Contestability and sunk costs: an analysis of product R+D competition

Abstract

The paper shows that Bertrand competition and contestability can be reconciled with sunk costs. When average total costs are constant over a range of output, marginal cost pricing does not conflict with the budget constraint faced by firms. Empirical observations support the notion of constant average total costs. When average total costs are constant, there is no trade-off between dynamic economies and static efficiency. The argument is applied to product R&D competition.