Acme is a monopolist who faces inverse market demand function P (Q, y) = 100 -...

Acme is a monopolist who faces inverse market demand function P (Q, y) = 100 - 2Q + y, where y is the quality level of Acme’s product. Acme has cost function function C(Q) = 20Q.

Suppose quality is costly. Specifically, assume that Acme must pay innovation cost I(y)= (1/4)(y^2). Thus, Acme’s total profits are x(Q,y)=P(Q,y)Q - C(Q) - I(y). Assuming Acme is allowed to act like a monopolist, we will work out Acme’s optimal quality choice, y*.

1. Suppose, for any given quality level γ, Acme is forced to deliver an output level that maximizes aggregate surplus for the given quality level γ.

(a) What is Acme’s optimal innovation choice, γ ∗, in this case?

(b) Determine aggregate surplus for this case.

2. Is it preferable for a social planner to grant Acme a patent for its innovation and thereby allow it to act like a monopolist?

Expert Solution

Rahul Sunny answered 1 year ago

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