IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Experimental evidence of a sunk–cost paradox: a study of pricing behavior in Bertrand–Edgeworth duopoly

  • Buchheit, Steve
  • Feltovich, Nick

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.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://hdl.handle.net/10943/363
Download Restriction: no

Paper provided by Scottish Institute for Research in Economics (SIRE) in its series SIRE Discussion Papers with number 2010-124.

as
in new window

Length:
Date of creation: 2010
Date of revision:
Handle: RePEc:edn:sirdps:363
Contact details of provider: Postal: 31 Buccleuch Place, EH8 9JT, Edinburgh
Phone: +44(0)1316508361
Fax: +44(0)1316504514
Web page: http://www.sire.ac.uk
Email:


More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Van Huyck John B. & Battalio Raymond C. & Beil Richard O., 1993. "Asset Markets as an Equilibrium Selection Mechanism: Coordination Failure, Game Form Auctions, and Tacit Communication," Games and Economic Behavior, Elsevier, vol. 5(3), pages 485-504, July.
  2. Jose Alpesteguia & Steffen Huck & Jörg Oechssler, 2003. "Imitation - Theory and Experimental Evidence," CESifo Working Paper Series 1049, CESifo Group Munich.
  3. Reinhard Selten & Klaus Abbink & Ricarda Cox, 2001. "Learning Direction Theory and the Winner’s Curse," Bonn Econ Discussion Papers bgse10_2001, University of Bonn, Germany.
  4. Daniel Friedman & Kai Pommerenke & Rajan Lukose & Garret Milam & Bernardo A. Huberman, 2004. "Searching for the Sunk Cost Fallacy," Experimental 0407008, EconWPA.
  5. Isaac, R Mark & Smith, Vernon L, 1985. "In Search of Predatory Pricing," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 320-45, April.
  6. John H. Kagel & Dan Levin, 1999. "Common Value Auctions with Insider Information," Econometrica, Econometric Society, vol. 67(5), pages 1219-1238, September.
  7. Don Coursey & R. Mark Isaac & Margaret Luke & Vernon L. Smith, 1984. "Market Contestability in the Presence of Sunk (Entry) Costs," RAND Journal of Economics, The RAND Corporation, vol. 15(1), pages 69-84, Spring.
  8. Reinhard Selten, 1973. "A Simple Model of Imperfect Competition, where 4 are Few and 6 are Many," Center for Mathematical Economics Working Papers 008, Center for Mathematical Economics, Bielefeld University.
  9. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  10. Cachon, Gerard P & Camerer, Colin F, 1996. "Loss-Avoidance and Forward Induction in Experimental Coordination Games," The Quarterly Journal of Economics, MIT Press, vol. 111(1), pages 165-94, February.
  11. Brown-Kruse, Jamie, et al, 1994. "Bertrand-Edgeworth Competition in Experimental Markets," Econometrica, Econometric Society, vol. 62(2), pages 343-72, March.
  12. Cason, T. & Friedman, D. & Wagener, F.O.O., 2003. "The dynamics of price dispersion, or Edgeworth variations," CeNDEF Working Papers 03-11, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  13. Brit Grosskopf, 2003. "Reinforcement and Directional Learning in the Ultimatum Game with Responder Competition," Experimental Economics, Springer, vol. 6(2), pages 141-158, October.
  14. Harrison, Glenn W., 1988. "Predatory pricing in a multiple market experiment : A note," Journal of Economic Behavior & Organization, Elsevier, vol. 9(4), pages 405-417, June.
  15. Dufwenberg, Martin & Gneezy, Uri, 2000. "Price competition and market concentration: an experimental study," International Journal of Industrial Organization, Elsevier, vol. 18(1), pages 7-22, January.
  16. Lorne Carmichael & W. Bentley MacLeod, 2003. "Caring About Sunk Costs: A Behavioral Solution to Holdup Problems with Small Stakes," Journal of Law, Economics and Organization, Oxford University Press, vol. 19(1), pages 106-118, April.
  17. Ondrej Rydval & Andreas Ortmann, 2004. "Loss avoidance as selection principle: evidence from simple stag-hunt games," CERGE-EI Working Papers wp245, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
  18. Edward L. Millner & Michael D. Pratt & Robert J. Reilly, 1990. "Contestability in Real-Time Experimental Flow Markets," RAND Journal of Economics, The RAND Corporation, vol. 21(4), pages 584-599, Winter.
  19. Ciliberto, Federico & Schenone, Carola, 2012. "Bankruptcy and product-market competition: Evidence from the airline industry," International Journal of Industrial Organization, Elsevier, vol. 30(6), pages 564-577.
  20. Van Boening, Mark V & Wilcox, Nathaniel T, 1996. "Avoidable Cost: Ride a Double Auction Roller Coaster," American Economic Review, American Economic Association, vol. 86(3), pages 461-77, June.
  21. Werner G¸th & Radosveta Ivanova-Stenzel & Manfred K–nigstein & Martin Strobel, 2003. "Learning to bid - an experimental study of bid function adjustments in auctions and fair division games," Economic Journal, Royal Economic Society, vol. 113(487), pages 477-494, 04.
  22. Offerman, Theo & Potters, Jan & Sonnemans, Joep, 2002. "Imitation and Belief Learning in an Oligopoly Experiment," Review of Economic Studies, Wiley Blackwell, vol. 69(4), pages 973-97, October.
  23. Maskin, Eric & Tirole, Jean, 1988. "A Theory of Dynamic Oligopoly, II: Price Competition, Kinked Demand Curves, and Edgeworth Cycles," Econometrica, Econometric Society, vol. 56(3), pages 571-99, May.
  24. R. McKelvey & T. Palfrey, 2010. "Quantal Response Equilibria for Normal Form Games," Levine's Working Paper Archive 510, David K. Levine.
  25. Nabil Al-Najjar & Sandeep Baliga & David Besanko, 2008. "Market forces meet behavioral biases: cost misallocation and irrational pricing," RAND Journal of Economics, RAND Corporation, vol. 39(1), pages 214-237.
  26. Bresnahan, T.F & Reiss, P.C., 1989. "Entry And Competition In Concentrated Markets," Papers 151, Stanford - Studies in Industry Economics.
  27. Kevin H. Shang & Jing-Sheng Song, 2003. "Newsvendor Bounds and Heuristic for Optimal Policies in Serial Supply Chains," Management Science, INFORMS, vol. 49(5), pages 618-638, May.
  28. Burgstahler, David & Dichev, Ilia, 1997. "Earnings management to avoid earnings decreases and losses," Journal of Accounting and Economics, Elsevier, vol. 24(1), pages 99-126, December.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:edn:sirdps:363. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Gina Reddie)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.