How much does industry matter in an emerging market economy?

Theories of firm profitability make different predictions about the relative importance of firm, industry and time specific factors. We assess, empirically, the relevance of these effects over a sixteen year period in India, as a regime of control and regulation, pre 1985, gave way to partial liberalisation between 1985 and 1991 and to more decisive liberalisation after 1991. We find that firm effects are important throughout, when rent seeking opportunities proliferated, as well as when competitive forces were enhanced by institutional change. In contrast, industry effects significantly increased after liberalisation, suggesting that industry structure matters more within competitive markets. These findings help understand the relevance of different models over different stages of liberalisation, and have important implications for both theory and policy.

Experimental evidence of a sunk–cost paradox: a study of pricing behavior in Bertrand–Edgeworth duopoly

A well–known implication of microeconomic theory is that sunk costs should have no effect on decision making. We test this hypothesis with a human–subjects experiment. Students recruited from graduate business courses, with an average of over six years of work experience, played the role of firms in a repeated price–setting duopoly game in which both firms had identical capacity constraints and costs, including a sunk cost that varied across experimental sessions over six different values. We find, contrary to the prediction of microeconomic theory, that subjects’ pricing decisions show sizable differences across treatments. The effect of the sunk cost is non–monotonic: as it increases from low to medium levels, average prices decrease, but as it increases from medium to high levels, average prices increase. These effects are not apparent initially, but develop quickly and persist throughout the game. Cachon and Camerer’s (1996) loss avoidance is consistent with both effects, while cost–based pricing predicts only the latter effect, and is inconsistent with the former.