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Economics of Innovation and Intellectual Property

by: Josefa Conn

Economics of Innovation and Intellectual Property ENVECON 143

Marketplace > University of California - Berkeley > Environmental Science & Policy > ENVECON 143 > Economics of Innovation and Intellectual Property
Josefa Conn

GPA 3.88

B. Wright

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B. Wright
Class Notes
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This 46 page Class Notes was uploaded by Josefa Conn on Thursday October 22, 2015. The Class Notes belongs to ENVECON 143 at University of California - Berkeley taught by B. Wright in Fall. Since its upload, it has received 43 views. For similar materials see /class/226618/envecon-143-university-of-california-berkeley in Environmental Science & Policy at University of California - Berkeley.

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Date Created: 10/22/15
EEP 143 Lecture 4 Outline Briefly More on public goods monopoly and price discrimination EX ante versus ex post views of incentives and intellectual property rights IPRs Alternatives to IP protection EEP143Lecture4WrightO7 News from Kevin Perkins House Expected to Vote on Contentious Patent Reform Bill Friday WASHINGTON AP The House this week is planning to take up a contentious patent reform bill that seeks to curtail infringement lawsuits that have resulted in large damage awards against companies such as Microsoft Corp The House bill sponsored by Reps Howard Berman DCalif and Lamar Smith RTexas would increase the information available to patent examiners and set up a process to reevaluate patents after they are granted Supporters argue such postgrant reviews would help weed out patents for minor innovations and overly broad patents by allowing companies to challenge them without having to go through litigation The House Judiciary Committee unanimously approved the legislation in July and the Senate Judiciary Committee has approved a similar bill EEP143Lecture4WrightO7 Private Goods The competitive market is efficient price marginal cost Why is that efficient What if a template must be developed Demand curve Marginal cost Clocks EEP143Lecture4WrightO7 From last class Price Discrimination What is price discrimination Who gains from perfect price discrimination Who gains from imperfect price discrimination ls imperfect price discrimination always bad Example We ll revisit these important questions later in the course EEP143Lecture4WrightO7 knowledge that DNA is a double helix software digital music What do these have in common EEP143Leoture4WrightO7 High cost to create Zero or low cost to distribute to users High cost to control access and use Are these advantages or disadvantages EEP143Lecture4WrightO7 So far discussion has considered efficiency of use of an existing innovation an ex post perspective Assumes the invention has been made EEP143Lecture4WrightO7 Ex ante vs ex post incentives In general opponents of IP emphasize the cost of limiting access to existing inven ons examples In general American and British economists stress the inventive effects of IP for future inventions EEP143Lecture4WrightO7 Ex ante vs ex post incentives There is also a European tradition inventor has a moral right to her invention Many lawyers view the patent grant as an exchange of monopoly right for disclosure of the innovation and how to make it EEP143Lecture4WrightO7 Ex ante vs ex post incentives Ex ante IP decentralizes innovation incen ves No negotiation before inventing No grant application users rather than taxpayers pay of Dutch art market support EEP143Lecture4WrightO7 Many lawyers some economists assume lPRs are the correct means of rewarding inven on Here 1 Start by modeling the problem 2 See if lPRs are the solution EEP143Lecture4WrightO7 Alternatives to IP protection Outline IntroduceRefresh the Net Present Value Concept Some notation in Consumer Surplus First Alternative Prizes Pros and Cons Second Alternative Contests Vickrey Auction Pros and Cons EEP143Lecture4WrightO7 Simple idea model Idea is a pair vc where c is initial cost of developing the idea into an inven on v is the perperiod consumer surplus given competitive pricing EEP143Lecture4WrightO7 Simple idea model What if v is received annually for many penods Evaluate in present dollars using the net present value of the invention EEP143Lecture4WrightO7 Net Present Value NPV NPV is a standard concept for evaluating business projects that will yield different cash flows in future periods In essence NPV evaluates the future cash flows 1 net of initial investment costs and 2 taking into account the opportunity costs of funds invested EEP143Lecture4WrightO7 Net Present Value NPV Example I want to invest 200 in a project that I know will yield 100 at year s end t1 90 at the end of next year t2 and 80 in t3 What is the NPV EEP143Lecture4Wright07 Net Present Value NPV First of all what is the current value of1 if it is received one year from now How much must put it in savings now to have a dollar in a year s time assume the interest rate is 10 Answer 111 So what is the NPV of the project W 100 90 2 80 3400 101 101 101 EEP143Lecture4WrightO7 Net Present Value NPV In a more general form 239 VI NPV Z c 21 1 7 Where Vt is the cash flow at the end of time t cis the investment costs incurred at t0 r is the interest rate r is the length at which the investment will yield cash flows total time of periods EEP143Lecture4WrightO7 Net Present Value NPV Assume Ct is the same for all time periods Special case T900 NPVzlv c r Since V22 1 I 12104 7 EEP143Lecture4WrightO7 Net Present Value NPV 3 1 To check set V i1 1 FY Then calculate 1r V term by term and subtract V term by term to get rV1 EEP143Lecture4WrightO7 Net Present Value NPV Here we make few notational simplifications First we will assume that vt is the same for all time periods So 239 T 1 NPV L CVZ CVT C 21 my 21 my So discounted time see Scotchmer is T 1 T EONY EEP143Leoture4WrightO7 Notation on Consumer Surplus We can express profits DWL and consumer surplus as fractions of v respectively 7rmd Why Strictly for ease of notation So if MCO with no fixed costs eg research then in perfect competition we have vSocia Surplus m1 MCO EEP143Lecture4WrightO7 Notation on Consumer Surplus But if for a monopoly P Note that drrm1 Can you calculate 77 if pp you know the functional form of the demand is linear MCO D Q EEP143Leoture4WrightO7 Information Goods the market doesn t work What is the price with free entry What is the price with intellectual property Isn t public funding better Why or why not Idea vc mv pm TCV software users EEP143Lecture4WrightO7 Alternatives to lPRs Prizes Targeted Prizes the sponsor has specified a specific objective they are announced ex ante Longitude Example Napoleon s prize for food preservation Prize for replacing ivory in billiard balls X Prize Foundation 1996 Award 10 millions to the first firm that will carry three passengers to a suborbital height of 100km twice within a single twoweek period EEP143Lecture4WrightO7 Targeted Prizes In 1795 Napoleon offered a prize for inventing a way to preserve food since its army had almost been destroyed in Piedmont Italy while the troops were searching for food and unready to defend themselves EEP143Leoture4WrightO7 Alternatives to lPRs Prizes In 1810 Nicolas Appert a French chef was awarded the prize He preserved boiled peas in champagne bottles Question What materials innovation enabled Apert s inventionand where did it come from EEP143Lecture4WrightO7 Alternatives to IPRs Prizes Two types of prizes Targeted Prizes the sponsor has specified a specific objective they are announced ex ante Bluesky Prizes they are awarded for an innovation that is identified as worthy eX post EEP143Lecture4WrightO7 Alternatives to IPRs Prizes Bluesky Prizes they are awarded for an innovation that is identified as worthy eX post Nobel Prizes McArthur Genius awards Academic tenure EEP143Lecture4WrightO7 Alternatives to lPRs Prizes Let a prize be denoted as vc where c is the cost of innovation v is the social surplus assuming the invention becomes a public good vSocia Surplus Assume i v is the same across all periods and ii that we can enjoy the surplus from the invention ad infinitum so r EEP143Lecture4WrightO7 Alternatives to lPRs Prizes So what is the value of the invention Social Value1rv if freely available So when is the invention socially desirable Assuming it costs 0 and is freely available then it s desirable if v c 2 O r The social value minus any costs incurred is greater than zero The essential question is EEP143Lecture4WrightO7 Alternatives to lPRs Prizes What is the optimal incentive that should be offered to the innovator in order to proceed with theinnova on We could pay her the costs that she incurred but 1 Maybe she could make more money by patenting the innovation and acting as a monopolist 2 We might not be able to observe c EEP143Lecture4WrightO7 Alternatives to lPRs Prizes We could pay her the profits a monopolist would make for the number of periods that a patent would be valid T 2 7w 2 WT where T is the patent tzo 1rt length EEP143Leoture4WrightO7 Alternatives to lPRs Prizes The benefit is that we avoid the DWL that would be incurred by a monopolist The disadvantage is that we will have duplication in costs it doesn t guarantee that only one innovator will invest on the idea How can we make sure that we will not have duplication in costs EEP143Lecture4WrightO7 How do we choose the best idea Depends on what we can observe What if we can observe both value and cost What if we can observe verify value but not cost EEP143Lecture4WrightO7 Alternatives to lPRs Contests The very first version of contests is based on commitment and it s very common The sponsor commits to give the prize to the contestant that will come closest However if the prize is big then they might be more than one contestant entering the race So we will again have duplication of costs If prize is small and two firms could win maybe neither will enter if each believes the competitor will enter EEP143Lecture4WrightO7 Alternatives to IPRs Contests Another approach in contests is auctions it hasn t been used in practice Most famous is a Vickrey auction assuming value but not cost is verifiable ex post EEP143Lecture4WrightO7 Vickrey Auction 2 substitute ideas by 2 innovators v1 C1 and v2 02 Define si1rvi oi the net social benefit of theiminnova on The sponsor asks for each contestant to report si Say firm 1 reports highest s Sponsor offers firm 1 an amount 1r v1 32 EEP143Leoture4WrightO7 Vickrey Auction Vickrey Auction The essence of the Vickrey auction is that it is a secondprice auction payment to firm 1 depends on response of firm 2 not firm 1 Sponsor will pay to innovator 1 1rv1 s2 Innovator 1 s net profits are 2 39 C1 8139 2 EEP143Leoture4WrightO7 Vickrey Auction Each firm has incentive to tell the truth Firm 1 invests if profit is positive 1rv1 s2 c1 s1 s2 gt O EEP143Lecture4WrightO7 Vickrey Auction Each firm has incentive to tell the truth For example consider firm 1 lf s1lt s2 then maybe firm 1 wants to overstate s1 to win the auction But if she does then she will only get s1 s2 lt0 because it s a second price auction lf s1 gts2 then maybe firm 1 wants to understate s1 then she either loses the auction and gets zero or gets s1 s2 the same as if she told the truth So there is no gain from lying Similarly for firm 2 EEP143Lecture4WrightO7 Vickrey Auction In the Vickrey auction we will not have duplication of costs Also if we know v1 and v2 we can know their costs through their reported valuations EEP143Leoture4WrightO7 Contests Choosing among Ideas Fairly easy if value is observable Vickrey auction Really hard if both value and cost are unobservable or unverifiable Why won t an auction work What would you auction Prototype Contest firms develop prototypes sponsor chooses What is the problem if prototypes are solicited without any commitment as to the price that will be paid Suppose that the government can make contingent contracts before investing contingent on choosing the prototype Does it solve the problem of 1 ensuring the best idea 2 at cheapest COSt EEP143Lecture4WrightO7 Conclusion We saw that we have alternatives to IP protection However they have their pros and cons Before we return to the IP economics part of the course it is worthwhile to be exposed in some law concepts and their connections with the economic concepts EEP143Lecture4WrightO7 EEP143Lecture4WrightO7 A N 0quot What does lP do lP creates as a legal matter excludability Does this solve the public goods problem What about nonrivalness lP provides at least a weak efficiency test as to whether the value of investment exceeds cost lP does a bad job of delegation It does not privilege the more efficient firms It does not regulate entry and duplication lP leads to deadweight loss lP concentrates costs among the users EEP143Lecture4WrightO7


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