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The Sunk Cost Bias and Managerial Pricing Practices

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Author Info
Nabil Al-Najjar
Sandeep Baliga () (Northwestern University)
David Besanko

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Abstract

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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Publisher Info
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

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Related research
Keywords: Sunk Cost Bias Bertrand Oligopoly Dynamic Learning

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Find related papers by JEL classification:
D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles

References listed on IDEAS
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  1. Friedman, James W. & Mezzetti, Claudio, 2001. "Learning in Games by Random Sampling," Journal of Economic Theory, Elsevier, vol. 98(1), pages 55-84, May. [Downloadable!] (restricted)
  2. Milgrom, Paul & Roberts, John, 1990. "Rationalizability, Learning, and Equilibrium in Games with Strategic Complementarities," Econometrica, Econometric Society, vol. 58(6), pages 1255-77, November. [Downloadable!] (restricted)
  3. 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. [Downloadable!] (restricted)
  4. 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. [Downloadable!] (restricted)
  5. Vives, Xavier, 1990. "Nash equilibrium with strategic complementarities," Journal of Mathematical Economics, Elsevier, vol. 19(3), pages 305-321. [Downloadable!] (restricted)
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  6. Theo Offerman & Jan Potters, 2006. "Does Auctioning of Entry Licences Induce Collusion? An Experimental Study," Review of Economic Studies, Blackwell Publishing, vol. 73(3), pages 769-791, 07. [Downloadable!] (restricted)
  7. Dekel, Eddie & Ely, Jeffrey & Yilankaya, Okan, 2004. "Evolution of Preferences," Micro Theory Working Papers dekel-04-08-13-01-21-07, Microeconomics.ca Website, revised 09 Jun 2006. [Downloadable!]
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  8. Samuelson, Larry, 2001. "Introduction to the Evolution of Preferences," Journal of Economic Theory, Elsevier, vol. 97(2), pages 225-230, April. [Downloadable!] (restricted)
  9. Federico Echenique., 2000. "Comparative Statics by Adaptive Dynamics and The Correspondence Principle," Economics Working Papers E00-273, University of California at Berkeley. [Downloadable!]
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  10. Fershtman, Chaim & Judd, Kenneth L, 1987. "Equilibrium Incentives in Oligopoly," American Economic Review, American Economic Association, vol. 77(5), pages 927-40, December. [Downloadable!] (restricted)
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  11. 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. [Downloadable!] (restricted)
  12. 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. [Downloadable!]
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Full references

Cited by:
(explanations, 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.)

  1. Frank Milne & David Kelsey, 2006. "Imperfect Competition and Corporate Governance," Working Papers 1079, Queen's University, Department of Economics. [Downloadable!]
  2. Aviad Heifetz & Chris Shannon & Yossi Spiegel, 2007. "The Dynamic Evolution of Preferences," Economic Theory, Springer, vol. 32(2), pages 251-286, August. [Downloadable!] (restricted)
    Other versions:
  3. Buccirossi, Paolo & Spagnolo, Giancarlo, 2006. "Optimal Fines in the Era of Whistleblowers," CEPR Discussion Papers 5465, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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This page was last updated on 2008-11-20.

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