Working Paper: CEPR ID: DP6162
Authors: Lus M. B. Cabral; Thomas Ross
Abstract: The received wisdom is that sunk costs create a barrier to entry - if entry fails, then the entrant, unable to recover sunk costs, incurs greater losses. In a strategic context where an incumbent may prey on the entrant, sunk entry costs have a countervailing effect: they may effectively commit the entrant to stay in the market. By providing the entrant with commitment power, sunk investments may soften the reactions of incumbents. The net effect may imply that entry is more profitable when sunk costs are greater.
Keywords: barriers to entry; sunk costs
JEL Codes: L13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher sunk costs (G31) | change in incumbent behavior (D72) |
| sunk costs (G31) | facilitate entry (F55) |
| sunk costs (G31) | commit entrants to the market (G10) |
| sunk costs (G31) | incumbent's strategy (L21) |
| sunk costs (G31) | likelihood of entry (L26) |
| sunk costs (G31) | incumbent cannot induce exit (J63) |
| sunk costs (G31) | equilibrium for rational entry (D43) |