1. © Suzanne Scotchmer 09/07/2004 Contents May Be Used Pursuant to Creative Commons Attribution-NoDerivs-NonCommercial Common Deed 1.0Attribution-NoDerivs-NonCommercial Common Deed 1.0 The (Public Goods) Nature of Knowledge & Information Goods Longitude Example: What is the lesson? What do these have in common: Knowledge that “DNA is a double helix” software digital music Public Goods: Nonrivalness: High cost to create; zero cost to distribute or use. What is the efficiency conclusion? Nonexcludability: If the good is nonexcludable, IP will not work!!

2. © Suzanne Scotchmer 09/07/2004 Contents May Be Used Pursuant to Creative Commons Attribution-NoDerivs-NonCommercial Common Deed 1.0Attribution-NoDerivs-NonCommercial Common Deed 1.0 - p Clocks Demand curve Marginal cost Private Goods: The competitive market is efficient price = marginal cost: Why is that efficient? What if a template must be developed?

3. © Suzanne Scotchmer 09/07/2004 Contents May Be Used Pursuant to Creative Commons Attribution-NoDerivs-NonCommercial Common Deed 1.0Attribution-NoDerivs-NonCommercial Common Deed 1.0 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?) mv p m dv software users vv Idea (v,c)

4. © Suzanne Scotchmer 09/07/2004 Contents May Be Used Pursuant to Creative Commons Attribution-NoDerivs-NonCommercial Common Deed 1.0Attribution-NoDerivs-NonCommercial Common Deed 1.0 What does IP do? 1.IP creates (as a legal matter) excludability. –Does this “solve” the public goods problem? –What about nonrivalness? 2.IP provides at least a weak efficiency test as to whether the value of investment exceeds cost 3.IP does a bad job of delegation –It does not privilege the more efficient firms –It does not regulate entry and duplication 4.IP leads to deadweight loss 5.IP concentrates costs among the users

5. © Suzanne Scotchmer 09/07/2004 Contents May Be Used Pursuant to Creative Commons Attribution-NoDerivs-NonCommercial Common Deed 1.0Attribution-NoDerivs-NonCommercial Common Deed 1.0 Intellectual Property: Compared to what? Public Sponsorship? 1840’s, photography: A patent buy-out. 1960’s and 1970’s Super Sonic Transport Public support for private enterprise. 1700’s and 1800’s Lyons’ weavers Prizes in a guild Napoleon: Food preservation Invention for the public good NIH, NSF: Researcher-initiated projects NASA: Targeted government objectives

6. © Suzanne Scotchmer 09/07/2004 Contents May Be Used Pursuant to Creative Commons Attribution-NoDerivs-NonCommercial Common Deed 1.0Attribution-NoDerivs-NonCommercial Common Deed 1.0 Prizes Targeted versus blue-sky research Lyons (blue-sky) Napoleon’s food-preservation (targeted) Simple model: Invest in a blue-sky “idea” (v,c)? Why not make the price depend on cost? Why doesn’t the prize-giver get ripped off? Needs to make the price depend on value Why doesn’t the inventor get ripped off? The role of IP as a background for prizes: Photography Hyatt and celluoid

7. © Suzanne Scotchmer 09/07/2004 Contents May Be Used Pursuant to Creative Commons Attribution-NoDerivs-NonCommercial Common Deed 1.0Attribution-NoDerivs-NonCommercial Common Deed 1.0 Simple Prizes and Scarce Ideas A single inventors has an idea. He must decide whether to invest in it, and we want him to make the “right” decision. An idea is a pair (v,c) where c is the cost of making the idea an innovation and v is per-period profit. (See the market diagram above.) Investment is efficient if (1/r) v > c. In the diagram, what is the defect of patents? If we were going to use prizes instead, what value of prize should we set? (How does the optimal prize relate to v? to c? How does this depend on what is observable? Verifiable?)

8. © Suzanne Scotchmer 09/07/2004 Contents May Be Used Pursuant to Creative Commons Attribution-NoDerivs-NonCommercial Common Deed 1.0Attribution-NoDerivs-NonCommercial Common Deed 1.0 Prizes: Can the prize be linked to value? How should the value of the prize be chosen? How was the prize chosen in the case of longitude? canning? The Lyonnaise silk weavers? Would it be better to link the prize to cost? What problems to patents and prize have in common?

9. © Suzanne Scotchmer 09/07/2004 Contents May Be Used Pursuant to Creative Commons Attribution-NoDerivs-NonCommercial Common Deed 1.0Attribution-NoDerivs-NonCommercial Common Deed 1.0 Targeted objectives: What if there is more than one idea? Contestants 1,2 have ideas (v 1,c 1 ), (v 2,c 2 ): Need to aggregate information and choose the best idea: Invest in idea-1 if (v 1 /r-c 1 ) > (v 2 /r-c 2 ) (Not necessarily the lower-cost idea.) c 2 v 2 /r c 1 v 1 /r 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?

10. © Suzanne Scotchmer 09/07/2004 Contents May Be Used Pursuant to Creative Commons Attribution-NoDerivs-NonCommercial Common Deed 1.0Attribution-NoDerivs-NonCommercial Common Deed 1.0 Vickrey Auction Reminder: Vickrey (2nd-price) auction to auction an item. Valuations v 1,v 2,... (Notice that v means something different.) Want to make sure that the agent with the highest valuation gets the object. How does a second-price auction do this? Application to “ideas”: Assume that v 1,v 2 are observable, but not cost. Rules: Agents report s 1,s 2 where s 1 = (v 1 /r)-c 1 (surplus) Firm 1 wins if s 1 >s 2 (otherwise firm 2 wins) Firm 1 then pays the auctioneer s 2 (the other guy’s surplus) Firm 1 is paid v 1 when it delivers the innovation. Prove: Neither firm wants to lie about its surplus s 1 or s 2 The winner makes nonnegative profit.

11. © Suzanne Scotchmer 09/07/2004 Contents May Be Used Pursuant to Creative Commons Attribution-NoDerivs-NonCommercial Common Deed 1.0Attribution-NoDerivs-NonCommercial Common Deed 1.0 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?