Sunk Costs, Contestability, and the Latent Contract Market

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Staff Reports

Sunk Costs, Contestability, and the Latent Contract Market

April 1999 Number 75

JEL classification: J7, J4, O, L8

Author: Chris Stefanadis

The idea that an industry with sunk costs may be contestable even in the absence of long-term contracts has received little attention from formal economic theory yet is popular among monopolists facing antitrust suits. The paper formally illustrates the argument. In an infinitely repeated game, there exists a class of contestable outcomes in which the monopolist sells only on the spot market and charges low prices along the equilibrium path to prevent customers from resorting to long-term contracts. Then, the crucial test for contestability is the level of transaction costs in the latent contract market.

Available only in PDF PDF

23 pages / 73 kb

For a published version of this report, see Christodoulos Stefanadis, "Sunk Costs, Contestability, and the Latent Contract Market," Journal of Economics and Management Strategy 12, no. 1 (spring 2003):
119-38.

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