Caring About Sunk Costs: A Behavioral Solution to Hold-Up Problems with Small Stakes

USC Law School, Olin Working Paper No. 99-19

21 Pages Posted: 25 Jan 2000

See all articles by H. Lorne Carmichael

H. Lorne Carmichael

Queen's University

W. Bentley MacLeod

Columbia University - Department of Economics; National Bureau of Economic Research (NBER); IZA Institute of Labor Economics

Multiple version iconThere are 2 versions of this paper

Date Written: December 9, 1999

Abstract

Economics students need to be taught that opportunity costs are important for optimal decisionmaking but that sunk costs are not. Why should this be? Presumably these students have been making optimal decisions all their lives, and the concepts should be easy for them. We show that caring about sunk costs can help agents achieve efficient investments in a simple team production environment. Further, the solution we propose is uniquely efficient if the environment is sufficiently complex. Hence, in addition to explaining contract form and ownership (Williamson (1975) and Hart (1995)), studies of the holdup problem may also provide insights into observed behavior in day to day bilateral bargaining problems.

JEL Classification: C78

Suggested Citation

Carmichael, H. Lorne and MacLeod, William Bentley, Caring About Sunk Costs: A Behavioral Solution to Hold-Up Problems with Small Stakes (December 9, 1999). USC Law School, Olin Working Paper No. 99-19. Available at SSRN: https://ssrn.com/abstract=200776 or http://dx.doi.org/10.2139/ssrn.200776

H. Lorne Carmichael (Contact Author)

Queen's University ( email )

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William Bentley MacLeod

Columbia University - Department of Economics ( email )

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United States

National Bureau of Economic Research (NBER)

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IZA Institute of Labor Economics ( email )

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