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

Posted: 8 Apr 2003

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

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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.

Suggested Citation

Carmichael, H. Lorne and MacLeod, William Bentley, Caring About Sunk Costs: A Behavioral Solution to Hold-Up Problems with Small Stakes. Journal of Law, Economics, & Organization, Vol. 19, No. 1, Spring 2003. Available at SSRN: https://ssrn.com/abstract=355301

H. Lorne Carmichael

Queen's University ( email )

Kingston, Ontario K7L 3N6 K7L 3N6
Canada
615-533-2253 (Phone)
615-533-6668 (Fax)

William Bentley MacLeod (Contact Author)

Columbia University - Department of Economics ( email )

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New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

IZA Institute of Labor Economics ( email )

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Germany

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