Suppose that a leading computer software firm holds the copyright to a statistical software package. It wished to hire an expert statistician to develop a new module that it will then market as an independent add-on to the basic package. It hires Dr. Johnston, a statistician at a local university. To motivate Dr. Johnston to write a powerful and user-friendly program, it offers royalties representing 30% of gross sales. Before agreeing to the contract, Dr. Johnston computes the expected profits. He estimates that developing the software will take 200 hours. He routinely consults at $250 per hour. Based on sales of a similar module for a competing statistical package, he believes that the software sales would be about $300,000. Answer the following questions.
a) What is the opportunity cost of writing the software for Dr. Johnston?
b) What is the rent to Dr. Johnston if everything goes according to the plan?
c) What is the relationship specific investment by Dr. Johnston? What is the quasi-rent to Dr. Johnston from this transaction? (Assume that he can’t sell this software to anyone else)
d) What is the relationship specific investment and quasi-rent to Dr. Johnston from this transaction if he could sell this software to another firm for $40,000?
e) Now, suppose that Dr. Johnston faces a problem when he delivers his finished product: the firm informs him that one of its employees in his spare time has developed a software package almost as good as his and does not want to pay him the 30% royalty he was promised. If he does not re-negotiate with them, the firm will market this other program at a lower price and his package will not reap the level of sales he had predicted. The firm offers him a royalty of 20%. Should Dr. Johnston agree to the deal? (Assume his alternative is same as in part d above) Why or why not? Has Dr. Johnston been held up? Why?