controlled by management in the short run. Each point on the AVC curve is determined by dividing total variable costs at a given level of output by the quantity of output.

The Average Total Cost curve (AC) for a firm is simply the combination of the AFC and AVC curves for that firm. Each point on the AC curve is determined by dividing fixed and variable costs (i.e. total costs) at a given level of output by the quantity of output.

Marginal Cost curves (MC) are the series of points which show the additional costs experienced by a firm for each additional unit of production.

In all cases in this analysis, the Demand and Marginal Revenue curves are held constant and are identical for both firms

because both serve the same market.

The cost curves are

different for each of the two firms, but are held constant for

production increases. The primary difference in production cost between Firm A and Firm B is shown by their average fixed cost curves (AFC).

Because of the difference in cost borne by each

firm for product development, Firm A's AFC curve is considerably higher than is Firm B's.

Variable costs on the other hand, might be lower for Firm A which developed and introduced the new product and which may utilize more efficient production technologies and techniques. As drawn, therefore, Firm A's average variable cost curve (AVCa)

is lower than Firm B's (AVCь). This small cost advantage to Firm A, however, is far outweighed by Firm B's lower level of fixed

costs.

The equilibrium conditions which these graphs demonstrate are illustrative only. Other firms with different cost structures would exhibit different levels of profit or loss. However, the graphs drawn here do provide an accurate and vivid indication of the nature of the injury which can be caused by copying.

As illustrated in Graph A, Firm A which introduces a new semiconductor product would produce to sell a quantity Qa of its new chips because that is the quantity at which its Marginal

Costs (MCa) equal its Marginal Revenues (MR) and is therefore the quantity at which profit is maximized. Because no one else had yet developed the new product, Firm A could expect to hold some degree of market power in that product line, and could be expected to price at Pa so as to earn a profit on the sale of the new product.1/ This profit is indicated on Graph A as the

diagonally crossed area.

The average fixed cost curve (AFCa), the marginal cost curve (MCa) and average cost curve (AC) reflect the costs associated with the development, production and marketing of the innovative new device by Firm A. Average fixed costs in this example make up approximately one-third of Firm A's total average costs at quantity Qa' Product development costs can be assumed to represent approximately half of those fixed costs.

If another firm, Firm B, were now to copy Firm A's new chip, the economic outlook for Firm A would change dramatically. Graph

Bl illustrates the price (Pb) at which Firm B, a copying firm, could sell its product if it were to choose to appropriate only

1/

A standard pricing practice in the semiconductor industry
(said to have been introduced in the U.S. by Henry Ford in
pricing the Model T) is to anticipate future reductions in
production costs and to price according to predicted future
costs in order to expand the size of the market more
rapidly. The cost curves as drawn, therefore, would more
accurately be viewed as anticipated future cost curves.
Nevertheless, the graphs do portray the type of injury Firm A
would suffer due to piracy.

half the market. This analysis assumes that Firm B has fixed costs 50% lower than Firm A because it bears no product and market R&D costs. Note also that once Firm B has decided to split the market with Firm A it faces a new demand curve (d') and new Marginal Revenue Curve (MR') which reflect a market half the size of the original market. Firm B would price at Pb a price somewhat less than Pa- and, because of demand elasticity, world sell a quantity Ob which is less than Qa and equal to one-half the new total market. At this combination of price and sales, Firm B would earn a profit as shown in the diagonally crossed portion of Graph Bl.

However, were Firm B later to choose to take as much market share as possible without losing any money it could price as low as Pminb Graph B2 shows that at sales of Op or greater Firm B's revenues would exceed its average costs at price Pminb. In Graph B2, Firm B has taken over the entire market and therefore operates using the market demand curve (D). Pminb, however was set taking into account the level of production in Graph Bl because it is from that level of production that Firm B will begin to expand its sales. Only at a price of Pminb or higher can this expansion occur without Firm B ever suffering a loss.