The Sunk Cost Bias and Managerial Pricing Practices

This paper provides an explanation for why the sunk cost bias persists among firms competing in a differentiated product oligopoly. Firms experiment with cost methodologies that are consistent with real-world accounting practices, including ones that allocate fixed and sunk costs to determine“variable” costs. These firms follow “naive” adaptive learning to adjust prices. Costing methodologies that increase profits are reinforced. We show that all firms eventually display the sunk cost bias. For the canonical case of symmetric linear demand, we obtain comparative statics results showing how the degree of the sunk cost bias changes with demand, the degree of product differentiation, and number of firms. ∗We thank Ronald Dye, Federico Echenique, Jeff Ely, Claudio Mezzetti, Bill Sandholm and Beverly Walther for helpful discussions. We also thank seminar participants at Cambridge, LSE, Oxford, UCL, Pompeu Fabra, INSEE, and UCSD for their comments.