Econ 522Economics of Law

Dan QuintFall 2011Lecture 7

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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 $124)

Monday…

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Take 1: Full Information (values on nametags)

Our experiment…

26/28 = 93%586032

purple chip2

purple chip4

purple chip4

(sorry)6

purple chip6

purple chippurple chip8

purple chip

purple chipred chip8

purple chippurple chip10

purple chippurple chip10

red chipred chip12

fraction of potential gains realized

actual final allocation

efficientallocation

startingallocation

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Take 2: Private Information (values hidden)

Our experiment…

18/24 = 75%424824

purple chip2

purple chip3

purple chip3

4

purple chippurple chip4

red chippurple chip6

purple chipred chip6

purple chippurple chip8

purple chippurple chip8

purple chipred chip10

fraction of potential gains realized

actual final allocation

efficientallocation

startingallocation

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Take 3: Uncertainty

Take 4: Adverse Selection

Our experiment…

100%12128

chip2 X die roll(actually 8)

chipchip3 X die roll(actually 12)

fraction of potential gains realized

actual finalallocation

efficientallocation

startingallocation

0%121812

chip2 X die roll(actually 12)

chip

chip3 X die roll(actually 18)

fraction of potential gains realized

actual finalallocation

efficientallocation

startingallocation

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Coase works pretty well, except under asymmetric info Full info: 93% of gains achieved Private info: 75% Uncertainty: 100% Asymmetric info: 0%

Comparing “uncertainty” to “asymmetric info”… Seller’s value was 2 X die roll, buyer’s value was 3 X die roll If nobody knows die roll, no problem – they can trade based on the

expected value But if seller knows die roll, problem In strategic settings, information can have negative value –

the seller could be worse off for having information!

Conclusion

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(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?

Discussion question

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Applications ofProperty 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 $450 each

Information: costly to generate, easy to imitate

up-front investment: 1,000monopoly profits: 2,500duopoly profits: 450 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

(-550, 450) (1500, 0)

(0, 0)

up-front investment: 1,000monopoly profits: 2,500duopoly profits: 450 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

(-550, 450) (1500, 0)

(0, 0)

up-front investment: 1,000monopoly profits: 2,500duopoly profits: 450 each

450 – P

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Comparing the two outcomes

FIRM 1 (innovator)

Innovate Don’tFIRM 2 (imitator)

Imitate Don’t

(-550, 450) (1500, 0)

(0, 0)

up-front investment: 1,000monopoly profits: 2,500duopoly profits: 450 each

FIRM 1 (innovator)

Innovate Don’tFIRM 2 (imitator)

Imitate Don’t

(-550, 450 – P) (1500, 0)

(0, 0)

Without patents: Drug never

discovered

With patents: Drug gets

discovered But…

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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…

Patents solve one inefficiencyby introducing another

CS1,250

Profit2,500

P = 50P = 100 – Q

Q = 50

DWL1,250

CS4,050

Profit 450 x 2P = 10

Q = 90

DWL50

Monopoly Duopoly

up-front investment: 1,000monopoly profits: 2,500duopoly profits: 450 each

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

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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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Narrow patents might allow us each to patent own invention Broad patents might not

“Winner-take-all” race to be first

Patent breadth

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Does a patent on the “pioneering invention” cover the application as well?

Can you patent an improvement to an existing product?

Patent breadth

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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

Patent length

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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

Do the details matter?

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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

Do the details matter?

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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

Do the details matter?

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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

Alternatives to patents for encouraging innovation

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patents

copyrights

trademarks

trade secrets

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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

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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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?

Copyright

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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?

Copyright

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patents

copyrights

trademarks

trade secrets

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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

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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 continuedto offer food services from buildings with goats on the roof”

http://online.wsj.com/article/SB10001424052748704285104575492650336813506.html

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Trademark dilution

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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