New York University)

  • Thomas Ross

    (University of British Columbia)

Abstract

The received wisdom is that sunk costs create a barrier to entry— if entry fails, then the entrant, unable to recover sunk costs, incurs greater losses. In a strategic context where an incumbent may prey on the entrant, sunk entry costs have a countervailing effect: they may effectively commit the entrant to stay in the market. By providing the entrant with commitment power, sunk investments may soften the reactions of incumbents. The net effect may imply that entry is more profitable when sunk costs are greater.

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Bibliographic Info

Paper provided by Portuguese Competition Authority in its series Working Papers with number 19.

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Length: 18 pages
Date of creation: Feb 2007
Date of revision:
Handle: RePEc:pca:wpaper:19

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  1. Dixit, Avinash, 1980. "The Role of Investment in Entry-Deterrence," Economic Journal, Royal Economic Society, vol. 90(357), pages 95-106, March.
  2. Kyle Bagwell & Garey Ramey, 1996. "Capacity, Entry, and Forward Induction," RAND Journal of Economics, The RAND Corporation, vol. 27(4), pages 660-680, Winter.
  3. Guillermo Caruana & Liran Einav, 2008. "A Theory of Endogenous Commitment," Review of Economic Studies, Oxford University Press, vol. 75(1), pages 99-116.
  4. T.W. Ross, 2004. "Sunk Costs and the Entry Decision," Journal of Industry, Competition and Trade, Springer, vol. 4(2), pages 79-93, 06.
  5. John Connor, 2001. "“Our Customers Are Our Enemies”: The Lysine Cartel of 1992–1995," Review of Industrial Organization, Springer, vol. 18(1), pages 5-21, February.
  6. Barton L. Lipman & Ruqu Wang, 1997. "Switching Costs in Frequently Repeated Games," Discussion Papers 1190, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  7. Daniel F. Spulber, 1989. "Regulation and Markets," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262192756, December.
  8. A. Michael Spence, 1977. "Entry, Capacity, Investment and Oligopolistic Pricing," Bell Journal of Economics, The RAND Corporation, vol. 8(2), pages 534-544, Autumn.
  9. Bolton, Patrick & Scharfstein, David S, 1990. "A Theory of Predation Based on Agency Problems in Financial Contracting," American Economic Review, American Economic Association, vol. 80(1), pages 93-106, March.
  10. Cabral, Luis M B & Riordan, Michael H, 1997. "The Learning Curve, Predation, Antitrust, and Welfare," Journal of Industrial Economics, Wiley Blackwell, vol. 45(2), pages 155-69, June.
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Cited by:
  1. Robert S. Pindyck, 2009. "Sunk Costs and Risk-Based Barriers to Entry," NBER Working Papers 14755, National Bureau of Economic Research, Inc.
  2. Pannone, Andrea, 2010. "Production, unemployment and wage flexibility in an ICT-assisted economy: A model," Structural Change and Economic Dynamics, Elsevier, vol. 21(3), pages 219-230, August.
  3. Alex Bryson & Harald Dale-Olsen, 2008. "A Tale of Two Countries: Unions, Closures and Growth in Britain and Norway," CEP Discussion Papers dp0867, Centre for Economic Performance, LSE.
  4. Kessides, Ioannis N. & Tang, Li, 2011. "Sunk costs, market contestability, and the size distribution of firms," Policy Research Working Paper Series 5540, The World Bank.

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