Abstract
How do firms recover precontract costs? For example, suppose 10 firms compete in a sealed-bid auction for the right to explore and develop an offshore oil field. Each spends $500,000 to estimate the value of the field and to prepare its bid. Suppose this investigation reveals that the tract is worth approximately $20 million. If sunk costs do not matter, competition dictates that the winner must bid $20 million, but if the winner is to recover its prebid costs the maximum offer can be only $19.5 million. Furthermore, long-run industry equilibrium considerations suggest that the highest bid will be only $15 million ($20 million minus the total bid preparation costs of $5 million). If competition forces firms to charge marginal cost, why do firms ever invest in resources which become sunk? In some industries, inframarginal rents can be used to recover these costs. However, the example above, as well as many others, involves an all-or-none deci-
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Disclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.