Endogenous Sunk Costs Industry Size And Market Structure

Sunk Costs and Market Structure bridges the gap between the new generation of game theoretic models that has dominated the industrial organization literature over the past ten years and the traditional empirical agenda of the subject as embodied in the structure-conduct-performance paradigm developed by Joe S. Bain and his successors.

I discuss a model of endogenous innovation that brings to the forefront the in-house R&D activity of the modern corporation. In a symmetric oligopoly, firms undertake cost-reducing R&D subject to a research technology with incomplete spillovers. Concentration of sales and R&D resources determine the optimal scale and the efficiency of firms' R&D operations and, thus, the rate of productivity growth. In addition, R&D expenditures (a sunk cost) are one component of total fixed costs and determine the number of active firms in zero-profit equilibrium. This feed-back makes the price, investment, entry, and exit decisions interdependent. A rich characterization of the balanced growth path, defined as the rate of growth and the number of firms that the market supports in general equilibrium, emerges. Multiple equilibria may exist and firms' expectations about rivalry determine the economy's performance.

To explain why many manufacturing industries have remained highly concentrated, John Sutton has developed a new theory of endogenous sunk costs which predicts that industries with significant endogenous sunk costs will have a lower bound on concentration even as industry demand increases. Endogenous sunk costs are fixed costs that firms can choose to invest in, which affect the price-cost margin of a firm. Any optional fixed investments in quality, advertising, and cost-reducing plant, that allow the firm to raise its price or lower its variable costs, qualify as endogenous sunk costs. This paper cuts through the mathematical complexity of the model and examines the intuition behind the theory, to provide a better understanding of how and when the theory of endogenous sunk costs can be applied, and its limitations. How the incentive for firms to invest in endogenous sunk costs increases as the market expands, and how this can limit the number of firms that can profitably remain in the market, is discussed. The paper examines the key conditions required for this effect, and shows how the same basic results can be obtained even if some of Sutton's assumptions are relaxed. It also examines the reasons for the model's unusual result that in some circumstances, a market expansion can actually induce a reduction in the number of firms, contrary to the usual expectation in industrial organization theory. A proof is provided of the proposition that concentration is bounded below for the Cournot model. The paper then discusses how endogenous sunk costs are likely to have a significant impact on industrial development in ways that Sutton did not discuss, for example when firms have a choice of variable cost-reducing investments.

This book presents an original empirical investigation of the market structure of airline city pair markets, shedding new light on the workings of competitive processes between firms. Examining a cross-section of US airline city pairs, Tabacco proposes for the first time that the industry can be understood as a natural oligopoly, each airline market being dominated by one to three airline carriers regardless of market size. The author questions the extent to which airlines deliberately prevent head-to-head competition within city pair markets, and draws intriguing conclusions about competitive forces from the observed market structure. Uncovering some of the main corporate strategies of the airline industry, the book is of immediate relevance to industry managers and practitioners, as well as academic economists.

Thoroughly revised according to classroom feedback, Industrial Organization: Markets and Strategies offers an up-to-date and rigorous presentation of modern industrial organization that blends theory with real-world applications and derives implications for firm strategy and competition policy. This comprehensive textbook acquaints readers with the most important models for understanding strategies chosen by firms with market power and shows how such firms adapt to different market environments. The second edition includes new and revised formal models and case studies. Formal models are presented in detail, and analyses are summarized in 'lessons' which highlight the main insights. Theories are complemented by numerous real-world cases that engage students and lead them to connect theories to real situations. Chapters include review questions, exercises, and suggestions for further reading to enhance the learning experience, and an accompanying website offers additional student exercises, as well as teaching slides.

This second edition of a successful textbook builds on the solid grounding of the previous edition and its introduction of the key pillars of game theory into managerial decision-making. Taking an international perspective, the book reflects cutting edge developments in economics such as behavioural economics and auction theory and shows how these can be applied in the workplace.

This book provides an evaluation of the industrial organization of banking with a focus on the interrelationship among bank behavior, market structure, and regulation. It addresses a wide range of public policy topics, including bank competition and risk, international banking, antitrust issues, and capital regulation. New to this edition, which has been updated throughout, is a broadened consideration of alternative theories of competition among banks, which includes discussions of such issues as the implications of large increases in bank reserve holdings in recent years, effects of nonprice competition through quality rivalry, analysis of mixed market structures involving both large and small banks, and international interactions of banks and policymakers. The intent of the book is to serve as a learning tool and reference for graduate students, academics, bankers, and policymakers seeking to better understand the industrial organization of the banking sector and the effects of banking regulations.