lecture 2 - intellectual property rights: the role of patents in innovation
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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
IBM vs Apple
� Winners & losers?
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10
100
1000
1985 1987 1989 1991 1993 1995 1997
IBM
Apple
Microsoft
Compaq
Intel
Bron: Worldscope database
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5
10
15
20
25
30
35
40
45
1981
1983
1985
1987
1989
1991
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1997
Bron: Harvard Business School Apple case studies 1992 & 1998
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
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
Designing patents
� Can we design a patent that strikes the balance between incentive and welfare generation?
� Patent length, breadth, width and height
Patents and spillovers – How can patents leave spillovers?
� Patentable and non-patentable parts of knowledge
� Standing on the shoulders of giants� Rent spillovers
Nordhaus model of patent length
� Minor and drastic innovations
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)
Nordhaus model of patent length
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Nordhaus model of patent length
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Invention possibilities function
NPV of net profits
Optimal R&D expenditures
Resulting NPV of profits
Nordhaus model of patent length
� NPV of profits for varying patent duration
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)
Nordhaus model of patent length
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Total welfare resulting from innovation
Consumer surplus after patent runs out
Part of total welfare due to increased consumer surplus
Nordhaus model of patent length
� Consumer surplus (NPV) as a function of patent duration
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
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
Van Dijk / Klemperer model of patent breadth – Horizontal differentiation
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Van Dijk / Klemperer model of patent breadth
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Find optimal price
Substitute into indifferent consumer
Consumer welfare loss “right”
Consumer welfare loss “left”
Total welfare loss
Van Dijk / Klemperer model of patent breadth
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Patent breadth is a tool to vary the ratio of welfare loss to incentive (=profit). Policy: pick the best ratio and adjust patent length
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
� ‘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) vsbroad patents: EU parliament debate
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
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”?
Van Dijk model of patent height -Vertical differentiation (quality)
U�v�mf�p if the consumer buys0 otherwise
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Indifferent consumer
Demand functions
Profit functions
Optimal prices yield a game (Nash equilibrium)
Van Dijk model of patent height
Van Dijk model of patent height
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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 firmis ruled out
Innovation possibilities function
Net profit functions
Optimal inventive step
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?
Patent strategies – Granstrand
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