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Sunk costs, contestability, and the latent contract market

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  • Chris Stefanadis

Abstract

The idea that an industry with sunk costs may be contestable even in the absence of long-term contracts has received little attention from formal economic theory yet is popular among monopolists facing antitrust suits. The paper formally illustrates the argument. In an infinitely repeated game, there exists a class of contestable outcomes in which the monopolist sells only on the spot market and charges low prices along the equilibrium path to prevent customers from resorting to long-term contracts. Then, the crucial test for contestability is the level of transaction costs in the latent contract market.

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  • Chris Stefanadis, 1999. "Sunk costs, contestability, and the latent contract market," Staff Reports 75, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:75
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    Cited by:

    1. Packalen, Mikko, 2010. "Complements and potential competition," International Journal of Industrial Organization, Elsevier, vol. 28(3), pages 244-253, May.
    2. Hongqi Ma & Guangjun Shen & Jingxian Zou, 2024. "Does excess capacity strengthen firms' dependence on the polluting path? Evidence from Chinese iron and steel firms," Economics of Transition and Institutional Change, John Wiley & Sons, vol. 32(3), pages 971-1000, July.
    3. T.W. Ross, 2004. "Sunk Costs and the Entry Decision," Journal of Industry, Competition and Trade, Springer, vol. 4(2), pages 79-93, June.

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    Keywords

    Monopolies; Contracts; Antitrust law;
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