There are two existing firms in the market for computer chips. Firm A knows how
ID: 1205130 • Letter: T
Question
There are two existing firms in the market for computer chips. Firm A knows how to reduce the production costs for the chip and is considering whether to adopt the innovation or not. Innovation incurs a fixed setup cost of C, while increasing the revenue. However, once the new technology is adopted, another firm, B, can adopt it with a smaller setup cost of C/3. If A innovates and B does not, A earns $30 in revenue while B earns $10. If A innovates and B does likewise, both firms earn $20 in revenue. If neither firm innovates, both earn $10.
a) Under what condition (i.e., for what values of C) will firm B have an incentive to adopt if firm A adopts the innovation? Explain.
b) Under what condition will firm A innovate? Explain.
Explanation / Answer
a.
The value of C would be equal to or below $30. If C = $30, the setup cost for B would be C/3 = $30/3 = $10. Firm B earns additional ($20 - $10 =) $10 after the adoption of innovative technology. It becomes the break-even, since the additional revenue is equal to set-up cost. Searching the break-even is required here, since the set-up cost is one time cost and it has no relevance after the recovery.
b.
Firm A will innovate if the setup cost (C) is equal to or below $20. This is the difference in revenues before and after the adoption of innovative technology. ($30 - $10 = $20). Such additional revenues at-least should be equal to setup cost to achieve the break-even point.