Economists have long had a wide agreement on the best way to approach the economics of patents. The analysis is of long enough standing and well enough known that we may without exaggeration describe it as a classic piece of economic analysis. To a considerable extent, the analysis also applies to other forms of intellectual property, such as copyright, as well as patents. (This is not to say there is wide agreement on the conclusions of the analysis. As we will see, the conclusions depend on the details, as is so often the case. In Ross Perot's words, "The devil is in the details.")
Patent rights are a form of intellectual property designed to remedy the incentive problem by giving the inventor a monopoly in the use of her invention. The inventor may assign this right to another, such as her employer. (Indeed, the employer can require assignment as a condition of employment). The patent right may also be sold. The holder of the patent right may give others permission to use the patented invention in return for a money fee; this is called "licensing" the patent. Whether the patent is sold, assigned, licensed, or exploited by the inventor herself, the patent right creates a monopoly, and it is the monopoly profits that make the patent a profitable investment for a buyer or licensee.
So, let's apply the economic theory of monopoly and see what we find. For simplicity, suppose the invention is a new consumer product, such as a pharmaceutical, consumer electronic product, or a new kind of kitchen appliance. Also for simplicity, assume that the new consumer product can be produced under conditions of constant long run (average) cost. In Figure 1, output of the patented good (per period) is on the horizontal axis, price, cost, and benefits are on the vertical axis, and the average cost of production is shown by the horizontal line C, in red. The cost of developing the invention itself is not included in the average cost of production c. Remember that, with long run constant average costs, the marginal cost of production is the same as the average cost, so line C is also the marginal cost curve. Line D, in blue is the consumer demand relation. Line MR, also in blue, is the marginal revenue earned by the monopoly.
Recall, again, that we can interpret the demand relation as a marginal benefit curve. Using what we know about optimal production, we can immediately say that the optimal production of this consumer good will be at Q2, where the marginal benefit is equal to the marginal cost.
However, if Q2 is produced and sold, the monopolist will not have any profits -- price is equal to average cost. Therefore, the monopolist will raise the price above c, moving output and price backward along the demand relation D. The output that gives the biggest (maximum) profit to the monopolist is Q1, where the marginal cost line C intersects the marginal revenue curve, MR. Therefore, Q1 is the amount a profit-seeking monopolist will try to produce and sell. The price charged is p0 and the monopolist's profit is Q1*(p0-C). which can be visualized as the area of the rectangle p0xzC.
Patents, Monopoly, and Efficiency
Copyright