1. 38CO2000 Economics of Intellectual Property Rights (IPRs) Spring 2006: Lecture 2 Practical issues: -The course lasts until 3.5. -One lecture will be reduced against the lecture on 8.11, which is included in the course. The date will be announced later. -The exam is 9.5., 9-13. Needs a registration via weboodi.

2. Recapitulating from the last time: 1) The importance of the IPRs has dramatically increased over the past 30 years - We now know that technological progress is a major reason for economic growth and that IPRs are a major incentive mechanism that affects technological progress - Creation of the market for technology - Technological change - Legal changes - Success and failures of corporations 2) There is a wide array of various IPRs

3. Intellectual property rights Industrial Property Patents and other forms of protection of inventions Identification marks Copyrights Trade secret (secrecy)

4. 3) Knowledge is a public good. Non-rival and to various extent non- excludable. - There is a fundamental tradeoff between the creation of the incentive to innovate and using innovations once made - Ex ante, before investments in knowledge production, there is an appropriability problem. - Ex post, once knowledge exists, it does not wear out and there is no point to restricts its use -Intellectual property makes knowledge (more) excludable and hence creates the incentive to innovate ex ante but restricts its use ex post. -Appropriability follows from the nature of knowledge and institutions that support innovation. -This fundamental tradeoff is underlying the most debate concerning IPRs!

5. An example suppose it costs 1000.000€ to develop a new product MC of production = 50€ 100.000 buyers  the producer-innovator needs to get at least 60€ per product [(100.000*50+1000.000)/100.000] to make the innovative effort profitable suppose at least one other firm with an identical production technology enters in the industry suppose that there is no IPRs and the innovation is easy to copy, i.e., imitation/duplication cost  0€  in the competitive equilibrium the price will be 50€  both firms make zero profits  no incentive to make the innovation in the first place! This the essence of the appropriability problem (Arrow, 62)

6. Approbriability problem and the rise of IPRs Because of the approbriability problem, there is a market failure in the market for innovation (creating new knowledge). As usually, the source of market failure is that there is too little capitalism, i.e. property rights on knowledge are not well defined A straightforward solution: define property rights on knowledge, i.e., make products of knowledge excludable  intellectual property rights is a relatively old economic institution -e.g. chefs in Sybaris 700-500 BC - It is a puzzle whether IP is an old economic institution or a new. Is the notion of IP is inherent to humans?  rather capitalistic and democratic institution the rise of IPRs inherent to the rise of capitalism -e.g. formal patent law introduced 1474 in Venice

7. Another side of the coin: the ex post problem Once knowledge is created it is waste to restrict its use  widespread notion that knowledge should be a publicly accessible good  tensions trough history after major technological breakthrough, e.g., the antipatent movement of the end of 1800 century, compare with the free software movement There is nothing new in the current situation Let us develop the concepts used over this course and look the ex post problem in more detail It is also a major defect of IP compared with other institutions to support innovation

8. P (price) Q (quantity) or # of consumers MC Demand P(Q)=a-Q “willingness-to-pay” Q* P* Competitive market for “tangible” goods CS=W P max =a

9. In a competitive market for tangible (excludable, rival ) goods Producer surplus / profits (PS) = (P*-MC)Q*=0 Consumer surplus (CS) = (a-P*)Q*/2= Q *2/ 2 Social Welfare (W)= PS+CS=CS= (a-P*)Q*/2= Q* 2 /2 With integrals… Competitive markets are efficient since The good goes to the ones who value it most Price equals the opportunity cost of resources required to prodice the good (P=MC) i.e., the “indivisible hand” works Proofs…

10. P Q MC P(Q) Q*=Q max =a as P(Q)=a-Q P*=0 Market for non-proprietary information good -competitive - MC of production/duplication  0 CSc=Wc P max =a

11. In a market for non-proprietary information good (non-excludable, non- rival) PSc (little c stands for competitive given MC=0) = (P*-MC)Q*=0 CSc = (a-P*)Q*/2=a 2 /2 Wc = PSc+CSc=CSc=a 2 /2 A competitive market for non-proprietary information good is efficient like any other competitive market the ex post market!

12. P Q P(Q) QmQm PmPm Market for proprietary information goods MC a a=Q max CSp PSp DWL

13. In a market for a proprietary information good (excludable, non-rival) PSp (little p stands for proprietary) = (P m -MC) Q m = P m Q m >0=PSc CSp = (a-P m )Q m /2=( Q m ) 2 /2 < a 2 /2 = CSc Wp= PSp+CSp= P m Q m +(a-P m )Q m /2= (a+P m )Q m /2= <Wc Wc-Wp=DWL (Dead-weight loss due to proprietary pricing) A market for a proprietary information good is inefficient due to market power of the producer Recall: The problem ex ante i.e., the approbriability problem. There is no incentive to innovate unless PS>0. E.g., if the cost of innovation is 0<K<PSp, the information good is created under the proprietary system but not in the competitive system

14. In sum: there is a fundamental tradeoff between the creation of the incentive to innovate and spreading of innovations. If no IPRs or weak IPRs, there is little innovation If strong IPRs, there is price of innovations is too high and their use is restricted

15. Welfare Strength of IPRs

16. The current strong IPR/ “Intellectual Capitalism” era is rather young, about 30 years The question of our time: Does knowledge economy need to be capitalistic, i.e. do we need IPRs? - Cf. manifests, debate in popular press, free software movements, Boldrin-Levine, Bessen-Hunt etc In essence, would the incentive to innovate be sufficiently high or even higher without IPRs? Does not go well in the traditional left-right political division E.g, the Finnish MEPs that voted against the software patent directive last summer include Satu Hassi, Pia-Noora Kauppi, Eija-Riitta Korhola, Riitta Myller, Alexander Stubb… BUT as said there is nothing new in the current situation

17. An example: the adoption of patent law in Switzerland many rejections in the popular vote in the 19th century finally approved by the lobby from watch industry restricted to mechanical innovations because the Swiss chemical industry wanted to imitate Germans!

18. Note: there are other institutions to foster creation of knowledge than IP Public production Public procurement (contests) Subsidies Prizes - IP is not an ideal incentive mechanism. Nor are the others -The other mechanisms are better in solving the ex post problem but IP is better in solving the ex ante problem -Firms/innovators have better knowledge what should be invented or what is feasible to invent than the government -IP typically restricts the use of innovations (but only the users pay).

19. Is it optimal to combine the mechanisms, e.g., why publicly funded innovations are also protected by IPs? Is IP the best system? Is it possible to design the other systems better so that we can get rid off IPs? Come up with a new mechanism? Is it possible to design IP better? - Designing IP so that it does not restrict use while providing the incentive to innovate - Another major reason for the patent institution is disclosure i.e. spreading of innovations If IP is the best, are there too many or too few forms of IPRs? Do we need more sui generis IPRs (industry or even innovation specific IPRs)?

20. I.Intro II.Patent (and other IP) Policy II.1 Static context II.2 Cumulative context III.Management of Patents (and other IPs) III. 1. Patenting vs secrecy III. 2. Licensing IV. Competition Policy and IPRs V. Innovation and IPRs in Financial Services Sector Other… Overview