ER / Concepts
Sunk Cost
Created
Definition
A cost that cannot be recovered, whatever the firm decides next. Because no choice can change it, a firm ignores it when deciding what to do next.
Small vs large sunk cost
- Delivery truck: The truck can be resold → Small sunk cost → entry is low-risk.
- Power plant: Cannot be moved or used for anything else → its resale value falls with the market → large sunk cost → entry is very risky.
The size of the sunk cost determines how high the entry barrier is. This is why free entry fails in electricity generation.
SR vs LR
- SR: FC is sunk: paid whether the firm produces or shuts down → drops out of the decision → compare vs .
- LR: all factors are variable → no cost is sunk yet → compare vs .
Electricity
Once a plant is built, its capital cost is sunk. The plant keeps running as long as the price covers its fuel and CO2 costs (), even if it never recovers the capital cost.
Links: Shutdown Rule, Perfect Competition, W1.2 Organization of the Electricity Sector