Caring About Sunk Costs: A Behavioral Solution to Holdup Problems with Small Stakes

Posted: 29 Feb 2008

See all articles by Lorne Carmichael

Lorne Carmichael

Queen's University

W. Bentley MacLeod

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

Abstract

Economics students need to be taught that opportunity costs are important for optimal decision making 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. Furthermore, the solution we propose is uniquely efficient if the environment is sufficiently complex. Hence, in addition to explaining contract form and ownership (Williamson, 1975; Hart, 1995), studies of the holdup problem may also provide insights into observed behavior in day-today bilateral bargaining problems.

Suggested Citation

Carmichael, Lorne and MacLeod, William Bentley, Caring About Sunk Costs: A Behavioral Solution to Holdup Problems with Small Stakes. The Journal of Law, Economics, and Organization, Vol. 19, No. 1, pp. 106-118, 2003. Available at SSRN: https://ssrn.com/abstract=832309

Lorne Carmichael (Contact Author)

Queen's University

P.O. Box 382904
Cambridge, MA 02138
United States

William Bentley MacLeod

Columbia University - Department of Economics ( email )

420 W. 118th Street
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 )

P.O. Box 7240
Bonn, D-53072
Germany

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