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Sunk Investments Lead to Unpredictable Prices (Second Version)

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Author Info
George J.Mailath () (Department of Economics, University of Pennsylvania)
Andrew Postlewaite () (Department of Economics, University of Pennsylvania)
Larry Samuelson () (Department of Economics, University of Wisconsin)

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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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Publisher Info
Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 04-007.

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Length: 32 pages
Date of creation: 03 Jun 2003
Date of revision: 30 Jan 2004
Handle: RePEc:pen:papers:04-007

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Related research
Keywords: Sunk investments inefficient investments sunspots random prices.

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Find related papers by JEL classification:
D40 - Microeconomics - - Market Structure and Pricing - - - General
D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General

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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. [Downloadable!] (restricted)
  2. Shiller, Robert J & Weiss, Allan N, 1999. "Home Equity Insurance," The Journal of Real Estate Finance and Economics, Springer, vol. 19(1), pages 21-47, July. [Downloadable!] (restricted)
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  3. Geanakoplos, J. & Polemarchakis, H., 1991. "Overlapping generations," Papers 9131, Catholique de Louvain - Center for Operations Research and Economics.
  4. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August. [Downloadable!] (restricted)
    Other versions:
  5. 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. [Downloadable!] (restricted)
  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. [Downloadable!]
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