Econ 522Economics of Law
Dan Quint
Fall 2009
Lecture 6
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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
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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?
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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
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Dynamic Games and Sequential Rationality
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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
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Dynamic games
FIRM 1 (entrant)
Enter Don’t EnterFIRM 2(incumbent)
Accommodate Fight
(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”
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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 0, 30
Accommodate Fight
Enter
Don’t Enter
Firm 2’s ActionF
irm 1
’s A
ctio
n
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Dynamic games
FIRM 1 (entrant)
Enter Don’t EnterFIRM 2(incumbent)
Accommodate Fight
(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
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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
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Back to…Property Law
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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
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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: 1,000monopoly profits: 2,500duopoly profits: 250 each
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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)
Innovate Don’t
FIRM 2 (imitator)
Imitate Don’t
(-750, 250) (1500, 0)
(0, 0)
up-front investment: 1,000monopoly profits: 2,500duopoly profits: 250 each
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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 solvethe problem
FIRM 1 (innovator)
Innovate Don’t
FIRM 2 (imitator)
Imitate Don’t
(-750, 250 – P) (1500, 0)
(0, 0)
up-front investment: 1,000monopoly profits: 2,500duopoly profits: 250 each
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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
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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
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Patent breadth
Two variables in patent law: how broad patents are, and how long they last
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Patent breadth
Two variables in patent law: how broad patents are, and how long they last
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Patent breadth
Two variables in patent law: how broad patents are, and how long they last
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Patent breadth
Two variables in patent law: how broad patents are, and how long they last
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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
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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
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patents
copyrights
trademarks
trade secrets
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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
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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
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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
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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
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patents
copyrights
trademarks
trade secrets
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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
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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
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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
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patents
copyrights
trademarks
trade secrets
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Protection against misappropriation
But plaintiff must show… Valid trade secret Acquired illegally Reasonable steps taken to protect it
Trade Secrets
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patents
copyrights
trademarks
trade secrets
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Methods of public ownership
How are property rights established, verified, lost
Exceptions and limitations to property rights
Thursday…