Question: a) Suppose two firms have substitutable ideas for a desirable innovation. Per period values are given by v1=$500 and v2=$450, and up-front R&D costs are

a) Suppose two firms have substitutable ideas for a desirable innovation. Per period values are given by v1=$500 and v2=$450, and up-front R&D costs are given by c1=$80 and c2=$20. If the firms’ values and costs are public information, known to everyone, which of the two firms should a sponsor choose to develop the innovation?

A. Firm 1

B. Firm 2

b) Suppose the firms values and costs are private information, known only to the firms, and the sponsor uses the Vickrey Auction format (discussed in class) to choose the optimal idea. If firm 1 misrepresents its idea by bidding $450 and firm 2 reports its social surplus honestly, what will be firm 1's payoff?

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