Re: Sunk Costs and Nike and Captialism

["Chris Barrett" <BARRETT@xxxxxxxxxxxxxxxxxx>]

I will take the liberty of responding briefly to two points Gil S.
makes.  If this is a thread of interest only to the two of us, I
hope someone will send me (or both of us) a note and we can take the
exchange private.  I apologize as well for the brevity.  My wife and
I just welcomed our third child (a daughter) on Sunday and I haven't
the time or energy to dive into much detail right now.

> > 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.

No.  Sunk costs are, by definition, exit costs and destroy the
competitive pricing basis of constestable markets theory.  This is
one basic reason why Baumol's work in this area is not particularly
useful.

> 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.

See papers over the past 3-5 years by Avinash Dixit, Jean-Paul Chavas
or Robert Pindyck -- much of it using "hysteresis" as the cover for
the sunk costs issues we're discussing -- or Richard Baldwin's (AER)
"beachhead effects" paper of about 1991.

All the best --

Chris
 ===================================================================
Christopher B. Barrett                  Phone: (608) 262-9491
Depts. of Agricultural Economics        Fax:   (608) 262-4376
    and Economics                 Internet: Barrett@xxxxxxxxxxxxxxxxxx
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