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Question: Increasing returns and imperfect competition: Suppose a new piece of computer software - say a word processor with perfect speech recognition - can be created for a onetime cost of $100 million. Suppose that once it's created, copies of the software can be distributed at a cost of $1 each.
(a) If Y denotes the number of copies of the computer program produced and X denotes the amount spent on production, what is the production function; that is, the relation between Y and X?
(b) Make a graph of this production function. Does it exhibit increasing returns? Why or why not?
(c) Suppose the firm charges a price equal to marginal cost ($1) and sells a million copies of the software. What are its profits?
(d) Suppose the firm charges a price of $20. How many copies does it have to sell in order to break even? What if the price is $100 per copy?
(e) Why does the scale of the market - the number of copies the firm could sell - matter?
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