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					      Econ 522
   Economics of Law


Dan Quint
Spring 2012
Lecture 7
 Last week…


 Established properties of an efficient property law system
      Private goods are privately owned, public goods are not
      Owners have maximum liberty over how they use their property
      Injunctive relief used when transaction costs are low,
       damages used when transaction costs high


 We tried “testing Coase” through an experiment
      Can UW undergrads reallocate poker chips efficiently?
      (Cost me $162)



                                                                      1
 Our experiment…

 Take 1: Full Information (values on nametags)

                starting      efficient    actual final   fraction of potential
               allocation    allocation    allocation        gains realized
     12                       red chip      red chip
     10                      purple chip   purple chip
     10                      purple chip   purple chip
      8         red chip     purple chip
      8                      purple chip   purple chip
      6        purple chip                 purple chip
      6
      4        purple chip
      4        purple chip
      2        purple chip
                   32            60            58             26/28 = 93%



                                                                              2
 Our experiment…

 Take 2: Private Information (values hidden)

                 starting     efficient    actual final   fraction of potential
                allocation   allocation    allocation        gains realized
     10                       red chip     purple chip
      8                      purple chip    red chip
      8                      purple chip   purple chip
      6         red chip     purple chip
      6                      purple chip   purple chip
      4        purple chip                 purple chip
      4
      3        purple chip
      3        purple chip
      2        purple chip
                   24            48            44             20/24 = 83%



                                                                              3
 Our experiment…


 Take 3: Uncertainty
      All three chips got sold, at price of $8 each
      Rolled 1, 2, and 4, so two buyers lost money…
      …but we did achieve 100% of gains from trade


 Take 4: Asymmetric Information
      Rolled 3, 6, 6
      Two of the chips (the 3 and one 6) got sold
      60% of the gains from trade were realized
      (And even that surprised me!)


                                                       4
 Conclusion


 Coase works pretty well, except under asymmetric info

      Full info: 93% of gains achieved

      Private info: 83%

      Uncertainty: 100%

      Asymmetric info: 60%




                                                          5
 Comparing pure uncertainty to asymmetric
 information
 Consider a seller in the last two cases
      Your value = 2 x die roll, EV = $7.00


 If you know nothing…
      Trade at some price between $7 and $10.50
      Expected payoff might be $8 or $9


 If you know value exactly…
      Asymmetric information might stop you from being able to sell
      If so, expected payoff is $7


 So information has negative value!
                                                                       6
Discussion question

(old exam question, question by Alex Tabarrok at Marginal Revolution blog)


In Virginia, the common law has long held that if a
neighbor’s tree encroaches on your yard you may cut the
branches as they cross the property line, but any damage
the tree does to your property is your problem. Your
neighbor can even sue if your pruning kills the tree.
In 2007, the Virginia Supreme Court overruled this 70-year-
old precedent, making it your neighbor’s duty to prune or
cut down the tree if it is a “nuisance.”
Which is better: the new rule or the old? What would the
Coase Theorem say about the two rules?
                                                                             7
Applications of
Property Law




                  8
 Intellectual Property


 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


                                                                      9
                                         up-front investment: 1,000
 Information: costly to generate,        monopoly profits: 2,500
                                         duopoly profits: 450 each
 easy to imitate

 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 $450 each
                                                              10
                                                    up-front investment: 1,000
 Information: costly to generate,                   monopoly profits: 2,500
                                                    duopoly profits: 450 each
 easy to imitate

                             FIRM 1 (innovator)
                       Innovate                 Don’t
 FIRM 2 (imitator)
                                                        (0, 0)
         Imitate                  Don’t

        (-550, 450)          (1500, 0)


 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)
                                                                         11
                                                     up-front investment: 1,000
 Patents: one way to solve                           monopoly profits: 2,500
                                                     duopoly profits: 450 each
 the problem
 Patent: legal monopoly
      Other firms prohibited from imitating Firm 1’s discovery

                             FIRM 1 (innovator)
                       Innovate                 Don’t
 FIRM 2 (imitator)
                                                        (0, 0)
         Imitate                  Don’t

        (-550, 450)          (1500, 0)
            450 – P

 Subgame perfect equilibrium: firm 2 does not imitate;
  firm 1 innovates, drug gets developed                                   12
                                                      up-front investment: 1,000
  Comparing the two outcomes                          monopoly profits: 2,500
                                                      duopoly profits: 450 each


                                                         FIRM 1 (innovator)
                    FIRM 2 (imitator)
                                           Innovate     Don’t
Without patents:                                                     (0, 0)
     Drug never      Imitate              Don’t
      discovered
                     (-550, 450)         (1500, 0)

                                                         FIRM 1 (innovator)
 With patents:      FIRM 2 (imitator)
                                           Innovate     Don’t
     Drug gets
      discovered                                                     (0, 0)
     But…            Imitate              Don’t

                   (-550, 450 – P)       (1500, 0)                            13
                                                    up-front investment: 1,000
  Patents solve one inefficiency                    monopoly profits: 2,500
                                                    duopoly profits: 450 each
  by introducing another
 Without patents, inefficient outcome: drug not developed
 With patents, different inefficiency: monopoly!

                 Monopoly                                Duopoly
             Net Surplus = 2,750                    Net Surplus = 3,950

          CS
         1,250
P = 50
                          P = 100 – Q             CS
          Profit                                 4,050
          2,500                                                       DWL
                     DWL
                                        P = 10                         50
                     1,250                       Profit 450 x 2
                 Q = 50                                      Q = 90
 Once the drug has been found, the original incentive
  problem is solved, but the new inefficiency remains…                      14
 Patents: a bit of history


 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
                                                                 15
 Patent breadth




 Narrow patents might allow us each to patent own invention
 Broad patents might not
      “Winner-take-all” race to be first

                                                         16
 Patent breadth




 Does a patent on the “pioneering invention” cover the
  application as well?
 Can you patent an improvement to an existing product?
                                                          17
 Patent length


 Patent length
      Need to last long enough for firms to recover up-front investment…
      …But the longer patents last, the longer we have DWL from
       monopoly
      (Example from textbook: drug price drops from $15 to $1 per pill
       when patent expires)
      Tradeoff between ex-post inefficiency and ex-ante incentive provision


 U.S.: all patents last 20 years
      Jeff Bezos (founder of Amazon) once suggested software patents
       should last just 3 years
      Germany: full-term patents for major inventions, 3 year “petty
       patents” for minor ones, annual renewal fees
                                                                       18
 Do the details matter?


 Coase: without transaction costs, initial allocation of rights
  irrelevant for efficiency

 But transaction costs may be high
      Uncertainty on whether a patent is valid
      Uncertainty of outcome of research
      Many parties




                                                               19
 Do the details matter?


 Coase: without transaction costs, initial allocation of rights
  irrelevant for efficiency

 But transaction costs may be high
      Uncertainty on whether a patent is valid
      Uncertainty of outcome of research
      Many parties




                                                               20
 Do the details matter?


 Coase: without transaction costs, initial allocation of rights
  irrelevant for efficiency

 But transaction costs may be high
      Uncertainty on whether a patent is valid
      Uncertainty of outcome of research
      Many parties




                                                               21
 Alternatives to patents for encouraging
 innovation

 government purchase of drug patents

 prizes
      Google $30 million prize for landing a rover on the moon


 direct government funding of research
      ~25% of research spending in U.S. is funded by government




                                                                   22
patents
copyrights
trademarks
trade secrets



                23
 Copyright


 Property rights over original expressions
      writing, music, other artistic creations


 Creations like this 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
                                                               24
 Copyright


 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                              25
 Copyright




 Retelling of Gone With The Wind, from point of view of a
  slave on Scarlett’s plantation, published in 2001
      Margaret Mitchell’s estate sued to halt publication
      Eventually settled out of court
      Was there really any harm?
                                                             26
 Copyright




 Retelling of Gone With The Wind, from point of view of a
  slave on Scarlett’s plantation, published in 2001
      Margaret Mitchell’s estate sued to halt publication
      Eventually settled out of court
      Was there really any harm?
                                                             27
patents
copyrights
trademarks
trade secrets



                28
 Trademarks




 Reduce confusion over who made a product

 Allow companies to build reputation for quality

 Don’t expire, unless abandoned

 Generic names can’t be trademarked
                                                    29
 Trademarks – example


 WSJ article 9/17/2010: “Lars Johnson Has Goats On His
  Roof and a Stable of Lawyers To Prove It”
     Restaurant in Sister Bay WI put
      goats on roof to attract customers

     “The restaurant is one of the top-
      grossing in Wisconsin, and I’m
      sure the goats have helped.”

     Suing restaurant in Georgia

     “Defendant has willfully continued
      to offer food services from
      buildings with goats on the roof”
                                                                                   30
  http://online.wsj.com/article/SB10001424052748704285104575492650336813506.html
Trademark dilution




                     31
patents
copyrights
trademarks
trade secrets



                32
 Trade Secrets


 Protection against misappropriation

 But plaintiff must show…
      Valid trade secret
      Acquired illegally
      Reasonable steps taken to protect it




                                              33
patents
copyrights
trademarks
trade secrets



                34

				
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