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Sunk Investments Lead to Unpredictable Prices

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  • George Mailath

    () (Department of Economics, University of Pennsylvania)

  • Andrew Postlewaite

    () (Department of Economics, University of Pennsylvania)

  • Larry Samuelson

    () (Department of Economics, University of Wisconsin-Madison)

Abstract

We study transactions that require investments before trading in a competitive market, when forward contracts fixing the transaction price are absent. We show that, despite the market being perfectly competitive and subject to arbitrarily little uncertainty, the inability to jointly determine investment levels and prices may make it impossible for buyers and sellers to predict the prices at which they will trade, leading to inefficient levels of investment and trade.

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Bibliographic Info

Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 03-014.

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Length: 35 pages
Date of creation: 03 Jun 2003
Date of revision:
Handle: RePEc:pen:papers:03-014

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Keywords: General equilibrium; sunspots; incomplete markets;

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  1. Paul Milgrom & Ilya Segal, 2002. "Envelope Theorems for Arbitrary Choice Sets," Econometrica, Econometric Society, vol. 70(2), pages 583-601, March.
  2. Cole, Harold L. & Mailath, George J. & Postlewaite, Andrew, 2001. "Efficient Non-Contractible Investments in Large Economies," Journal of Economic Theory, Elsevier, vol. 101(2), pages 333-373, December.
  3. Manuelli, Rodolfo & Peck, James, 1992. "Sunspot-like effects of random endowments," Journal of Economic Dynamics and Control, Elsevier, vol. 16(2), pages 193-206, April.
  4. Grossman, Sanford J & Hart, Oliver, 1985. "The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration," CEPR Discussion Papers 70, C.E.P.R. Discussion Papers.
  5. Robert J. Shiller & Allan N. Weiss, 1994. "Home Equity Insurance," Cowles Foundation Discussion Papers 1074, Cowles Foundation for Research in Economics, Yale University.
  6. Franklin Allen & Douglas Gale, 2003. "Financial Fragility, Liquidity and Asset Prices," Center for Financial Institutions Working Papers 01-37, Wharton School Center for Financial Institutions, University of Pennsylvania.
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