Crying Over Spilt Milk: Sunk Costs, Fairness Norms and the Hold-up Problem

Crying Over Spilt Milk: Sunk Costs, Fairness Norms and the Hold-up Problem

This article explores a possible connection between two behavioural anomalies in economics, the observed responsiveness of individual decision makers to sunk costs, and the apparent failure of backward induction to predict outcomes in experimental bargaining games. In particular, we show that under some conditions, a ‘sunk cost sensitive’ fairness norm can evolve in such environments. Under thi...

Sunk Costs, Fairness, and Disagreement

We study a bilateral trading relationship in which one agent, the seller, can make a non–recoverable investment in order to generate potential gains from trade. Afterwards, the seller makes a price offer that the buyer can either accept or reject. Economic theory predicts that if agents are selfish, neither the level of investment cost nor the buyer’s information about costs should affect the o...

Spilt Milk

Are sunk costs really sunk?

The problem of relevance of sunk costs in managerial decisions concerning a plant is studied. It is shown that under fairly general assumptions about the rationality of the managers the irrelevance of such costs, frequently claimed by economists and accountants, is weakly founded. An application to a specific problem of use of a machine is studied and the optimal use decision problem solved.

Hold-up and the evolution of investment and bargaining norms

The purpose of this paper is to explore the evolution of bargaining norms in a simple team production problem with two sided relationship specific investments and competition. The puzzle we wish to address is why efficient bargaining norms do not evolve even though there exist efficient sequential equilibria? Conditions under which stochastically stable bargaining conventions exist are characte...