Measuring the Importance of Sunk Costs

This paper devises new methods for measuring firms' sunk costs and their effect on market structure. It builds on our earlier work that estimated the size of unobserved fixed costs from entry thresholds, the amount of market demand necessary to support a new entrant. Here we show that differences between entry and exit thresholds provide information about the extent of sunk costs and their option value. The latter half of the paper uses panel data on the location of rural dentists' practices to estimate entry and exit thresholds. We find dentists' exit thresholds are well below their entry thresholds. It thus appears dentists sink significant costs. A simulation suggests that dentists in large rural markets incur greater sunk costs than those in small markets.