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  • 1. The economics of patents Merit course – 2005 Motivation: to see “how patents work” and how economic theory can help to design them the role of patents patent length Other patent dimensions
  • 2. IBM vs Apple Winners & losers? 1000 45 40 Microsoft 35 100 30 25 Intel 10 20 Compaq 15 Apple 10 1 5 IBM 0 0 1981 1983 1985 1987 1989 1991 1993 1995 1997 1985 1987 1989 1991 1993 1995 1997 Bron: Harvard Business School Apple case studies 1992 & 1998 Bron: Worldscope database
  • 3. Technology Spillovers and incentives The problem that spillovers create is an incentive problem This may be solved by the award of a patent: the legal monopoly to be the only user of an invention Monopolies make an economist alert! Technology spillovers are not totally bad: they are a source of welfare – Example: the history of the personal computer
  • 4. The role of patents The three Ps: – Patronage (e.g., universities) – Procurement (e.g., defense or public sector research institutes) – Patents Patents and spillovers: publication of patented inventions
  • 5. Designing patents Can we design a patent that strikes the balance between incentive and welfare generation? Patent length, breadth, width and height
  • 6. Patents and spillovers – How can patents leave spillovers? Patentable and non-patentable parts of knowledge Standing on the shoulders of giants Rent spillovers
  • 7. Nordhaus model of patent length Minor and drastic innovations
  • 8. Nordhaus model of patent length Longer patents create a longer profit stream for the inventor, but at a decreasing rate (profits far away in the future are worth less)
  • 9. Nordhaus model of patent length Maximum profit for a monopolist minor (A Bc) (c c), qx A Value of the consumer surplus S cd. B 0
  • 10. Nordhaus model of patent length Invention possibilities function cc R, c T NPV of net profits minor V e d R. 0 T T 1e V c R (A Bc)e d R c R (A Bc) R. 0 T V 1e (1 ) cR (A Bc) 10 R Optimal R&D 1 T 1e expenditures 1 R c(A Bc) . T T 1e 1e 1 V c c(A Bc) (A Bc) Resulting NPV of 1 profits T 1e 1 c(A Bc) .
  • 11. Nordhaus model of patent length NPV of profits for varying patent duration
  • 12. Nordhaus model of patent length Longer patents create less consumer welfare (they leave a shorter period for consumers to benefit from all the advantages of the patent)
  • 13. Nordhaus model of patent length Total welfare resulting T e WV e d V . from innovation T q x(c) A 1 Consumer surplus after B(c c)2, cd B 2 patent runs out q x(c) 2 Part of total welfare due T T T e 12 1e e 2 1 Bc c(A Bc) 2 to increased consumer T T 1e e 1 c (A Bc) c(A Bc) . surplus
  • 14. Nordhaus model of patent length Consumer surplus (NPV) as a function of patent duration
  • 15. Nordhaus model of patent length Total welfare as a function of patent duration Higher demand elasticity decreases optimal patent life, higher technological opportunities leads to shorter optimal patent life
  • 16. Patent breadth Systems nature of knowledge: spillovers are often in the form of relevant implications by outsiders In the spirit of the Nordhaus model: be careful not to prevent too many spillovers from locking out Modeling patent breadth: Horizontal product differentiation
  • 17. Van Dijk / Klemperer model of patent breadth – Horizontal differentiation vp d if the consumer buys U 0 otherwise b p The indifferent vp |w 0| v |w b| w . 2 2 consumer
  • 18. Van Dijk / Klemperer model of patent breadth 1 pb p Profit function . 2 2 1 b ( 1)p b 0 p , Find optimal price p 2 2 1 1 Substitute into indifferent b b b w , pw . 2( 1) 2( 1) consumer b Consumer welfare loss “right” b2 ( 2)2 (b )d . 1 1)2 8( w w b 2 (4 ) Consumer welfare loss “left” (p )d . 2 8 ( 1) 0 1 b2 ( 2)2 b 2 (4 ) b b . Total welfare loss 1 2 2( 1) 1 1)2 8 ( 1)2 8(
  • 19. Van Dijk / Klemperer model of patent breadth 1 1 2)2 b( b b (4 ) b 1 2 1. 4( 1) 1 4( 1) 1 Broad patents are bad, because they sacrifice a lot of consumer surplus for little profits (incentives) Narrow patents are bad, because they sacrifice a lot of consumer surplus for little profits (incentives) Patent breadth is a tool to vary the ratio of welfare loss to incentive (=profit). Policy: pick the best ratio and adjust patent length
  • 20. Patent breadth ‘Gold mining’ of patents – Genetic technology – The importance of applicability of patents A trend towards broader patents (pro-patent era in the US) Software protection: copyright (narrow) vs broad patents: EU parliament debate
  • 21. Prudence in patent breadth Systems nature of knowledge: one invention depends on another one A prudent rule is to leave an important part of the relevant implications to outsiders (do not award broad patents on all imaginable applications of a discovery) Genetic research is an important contemporary example
  • 22. The last aspect of patent protection: Inventive step Every patent must have a minimum degree of novelty and must not be obvious to “someone skilled in the art” – But check some of the patents in patent databases on the web – Would you consider the “one click to buy” system at Amazon.com “not obvious to someone skilled in the art”?
  • 23. Van Dijk model of patent height - Vertical differentiation (quality) v m f p if the consumer buys U 0 otherwise p2 p1 Indifferent consumer m f1 p 1 m f2 p2 m , f2 f1 p2 p1 p2 p1 x1 , x2 1 . Demand functions f2 f1 f2 f1 p2 p1 p2 p1 Profit functions p1 , p2 p2 . 1 2 f2 f1 f2 f1 p2 2p1 1 1 0 p1 p, 22 p1 f2 f1 p1 2p2 Optimal prices yield a game 1 2 1 0 p2 (p f f )., 2121 p2 f2 f1 (Nash equilibrium) f2 f1 f2 f 1 p1 , p2 2 . 3 3
  • 24. Van Dijk model of patent height
  • 25. Van Dijk model of patent height Innovation possibilities function f 2. R(f ) f2 f1 f2 f1 2 2 Net profit functions V1 f1 , V2 4 f2 , 9 9 V1 1 2 f1 0 f1 0, f1 9 Optimal inventive V2 4 2 2 f2 0 f2 . step f2 9 9 When h 2/9 patent height does not become restrictive When h>4/9 the imitator decides not to enter the market When 2/9 < h < 4/9 the first-best choice of the imitating firm is ruled out
  • 26. Strategic patents Patents are intended as legal protection from imitation The Yale survey: only one third of innovations is protected by a patent Why not the other two thirds? novelty requirements secrecy better alternative afraid of inventing around Can patents serve a different function than just protection?
  • 27. Patent strategies – Granstrand
  • 28. Strategic patents Costs of litigation are an important aspect of strategic patenting Strategic patenting puts more emphasis on the non-competitive aspects of patents, and hence on the inefficiencies rather than the welfare-creating effects