econ 522 economics of law dan quint fall 2009 lecture 6

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)


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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)


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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


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Patent breadth


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Patent breadth


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Patent breadth

Patent length tradeoff: how long to maintain ex-post inefficiency (monopoly) to

create enough incentive for innovation?


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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


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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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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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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…

econ 522 economics of law dan quint fall 2009 lecture 6

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