Instructions: Show all of your work!!!! This first homework assignment is due in class by Thursday, 2/9. Recall that there is a one week grace period after the due date where I accept late submissions (at no penalty), but after that the answer key goes live and submissions are no longer accepted.

1. Consider a perfectly competitive market with a price of $12, where each firm has a cost function of C (q) = 50 + 2q + 0. 5q2 .

a)   Is the market in long-run equilibrium? Explain why or why not.

b)   What is the value to a firm of a cost-saving process innovation that reduces the cost function to c (q) = 10 + 0.5q2?

c)   Illustrate this innovation graphically using a well-labeled diagram.

2. Consider a pharmaceutical company considering research and development of a new drug. They estimate that demand for this new, innovative product (the only of its kind) is given byp = 200 − q, and the firm knows that once the drug is developed it can produce as much as it would like at a constant marginal cost of $10 (this implies a cost function of C (q) = 10q).

(a)  What is the monopolist’s profit-maximizing price and quantity produced, pm  and qm  if they

develop the drug? Be sure to include a well-labeled diagram!

(b) If the firm expects that the R&D will cost $10,000, should the firm pursue this product innovation?

(c)  What is the most the firm should be willing and able to spend on this innovation?

(d) What is the socially optimal quantity of output, q*?

(e)  What is the value of the innovation to society if it was competitively/efficiently supplied?

(f)   Calculate the deadweight welfare loss we should expect if the firm produces the new drug as a monopoly.