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The Sunk Cost Bias and Managerial Pricing Practices

  • Nabil Al-Najjar
  • Sandeep Baliga

    ()

    (Northwestern University)

  • David Besanko

This paper provides an explanation for why the sunk cost bias persists among firms in a competitive environment in which rich learning possibilities are allowed. We envision firms that experiment with cost methodologies that are consistent with real-world accounting practices, including ones that confuse the relevance of variable, fixed, and sunk coststo pricing decisions. Firms follow “naive†adaptive learning to adjust prices and reinforcement learning to modify their costing methodologies. Costing and pricing practices that increase profits are reinforced. We show that all firms eventually display the sunk cost bias in their pricing behavior

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 851.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:851
Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
Fax: 1-314-444-8731
Web page: http://www.EconomicDynamics.org/society.htm
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  1. Federico Echenique, 2000. "Comparative Statics by Adaptive Dynamics and The Correspondence Principle," Econometric Society World Congress 2000 Contributed Papers 1906, Econometric Society.
  2. Theo Offerman & Jan Potters, 2006. "Does Auctioning of Entry Licences Induce Collusion? An Experimental Study," Review of Economic Studies, Oxford University Press, vol. 73(3), pages 769-791.
  3. Milgrom, Paul & Roberts, John, 1990. "Rationalizability, Learning, and Equilibrium in Games with Strategic Complementarities," Econometrica, Econometric Society, vol. 58(6), pages 1255-77, November.
  4. Fershtman, Chaim & Judd, Kenneth L, 1987. "Equilibrium Incentives in Oligopoly," American Economic Review, American Economic Association, vol. 77(5), pages 927-40, December.
  5. Aviad Heifetz & Chris Shannon & Yossi Spiegel, 2005. "The Dynamic Evolution of Preferences," Discussion Papers 1415, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  6. Friedman, James W. & Mezzetti, Claudio, 2001. "Learning in Games by Random Sampling," Journal of Economic Theory, Elsevier, vol. 98(1), pages 55-84, May.
  7. David A. Brown & Peter Booth & Francesco Giacobbe, 2004. "Technological and organizational influences on the adoption of activity-based costing in Australia," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 44(3), pages 329-356.
  8. Milgrom, Paul & Roberts, John, 1991. "Adaptive and sophisticated learning in normal form games," Games and Economic Behavior, Elsevier, vol. 3(1), pages 82-100, February.
  9. Samuelson, Larry, 2001. "Introduction to the Evolution of Preferences," Journal of Economic Theory, Elsevier, vol. 97(2), pages 225-230, April.
  10. Parayre, Roch, 1995. "The strategic implications of sunk costs: A behavioral perspective," Journal of Economic Behavior & Organization, Elsevier, vol. 28(3), pages 417-442, December.
  11. Vives, Xavier, 1990. "Nash equilibrium with strategic complementarities," Journal of Mathematical Economics, Elsevier, vol. 19(3), pages 305-321.
  12. Smith, Vernon L, 1991. "Rational Choice: The Contrast between Economics and Psychology," Journal of Political Economy, University of Chicago Press, vol. 99(4), pages 877-97, August.
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