Econ 522 Economics of Law Dan Quint Fall 2011 Lecture 7

1  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…

2  Take 1: Full Information (values on nametags) Our experiment… 26/28 = 93% purple chip2 4 4 (sorry)6 purple chip6 8 red chip8 purple chip 10 purple chip 10 red chip 12 fraction of potential gains realized actual final allocation efficient allocation starting allocation

3  Take 2: Private Information (values hidden) Our experiment… 18/24 = 75% purple chip red chip purple chip6 red chip6 purple chip 8 8 red chip10 fraction of potential gains realized actual final allocation efficient allocation starting allocation

4  Take 3: Uncertainty  Take 4: Adverse Selection Our experiment… 100%12 8 chip 2 X die roll (actually 8) chip 3 X die roll (actually 12) fraction of potential gains realized actual final allocation efficient allocation starting allocation 0% chip 2 X die roll (actually 12) chip 3 X die roll (actually 18) fraction of potential gains realized actual final allocation efficient allocation starting allocation

5  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

6 (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

7 Applications of Property Law

8  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

9  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: 1,000 monopoly profits: 2,500 duopoly profits: 450 each

10  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) InnovateDon’t FIRM 2 (imitator) ImitateDon’t (-550, 450)(1500, 0) (0, 0) up-front investment: 1,000 monopoly profits: 2,500 duopoly profits: 450 each

11  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 solve the problem FIRM 1 (innovator) InnovateDon’t FIRM 2 (imitator) ImitateDon’t (-550, 450)(1500, 0) (0, 0) up-front investment: 1,000 monopoly profits: 2,500 duopoly profits: 450 each 450 – P

12 Comparing the two outcomes FIRM 1 (innovator) InnovateDon’t FIRM 2 (imitator) ImitateDon’t (-550, 450)(1500, 0) (0, 0) up-front investment: 1,000 monopoly profits: 2,500 duopoly profits: 450 each FIRM 1 (innovator) InnovateDon’t FIRM 2 (imitator) ImitateDon’t (-550, 450 – P)(1500, 0) (0, 0) Without patents:  Drug never discovered  With patents:  Drug gets discovered  But…

13  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 inefficiency by introducing another CS 1,250 Profit 2,500 P = 50 P = 100 – Q Q = 50 DWL 1,250 CS 4,050 Profit 450 x 2 P = 10 Q = 90 DWL 50 MonopolyDuopoly up-front investment: 1,000 monopoly profits: 2,500 duopoly profits: 450 each Net Surplus = 2,750Net Surplus = 3,950

14  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

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

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

17  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

18  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?

19  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?

20  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?

21  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

22 patents copyrights trademarks trade secrets

23  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

24  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

25  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

26  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

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 Trademark dilution

31 patents copyrights trademarks trade secrets

32  Protection against misappropriation  But plaintiff must show…  Valid trade secret  Acquired illegally  Reasonable steps taken to protect it Trade Secrets

33 patents copyrights trademarks trade secrets