1. Econ 522 Economics of Law Dan Quint Fall 2009 Lecture 6

2. 1  HW1: due Tues Oct 6, at the start of class  Officially: due at 11 a.m. sharp  Once I start my lecture, it’s late, will lose points  (Sorry, but I mean it)  Scheduling  Usual OH (Wed 1:30-3:30) this week  No office hours next Wednesday (Sept 30)  No lecture next Thurs (Oct 1)  Will hold extra OH Monday afternoon Oct 5, time TBA  And Monday afternoon Oct 12, time TBA Logistics

3. 2 1.What things can be privately owned?  Private goods should be privately owned  Public goods should be publicly provided/regulated 2.What can owners do with their property?  Maximum liberty – owners can do anything that doesn’t impinge on others’ rights/property 3.How are property rights established? 4.What remedy is given when rights are violated?  Low transaction costs  injunctive relief  High transaction costs  damages Last lecture: what would an efficient property law system look like?

4. 3  How is the law actually designed?  Can we find an economic rationale for the way the law is designed?  Today:  A bit more game theory: sequential rationality  First application of property law: intellectual property Next three lectures: applications

5. 4 Dynamic Games and Sequential Rationality

6. 5  Game theory we’ve seen so far: static games  “everything happens at once”  (nobody observes another player’s move before deciding how to act)  Dynamic games  one player moves first  second player learns what first player did, and then moves Dynamic games

7. 6 FIRM 1 (entrant) EnterDon’t Enter FIRM 2 (incumbent) AccommodateFight (10, 10)(-10, -10) (0, 30)  A strategy is one player’s plan for what to do at each decision point he/she acts at  In this case: player 1’s possible strategies are “enter” and “don’t”, player 2’s are “accommodate” and “fight”

8. 77  We can look for equilibria like before  we find two: (Enter, Accommodate), and (Don’t Enter, Fight)  question: are both equilibria plausible?  sequential rationality We can put payoffs from this game into a payoff matrix… 10, 10-10, -10 0, 30 AccommodateFight Enter Don’t Enter Firm 2’s Action Firm 1’s Action

9. 8 Dynamic games FIRM 1 (entrant) EnterDon’t Enter FIRM 2 (incumbent) AccommodateFight (10, 10)(-10, -10) (0, 30)  In dynamic games, we look for Subgame Perfect Equilibria  players play best-responses in the game as a whole, but also in every branch of the game tree  We find Subgame Perfect Equilibria by backward induction  start at the bottom of the game tree and work our way up

10. 9  Firm 1 knows firm 2 is rational  So he knows that if he enters, firm 2 will do the rational thing – accommodate  So we enters, counting on firm 2 to accommodate  This is the idea of sequential rationality – the assumption that, whatever I do, I can count on the players moving after me to behave rationally in their own best interest The key assumption behind subgame perfect equilibrium: common knowledge of rationality

11. 10 Back to… Property Law

12. 11  Intellectual property: broad term for ways that an individual, or a firm, can claim ownership of information  Patents – cover products, commercial processes  Copyrights – written ideas (books, music, computer programs)  Trademarks – brand names, logos  Trade Secrets Intellectual Property

13. 12  Example: new drug  Requires investment of $1,000 to discover  Monopoly profits would be $2,500  Once drug has been discovered, another firm could also begin to sell it  Duopoly profits would be $250 each Information: costly to generate, easy to imitate up-front investment: 1,000 monopoly profits: 2,500 duopoly profits: 250 each

14. 13  Solve the game by backward induction:  Subgame perfect equilibrium: firm 2 plays Imitate, firm 1 plays Don’t Innovate, drug is never discovered  (Both firms earn 0 profits, consumers don’t get the drug) Information: costly to generate, easy to imitate FIRM 1 (innovator) InnovateDon’t FIRM 2 (imitator) ImitateDon’t (-750, 250)(1500, 0) (0, 0) up-front investment: 1,000 monopoly profits: 2,500 duopoly profits: 250 each

15. 14  Patent: legal monopoly  Other firms prohibited from imitating Firm 1’s discovery  Subgame perfect equilibrium: firm 2 does not imitate; firm 1 innovates, drug gets developed Patents: one way to solve the problem FIRM 1 (innovator) InnovateDon’t FIRM 2 (imitator) ImitateDon’t (-750, 250 – P)(1500, 0) (0, 0) up-front investment: 1,000 monopoly profits: 2,500 duopoly profits: 250 each

16. 15  Without patents, inefficient outcome: drug not developed  With patents, different inefficiency: monopoly!  Once the drug has been found, the original incentive problem is solved, but the new inefficiency remains… BUT… patents solve one inefficiency by introducing another CS Profit P * = 50 P = 100 – Q Q * = 50 DWL

17. 16  First U.S. patent law passed in 1790  Patents currently last 20 years from date of application  For a patent application to be approved, invention must be:  novel (new)  non-obvious  have practical utility (basically, be commercializable)  Patentholder whose patent has been infringed can sue for both damages and an injunction against future violations  Patents are property – can be sold or licensed to others Patents: a bit of history

18. 17  Patent breadth Two variables in patent law: how broad patents are, and how long they last

19. 18  Patent breadth Two variables in patent law: how broad patents are, and how long they last

20. 19  Patent breadth Two variables in patent law: how broad patents are, and how long they last

21. 20  Patent breadth Two variables in patent law: how broad patents are, and how long they last

22. 21  Patent breadth  Patent length  tradeoff: how long to maintain ex-post inefficiency (monopoly) to create enough incentive for innovation? Two variables in patent law: how broad patents are, and how long they last

23. 22  Patent breadth  Patent length  tradeoff: how long to maintain ex-post inefficiency (monopoly) to create enough incentive for innovation?  Alternatives to patents  government purchase of drug patents  prizes  direct government funding of research Two variables in patent law: how broad patents are, and how long they last

24. 23 patents copyrights trademarks trade secrets

25. 24  Property rights over original expressions  writing, music, other artistic creations  These tend to fit definition of public goods  nonrivalrous  nonexcludable  so private supply would lead to undersupply  Several possible solutions  government subsidies  charitable donations  legal rights to creations – copyrights Copyright

26. 25  Copyright law less rigid than patent law  Unlike patent law, allows for certain exceptions  Copyrights last much longer than patents  Current U.S. law: copyright expires 70 years after creator’s death  No application process  Copyright law automatically applies to anything you’ve written/created Copyright

27. 26  Copyright law less rigid than patent law  Unlike patent law, allows for certain exceptions  Copyrights last much longer than patents  Current U.S. law: copyright expires 70 years after creator’s death  No application process  Copyright law automatically applies to anything you’ve written/created  Copyrights more narrow than patents  Cover exact text, not general idea Copyright

28. 27  Copyright law less rigid than patent law  Unlike patent law, allows for certain exceptions  Copyrights last much longer than patents  Current U.S. law: copyright expires 70 years after creator’s death  No application process  Copyright law automatically applies to anything you’ve written/created  Copyrights more narrow than patents  Cover exact text, not general idea Copyright

29. 28 patents copyrights trademarks trade secrets

30. 29 Trademarks  Trademarks do not expire, as long as they’re not “abandoned”  No trade-off between long-term incentives (innovation) and short- term inefficiency (monopoly) – little apparent downside

31. 30 Trademarks  Trademarks do not expire, as long as they’re not “abandoned”  No trade-off between long-term incentives (innovation) and short- term inefficiency (monopoly) – little apparent downside

32. 31  Trademarks do not expire, as long as they’re not “abandoned”  No trade-off between long-term incentives (innovation) and short- term inefficiency (monopoly) – little apparent downside  Protected against infringement and also dilution Trademarks

33. 32 patents copyrights trademarks trade secrets

34. 33  Protection against misappropriation  But plaintiff must show…  Valid trade secret  Acquired illegally  Reasonable steps taken to protect it Trade Secrets

35. 34 patents copyrights trademarks trade secrets

36. 35  Methods of public ownership  How are property rights established, verified, lost  Exceptions and limitations to property rights Thursday…