Dry milling

$0.53

$0.40

$0.10

$1.23

50

150

Task 1: Draw the marginal cost curve and the average total cost curve of a wet milling ethanol plant. Assume that the overhead cost is not recoverable if the plant shuts down temporarily.

Task 2: Draw the marginal cost curve and the average total cost curve of a dry milling ethanol plant.

Task 3: ADM’s Peoria plant is a wet-milling plant. Suppose the price of ethanol were $1.02 per gallon. Would ADM wish to temporarily suspend operations (shut down) at the Peoria plant? What is the minimum ethanol price at which operating the Peoria plant is optimal for ADM?

Task 4: Draw the current short-run industry supply curve for ethanol.

Task 5: Verify that the current equilibrium price of $1.53 is consistent with the short- run supply curve you derived above, combined with the demand function ! = 46.1 − 20!, where Q is billions of gallons per year.

Task 6: Suppose the demand for ethanol changes to ! = 23.05 − 10!. What do you predict will be the new price in the short run? How much ethanol will be produced in the new short-run equilibrium? How much will be produced by dry-milling plants? Wet-milling plants?

1 Actual plant capacities and costs vary more than is shown here.

2

2. AbbVie Pharmaceuticals (headquartered in Lake Forest, IL) has commenced a $10 million R&D project to develop a new drug to treat a rare disease. So far, it has spent $6 million of the $10 million, and preliminary results are positive. If the additional $4 million is invested, the drug will certainly be completed and is expected to generate profit of $18 million in present value for AbbVie. Meanwhile, a research biologist at Illinois Tech has independently developed a treatment for the same disease. The scientist has offered to sell her invention to AbbVie for $2 million. Her drug would be just as effective as AbbVie’s drug, and would also generate profit of $18 million in present value.

- Should AbbVie buy the drug for $2 million?
- What is the most AbbVie should be willing to pay for the Illinois Tech
- researcher’s drug?
- How would your answer change if the Illinois Tech biologist had developed her
- drug two years ago, before AbbVie started its own R&D project?

d. Suppose that Merck has also expressed interest in the biologist’s invention. If Merck buys the drug, there is a 50% chance that it will beat AbbVie’s drug to mar