Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Intellectual Property
E. Glen Weyl
University of Chicago
Lecture 12
Elements of Economic Analysis II
Fall 2013
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Introduction
Intellectual property: monopoly right to produce for time
Copyrights, patents, trade secrets, “authenticity rents”
One of the oldest tools of economic policy
At least back to 7th century BCE Greece
Today we’ll learn trade-offs, relationship to punishment of crime
1
What monopoly profits incentivize
2
Creative destruction and the dynamics of markets
3
Static and dynamic effects of crime
4
Importance of incentives for innovation
5
Harms of intellectual property
6
Innovation incentives v. ex-post distortion trade-off
7
Model of optimal intellectual property
8
Comparative statics and lessons for policy
9
Broader perspectives
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Incentives and monopoly rents
What monopoly incentivizes
Creative destruction and the importance of dynamics
Monopoly profits as an incentive
So far we viewed monopoly profits as transfer
Sometimes viewed as benign, total welfare
Redistribution might lead us to oppose
But monopoly rents/profits encourage pursuit of monopoly
Some may be left as rent, but substantial elasticity
If large, we should see monopoly more as price than rent
What it gives price to depends on how monopoly obtained
1
Activity could be pure waste/rent-seeking
In this case, monopoly profits are deadweight loss too!
This makes monopoly much worse than standard analysis
2
Could be the creation of new market
Then monopolist only captures profit, not CS
=⇒ Creating market has positive “entrepreneurial” externality
This makes monopoly far better than standard analysis
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Incentives and monopoly rents
What monopoly incentivizes
Creative destruction and the importance of dynamics
The rectangle and the triangle
In many cases crucial because profits greater than DWL
True in classic monopoly with some demands
When DWL large, so is CS
But more importantly, with other market power always
Just like on your exam
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Incentives and monopoly rents
What monopoly incentivizes
Creative destruction and the importance of dynamics
Ways of gaining a monopoly position
We have talked about ways of getting monopoly, refresh?
1
Protection by the government from lobbying
Examples: licensure, chartered corporations in history
Useful if just exporting-import: monopoly for nation
2
Private/illegal violence
Mafia controls industries: illegal industries and casinos
Exclusionary practices may be similar in some cases
3
Forming an illegal cartel in legal industry
Antitrust laws prevent, but did not in Europe before EU
Still occurs quite frequently: vitamins
4
Merger
Government reviews, but doesn’t always catch
In some countries, all mergers legal: beer in Perú
5
Intellectual property
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Incentives and monopoly rents
What monopoly incentivizes
Creative destruction and the importance of dynamics
Social value of ways of obtaining monopoly
What does each encourage, beyond static distortion?
1
Protection by government from lobbying
Expenditures on lobbying, cosying up to politicians
Bad if through payments to politician but...
If brings benefits to district, charity, research not terrible
2
3
Private/illegal violence: violence, very bad
Illegal cartel
May encourage some waste on enforcing illegally
Mostly quite similar to a merger
4
Merger
May result in some diseconomies of scale
Also encourages entry for buyout (upcoming problem set)
5
Intellectual property
We’ll stress benefits of entry, but also racing, stealing
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Incentives and monopoly rents
What monopoly incentivizes
Creative destruction and the importance of dynamics
Schumpeter’s “creative destruction”
Schumpeter emphasized importance of these dynamics
Most of what matter is innovation, progress
Static distortions likely fairly small (Harberger, etc.)
Creative power of capitalism transformed society
Be a bit careful: discounting, etc.; but broadly right
=⇒ Biggest industrial issues competitive process?
1
2
Far too much traditional emphasis on static distortions
Greatest threat to monopoly is being superseded
Comfortable monopolist left behind by new technology
3
4
5
Most important goal to incentivize this “creative destruction”
May require concentration to afford R&D
Innovation in hopes of (temporary) monopoly power
=⇒ Industrial policy should focus on new products
Only eliminate static distortion if does not conflict
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Incentives and monopoly rents
What monopoly incentivizes
Creative destruction and the importance of dynamics
Creative destruction in action
Schumpeterian competitive process resonates with high tech:
1
Facebook and previous social networks
Swept away competitors who were first to market
2
Apple’s repeated revolutions
Company defined not by product, but by process
Repeatedly changed the terms of competition
Not just quality, prices, but ways of looking at technology
3
Google’s trail blazing
Latecomer to search market dominated in few years
Benefits far outstrip marginal improvements
Google’s dominant position worth it?
4
Smartphones and Apps
Every six months who new business models
Less clear in other industries (even operating systems)
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Crime: static v. dynamic perspective
Basic trade-off in intellectual property
A model of optimal IP
Much crime is beneficial from a static perspective
An analogy may be useful to show importance of dynamics
Most criminal activity is by poor not rich
The law, in its majestic equality, forbids the poor and rich
man equally from sleeping underneath a bridge.
- Anatole France
=⇒ Most (property) criminal activity redistributive
Much entails little efficiency loss direct, just redistribution
Most efficiency loss comes from attempts to prevent
Redistribution good because of declining marginal utility
=⇒ From static perspective, crime should be legal!
Whenever an absurd conclusion, examine premises
What are long-term/dynamic effects of crime?
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Crime: static v. dynamic perspective
Basic trade-off in intellectual property
A model of optimal IP
Why dynamics are important in crime and monopoly
Of course crime is illegal because it would encourage:
1
2
3
Waste on criminal rather than productive activity
Waste on preventing others from stealing
Would discourage work more than optimal redistribution
None of these show up in static analysis
=⇒ Cannot have a theory of crime without dynamics
Schumpeter would argue industrial economics similar
Without dynamics cannot rationalize most policies
Static effects should be kept in mind, but just beginning
Do not get overly tied to the DWL triangle
Similarities between crime and IO broader
In crime, punishments instead of fines
=⇒ Deterring crime has (static) inefficiency cost
Similarly encouraging innovation has static DWL
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Crime: static v. dynamic perspective
Basic trade-off in intellectual property
A model of optimal IP
Harms created by intellectual property
So one harm created by IP is static DWL, but others?
1
Discouraging follow-on innovation
If you know idea patent, don’t build on it
Any benefit you get from follow-on held-up by original
Also can be costly even to access information
2
Litigation, negotiations, etc. can be complex, costly
Often hard even know what is or is not patented
Is given application covered or not?
Companies try to avoid such litigation at all costs
3
Can reduce intrinsic motivation to create
If quantity reduced, also reduces visibility
=⇒ Initial entrepreneurs afraid patent down road reduces use
“Common Public License” in “open source” software
Growing part of all software development
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Crime: static v. dynamic perspective
Basic trade-off in intellectual property
A model of optimal IP
intellectual property rights and innovation
15
Williams (2013)’s evidence
of ex-post distortion
TABLE 3
Cross-Section Estimates: Impact of Celera’s IP on Innovation Outcomes
ð1Þ
A. Publications in 2001–9
ðmean 5 2.197Þ:
Celera
B. 1ðknown, uncertain
phenotypeÞ ðmean 5 .453Þ
Celera
C. 1ðknown, certain
phenotypeÞ ðmean 5 .081Þ
Celera
D. 1ðused in any diagnostic
testÞ ðmean 5 .060Þ
Celera
Indicator variables for year of
disclosure
Number of publications in each
year 1970–2000
Detailed cytogenetic and molecular covariates
Observations
ð2Þ
ð3Þ
2.877
ð.177Þ***
2.328
ð.099Þ***
2.264
ð.107Þ***
2.162
ð.015Þ***
2.158
ð.015Þ***
2.128
ð.017Þ***
2.027
ð.007Þ***
2.017
ð.006Þ***
2.014
ð.007Þ**
2.023
ð.006Þ***
2.014
ð.005Þ***
2.013
ð.006Þ**
Yes
Yes
Yes
No
Yes
Yes
No
27,882
No
27,882
Yes
16,485
Note.—Gene-level
All2013
estimatesIPare from OLS models. The samples in
Weyl, observations.
ECON20110, Fall
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Crime: static v. dynamic perspective
Basic trade-off in intellectual property
A model of optimal IP
Why innovation is always under-rewarded
Nonetheless, getting rewards to innovation very important:
1
At best, entrepreneur gets profits
But also generates consumer surplus
Called “market maker externality”
2
Significantly lessened by price discrimination
However almost always imperfect, as we saw
Much more attractive to allow innovator to allow here
Very big in pharmaceutical industry
Also happens through licensing negotiations for patent use
3
Formal government protection also encourages disclosure
Otherwise innovator would hold as secret to avoid copying
Allows follow-on innovators to build on it
Increases rate of advance of technical knowledge
=⇒ Some IP exists even without government
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Crime: static v. dynamic perspective
Basic trade-off in intellectual property
A model of optimal IP
localized
0
.2
.4
.6
five−year survival rate
# clinical trials
# clinical trials / life−year lost
(a) R&D investments by five-year survival rates
Weyl, ECON20110, Fall 2013
IP
.8
.001
.0012
8,000
.0014
10,000
.0016
regional
number of clinical trials / life−year lost
.0018
metastatic
6,000
number of clinical trials
12,000
Figure 1:
time and R&D investments: Stage-level data
Budish
etSurvival
al. (2013)’s
evidence of incentive effects
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Crime: static v. dynamic perspective
Basic trade-off in intellectual property
A model of optimal IP
The fundamental IP trade-off
=⇒ Fundamental trade-off of incentives v. ex-post distortion
1
2
More IP protection costs DWL
More IP protection benefits from more innovation
First protection brings only profits
Harberger triangle is triangle, so no loss
Eventually near peak profits, so only loss
Near monopoly optimal price, no gain from more protection
=⇒ Optimal protection always partial
Question is where between: costs v. benefits
1
Costs?
Deadweight loss from lost consumption
Deadweight loss from reduced follow-on innovation
2
Benefits?
Incentives to innovate product
Incentives to disclose, rather than holding as trade secret
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Crime: static v. dynamic perspective
Basic trade-off in intellectual property
A model of optimal IP
The supply and social demand for innovation
Let’s focus just on consumption distortion v. incentives
Each innovation creates market for new product
Products have no marginal cost of production
Most intellectual goods nearly free to copy
All have same (average) demand function Q(p)
Normalize Q(0) = 1 and monopoly price to p = 1
CS(p) =
R∞
x=p
Q(x)dx
Firm earns profits π(p) = pQ(p)
Innovations costly to produce; why?
Capital, time, most innovations don’t actually turn out
=⇒ Supply of innovations S(π)
Total welfare: consumers plus producers?
R π(p)
S (π(p)) CS(p) + π=0 S(π)dπ
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Solution and formula
Comparative statics and interpretation
Alternatives and alternative trade-offs
Calculating optimal IP
Take first-order condition?
π 0 (p)S 0 (π(p)) CS(p) + CS 0 (p)S (π(p)) + π 0 (p)S (π(p)) = 0
We can drop arguments and becomes?
π 0 S 0 CS = −S (CS 0 + π 0 )
Let DWL(p) = CS(0) − CS(p) − π(p)
Note that DWL0 (p) = −CS 0 (p) − π 0 (p) > 0 for p > 0
Thus we can rewrite it as?
π 0 S 0 CS = DWL0 S
S ≡
S0 π
S ,
so dividing through by Sπ 0 gives
S CS
π =
Weyl, ECON20110, Fall 2013
IP
DWL0
CS 0
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Solution and formula
Comparative statics and interpretation
Alternatives and alternative trade-offs
A formula for optimal innovation
This is crucial formula!
S
|{z}
elasticity of innovation supply
·
CS
π
|{z}
=
externality-to-reward ratio
DWL0
π0 }
| {z
marginal cost of incentives
This means that protection should be greater if?
1
2
3
Elasticity of innovation supply greater
More externalities generate per-unit profit
Less costly to reward innovations (less DWL per profit)
We would like to verify basic intuitions?
1
2
Higher is elasticity, more protection is optimal
Higher is DWL
π less is optimal
Take broader interpretation, but need demand form here
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Solution and formula
Comparative statics and interpretation
Alternatives and alternative trade-offs
Pass-through and a useful demand form
So we want a demand form that varies
DWL
π
Remember that pass-through affects
Also determines
DWL
π ;
CS
π
more curved both ways
Higher pass-through, higher is DWL
π
Simple class is that with constant pass-through ρ
Some special cases include everything you’ve seen:
1
2
3
Constant elasticity
Linear
Exponential
General form given by:
ρ
Q(p) = [1 − (1 − ρ)p] 1−ρ
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Solution and formula
Comparative statics and interpretation
Alternatives and alternative trade-offs
Calibrating the model
This form is very easy two work with:
1
1
CS(p) = [1 − (1 − ρ)p] 1−ρ
2
DWL(p) = 1 − (1 + ρp) [1 − (1 − ρ)p] 1−ρ
Etc., etc.
1
3
With this in hand, just need parameter ranges:
1
Many studies estimate S , rough .5 − 1
Data from earlier one example, but many others
Usually look at market expanding triggering innovation
Example: iPhone on Verizon’s effect on App development
2
Pass-through data much harder
Einav et al. (2012) indicates it may be all over the map
Besanko et al. (2005) best other: usually between .5 and 2
Let’s run with this last assumption, look at range
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Solution and formula
Comparative statics and interpretation
Alternatives and alternative trade-offs
Comparative statics
On left, higher is ρ; right higher is S
=⇒ Desired comparative statics:
1
2
Higher DWL
π lowers optimal protection
Higher S raises optimal protection
Optimal protection between .45 and .65
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Solution and formula
Comparative statics and interpretation
Alternatives and alternative trade-offs
Conclusions and interpretation
How does this match up with practice?
1
Patent length in US is about 20 years
Assuming 5% interest rate, compute “fraction of total life
1 − .9520 = .64, but incomplete, interest rate high
=⇒ US patent protection in the right range
2
Should also take into account other harms, benefits
Reduction in follow-on innovation part of DWL0
Importance of disclosure also part of CS
π
3
Unlike US practice, should probably differ by industry
Some of this may occur through enforcement, etc.
But less developed than similar for law enforcement
Industries with low S , high DWL should have less
Tech sector should have less (self-motivated, lawsuits costly)
Pharmaceuticals more (costly to create, discrimination)
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Solution and formula
Comparative statics and interpretation
Alternatives and alternative trade-offs
Other policy tools for encouraging innovation
While basic trade-off, many other tools to encourage innovation
1
Research and development subsidies
Extensive in US, tax credits, National Science Foundation
Also private through labs for good PR
2
Prizes or buyouts of patents
Historically popular and increasingly again (X-prizes)
3
Subsidies for purchasing innovative products
Common argument for buying green technology
4
5
Patent length v. breadth
Novelty, usefulness and non-obviousness requirements
Partly related to breadth, requirements of code
How should they be interpreted?
6
Division between sequential innovations
Which parts get best protection? Patent pools?
Weyl, ECON20110, Fall 2013
IP
Long-Term Incentives of Monopoly
Crime, Punishment and Intellectual Property
Optimal Intellectual Property
Solution and formula
Comparative statics and interpretation
Alternatives and alternative trade-offs
Trade-offs with other policy tools
Trade-offs in using other tools different
1
Research and development subsidies/corporate tax
Benefit: helps internalize CS
Cost: may want to redistribute form entrepreneurs
Gain overall: separate distribution from targeting
2
My job market paper explored IP v. prizes, subsidies
Smith quote: hard for planner to know what’s worthy
3
Length vs. breadth trade-off
Length over breadth: allows low DWL
π per period
Breadth v length: initial more important, buyout
Gain: lower overall DWL
π , more efficient reward
4
Division between sequential innovations
Patent pooling reduces DWL raises gains
Target based on elasticities
5
Criteria largely open question still
Weyl, ECON20110, Fall 2013
IP