Re: Sunk Costs and Nike and Captialism

[GSKILLMAN@xxxxxxxxxxxx]

In response to my comment about marginal conditions in the presence
of overhead costs, Chris B. writes:

> Remember two of the crucial assumptions of introductory micro: free
> entry and exit, and no uncertainty (or risk, for any of you who like
> to distinguish between the two).  Sunk costs destroy the free
> entry/exit assumption, with its implications for competitive pricing,
> zero marginal profits, etc.   If one adds uncertainty, the
> problems are compounded substantially, creating strong status quo
> biases among profit maximizing firms.  Gil is, of course, right that
> MR=MC is the a priori optimality condition for profit maximization,
> whether under perfect competition or pure monopoly/monopsony, but the
> difference in market structure is terribly important.  The MC=MR
> condition falls in the presence of uncertainty (whether or not agents
> are risk averse).

I agree that sunk costs may have implications for market structure--
and hope nothing I said suggested otherwise.  Note, though, that sunk
entry costs may still permit contestable markets and thus competitive
pricing.

Uncertainty is a new issue, but it only changes the form and not the
sense of marginal optimization conditions.  E.g., the risk-neutral
firm would maximize E{P(x)} (read "the expected value of profit as a
function of output x"), with first-order condition E{P'(x)} = 0, or
E{MR} = E{MC}.  The first-order condition would look different if the
firm were for some reason risk-averse, but there would still be
marginal conditions.

I'm not clear about the "status quo bias" Chris is referring to.
Truman Bewley's "Knightian" theory of uncertainty (as opposed to
risk) introduces a status quo bias, but I don't see why simple
riskiness does, unless firms are risk-averse and for some reason all
alternative are riskier than pursuing the status quo.
      Gil [gskillman@xxxxxxxxxxxxxxxxxx]