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Design of IP: Outline 09/14-16/04

Design of IP: Outline 09/14-16/04. What should determine the size of a reward for innovating? When ideas are scarce When ideas are common knowledge (patent races) In intellectual property, what determines the reward, and how should the reward be structured?.

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Design of IP: Outline 09/14-16/04

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  1. Design of IP: Outline 09/14-16/04 • What should determine the size of a reward for innovating? • When ideas are scarce • When ideas are common knowledge (patent races) • In intellectual property, what determines the reward, and how should the reward be structured?

  2. The optimal size of the reward (e.g., patent life) • Two arguments. Nordhaus (scarce ideas) and race (# of firms) • Nordhaus: Implicitly focuses on single inventors with scarce ideas. Tradeoff is between “too little innovation” and “too much deadweight loss.” The amount of innovation can always be increased by increasing the patent value, but it increases deadweight loss on every inframarginal innovation. • Race: Arises where ideas are not scarce. The problem is to avoid over-entry or under-rewards

  3. Optimal reward when Ideas are ScarceHigher reward (patent life T) increases deadweight loss. space of ideas (v,c) cost, c vT’ vT · ( v c ) b , , b · ( v c ) a , , a value, v

  4. Optimal reward when ideas are common knowledge • High reward may lead to a race • Problem with Races: Duplication of effort? • Problem with Races: Pursue the right ideas? (the problem of aggregating information) • Is a race beneficial for society? • May duplicate costs (bad) • May increase the probability of success or the time of discovery (good). • We cannot know which of these possibilities is more important without knowing how innovation works: need the right model of the creative environment.

  5. A race model with independent successes and failures. • If successes and failures are independent, “duplication” is not well defined. • Suppose (for simplicity) that each firm pays a fixed cost c upfront to enter the race. • Suppose each firm has an independent probability  of success in each time period. • It may take several time periods to receive the innovation. The innovation will be sooner if there are more firms, but the cost is also higher.

  6. Races continued • P(n)=probability at least one firm succeeds • S= social welfare in case of success • What does the diagram look like, and how many entrants will there be if the private reward is less than S? • Should the private reward be less than S? P(n)S cn free entry outcome if winner receives the whole social value optimal n* ne number of firms n

  7. Races continued • Modify diagram to account for the fact that the winner receives less than the whole social value. • Reduces number of entrants, possibly to the efficient number. cn P(n)S P(n)  free entry outcome if winner receives  instead of S n* ne number of firms n

  8. A second model, with unambiguous duplication. • Suppose firms have different “ideas” to fill the same niche. • Suppose (v1/r – c1) < (v2/r – c2) How do we make sure that the best idea is chosen? Patents and simple prizes fail, as we have seen. • Cannot just auction the right to develop it: Why not? c1v1/r c2 v2/r • Vickrey auction works, but only if value can be observed. • Prototype contest: Leads to duplicated cost and possibly not the best • Patents and Prizes do not work very well! (Why?)

  9. Policy Levers to set the value of an IP reward • So far we have mainly been discussing the optimal size of the reward, however it is given. But the reward can also be structured in different ways. • Length T • Breadth: A second policy lever for determining the size of a reward. Broader IP rights can be shorter, because they are more profitable in each period. • Oncomouse. What about an oncowalrus? • Amazon’s one-click patent.

  10. Breadth: Three Definitions • Breadth excludes horizontal substitutes • Define breadth on the product side • Breadth defines cost of entry • Define breadth on the technology side • Breadth excludes vertical substitutes • Defined for sequential innovation

  11. ˆ p 2 ˆ ˆ x ( p , p ) x ( p , p ) 1 1 2 2 2 1 ˆ p 1 ˆ ˆ P P ~ ~ = p p mc 1 2 ~ ~ P x ( p , p ) 2 2 1 ~ x ( p , p ) 1 1 2 Breadth & Horizontal Competition 1 2 1 substitute market

  12. Breadth & Cost of Entry IP Policy: (T,K) K = cost of entry n*(T,K) = equilibrium number of entrants: (1/n) T p(n) x(p(n)) = K

  13. The ratio test: Should breadth cause price to be lower, and the IP right to last longer? • The consumer cost of raising money through monopoly pricing is deadweight loss. • Goal: Maximize ratio of profit to deadweight loss. p p p* p* ~ p ~ p ~ ~ x(p*) x(p) x(p*) x(p)

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