Experimental evidence of a sunk–cost paradox: a study of pricing behavior in Bertrand–Edgeworth duopoly

Steve Buchheit, Nicholas J Feltovich

Research output: Working paperDiscussion paper

Abstract

A well–known implication of microeconomic theory is that sunk costs should have no effect on decision making. We test this hypothesis with a human–subjects experiment. Students recruited from graduate business courses, with an average of over six years of work experience, played the role of firms in a repeated price–setting duopoly game in which both firms had identical capacity constraints and costs, including a sunk cost that varied across experimental sessions over six different values. We find, contrary to the prediction of microeconomic theory, that subjects’ pricing decisions show sizable differences across treatments. The effect of the sunk cost is non–monotonic: as it increases from low to medium levels, average prices decrease, but as it increases from medium to high levels, average prices increase. These effects are not apparent initially, but develop quickly and persist throughout the game. Cachon and Camerer’s (1996) loss avoidance is consistent with both effects, while cost–based pricing predicts only the latter effect, and is inconsistent with the former.
Original languageEnglish
PublisherUniversity of Aberdeen
Number of pages41
Publication statusPublished - Apr 2008

Publication series

NameUniversity of Aberdeen Business School Working Paper Series
No.04
Volume2008
ISSN (Print)0143-4543

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    Buchheit, S., & Feltovich, N. J. (2008). Experimental evidence of a sunk–cost paradox: a study of pricing behavior in Bertrand–Edgeworth duopoly. (University of Aberdeen Business School Working Paper Series; Vol. 2008, No. 04). University of Aberdeen. http://hdl.handle.net/2164/200