The Sunk Cost Bias and Managerial Pricing Practices

46 Pages Posted: 25 Oct 2005

Date Written: October 2005

Abstract

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.

Keywords: learning, bounded rationality, pricing

Suggested Citation

Al-Najjar, Nabil I. and Baliga, Sandeep and Besanko, David A., The Sunk Cost Bias and Managerial Pricing Practices (October 2005). Available at SSRN: https://ssrn.com/abstract=825986 or http://dx.doi.org/10.2139/ssrn.825986

Nabil I. Al-Najjar (Contact Author)

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States
847-491-5426 (Phone)
847-467-1220 (Fax)

Sandeep Baliga

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States
847-467-4613 (Phone)
847-467-1220 (Fax)

David A. Besanko

Northwestern University - Kellogg School of Management ( email )

2211 Campus Drive
Evanston, IL 60208
United States
847-467-6505 (Phone)
847-467-1777 (Fax)

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