1/23/12

Perfect competition and economic profit: a question about selling secrets


Understanding how a perfectly competitive firm works is important for answering some of these "tricky" questions about perfect competition.  To be quite honest, I don't know exactly what the instructor is looking for in this case but I can make a pretty good guess based on the properties of a perfectly competitive market in economics:



A firm in a perfectly competitive market invents a new method of production that lowers marginal costs. What happens to its output? What happens to the profit it receives and the price it charges?

a. The firm has an employee who threatens to tell all other firms in the industry about how to implement this new technique. Will it be possible to bribe the employee not to do this? Explain why or why not.

b. Why should this employee probably choose to tell only some of the other firms rather than all of them?

c. What factors will determine the best number of firms to sell the secret to? (Assume that those who get the information keep the secret instead of selling it to still others.)

If MC cost decreases, then the firm is able to produce more, because the MR and MC curves will cross further to the right in the graph (see an example here). The price they charge will not change, because they are price takers, but because their costs have gone down, they are now able to make an economic profit. 

The firm is willing an able to pay the employee an amount equal to its economic profit to keep the secret.  They are willing to do this because they will make NO economic profit if the employees spills the beans, so they are willing to pay any amount lower than or equal to their economic profit to keep the secret.

The employee also has the incentive to not tell all firms about it, because is she does none of the firms will be able to make economic profit which means no bribe money :(.  By only telling a few firms, each firm can take advantage of the lower costs to make an economic profit which will then be transferred to the blabbermouth.

In essence, the employee is a monopoly with his information.  For each additional firm he tells the information to will gain him a customer, but probably lower the amount the additional firm is willing to pay (similar to a downward sloping demand curve).  This means he has to choose the optimal number of firms based on the marginal revenue acquired from each firm he shares his information to.  Since the marginal cost of sharing his information is essentially zero, he will continue to share his information  until the amount of revenue earned by having a new customer, is equal to the amount of revenue lost by having to lower prices to get that new customer (meaning MR = 0).
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