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sunk costs

  In production systems, a form of costs which cannot be recovered once committed. Baumol and Willig (1981) are responsible for introducing the concept of sunk costs into formal economic analysis. Recent application of the idea by economic geographers stems from the observation that \'sunk costs represent a nonrecoverable commitment to production in an industry; sunk costs are irrevocably committed to a particular use, and therefore are not recoverable in the case of exit\' (Mata, 1991, p. 52). Hence, Clark and Wrigley (1995, 1997) use the concept to enrich their analysis of corporate strategy with respect to the geography of investment, disinvestment, plant closure, and exit from an industry. They note how the existence of significant sunk costs (for example, investments in physical plant that cannot be resold, or continuing liabilities to cover the future cost of pensions for former employees) imposes a degree of immobility on large, multilocational corporate actors. Taking such costs into consideration, options such as firm exit and plant closure are \'extreme decisions\' (Clark and Wrigley, 1997), pursued only after many other possibilities have been tried or rejected, since the firm will suffer a significant financial setback. In this sense, the acknowledgement of sunk costs introduces an important complication into the analysis of spatial investment decisions, improving upon simpler theories based on ideas from neo-classical economics (Romans, 1965) in which capital is assumed to be perfectly or near-perfectly mobile. In addition to creating potential barriers to exit from an industry, sunk costs can also produce barriers to entry. If firms are aware that high sunk costs exist in a particular industry, this may discourage them from entering the market in the first place. In this way, as Baumol and Willig originally pointed out, the existence of sunk costs can create the conditions for sustaining monopoly or oligopoly. (See also cost structure; decision-making; economies of scale; restructuring.) (MSG)

References Baumol, W. and Willig, R. 1981: Fixed costs, sunk costs, entry barriers, and the sustainability of monopoly. Quarterly Journal of Economics 95: 405-31. Clark, G.L. and Wrigley, N. 1995: Sunk costs: a framework for economic geography. Transactions, Institute of British Geographers NS 20: 204-23. Clark, G.L. and Wrigley, N. 1997: Exit, the firm and sunk costs: reconceptualizing the corporate geography of disinvestment and plant closure. Progress in Human Geography 21: 338-58. Mata, J. 1991: Sunk costs and entry by small and large plants. In P.A. Gerosky and J. Schwalbach, eds, Entry and market contestability. Oxford: Blackwell, 49-62. Romans, J.T. 1965: Capital exports and growth among US regions. Middletown, CT: Wesleyan University Press.



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