What is the current profit-maximizing price per suit and what are the monopolist’s per-period profits?
In the text of this chapter we considered sleeping patents in the context of a process innovation. The same principles apply in the case of a product innovation. To see why, consider the following example: Assume that there are 100 aspiring Olympic swimmers whose tastes for low-water-resistance colored swimming suits are evenly distributed over the color spectrum from black to yellow. The “length” of this spectrum is normalized to be one unit. Each of these swimmers values the loss of utility from being offered swimming suits in other than their favorite color at $10 per unit of “distance.” Each swimmer will buy exactly one swimming suit per period provided that the full price for the suit—the price charged by the firm plus the value of utility loss if there is a color difference between the suits on offer and the swimmer’s favorite color—is less than $100 (these are very keen swimmers!). Production of low-water-resistance swimming suits is currently feasible only in black and is controlled by a monopolist who has a patent on the production of the black material. The marginal cost of making a swimming suit is $25.
a. What is the current profit-maximizing price per suit and what are the monopolist’s per-period profits? Now assume that research can be conducted that will allow the swimming suits also to be manufactured in yellow at the same marginal cost of $25.
b. If the monopolist undertakes the research and introduces the new color what will be the resulting equilibrium prices of black and yellow swimming suits? What is the impact on the monopolist’s per-period profit, ignoring research costs?
c. If a new entrant undertakes the research and introduces the new color, what will be the resulting equilibrium prices of black and yellow swimming suits? What will the entrant’s per-period profit be, again ignoring research costs?