Essays on intellectual property rights and product differentiation

This dissertation is a collection of essays on intellectual property rights and optimal product selection when innovation occurs sequentially. One of the highlights of this dissertation has been to show the possibility of full rent extraction by the patent holder when uncertainty in litigation is taken into consideration. The result of the theoretical model has practical policy implication regarding the design of an optimal patent system. The other highlight of this dissertation is to show the coexistence of maximal and minimal product differentiation in a sequentially growing market. This result sheds light on the simulation of a multi-dimensional product space.

Brief Summaries of Chapters:

Chapter 1 presents a survey of the historical, legal, and economic aspects of patents. The emphasis in this survey is to recognize the crucial elements in the current patent law practice and to initiate research projects thereof.

Chapter 2 considers a model of sequential innovation in which patent infringement occurs and the outcome of litigation is uncertain. By recognizing the "diminishing returns to litigation" exhibited in the winning probability distribution function for the plaintiff, it is shown that a basic researcher holding a patent is able to extract all the profit facilitated by the basic innovation. More intriguingly, under rather general circumstances, broader patent breadth may diminish the patent holder's incentive to innovate.

Chapter 3 extends the previous model to include a rule on the reasonable royalty to determine the damage award. In addition to the full rent extraction results, the extended model further reveals that the second innovator has incentive to "invent around" with close imitation or "invent enough" with a much improved product. Comparative statics with respect to parameters of litigation cost and granted patent breadth are performed. Among other things, it is demonstrated that an increase in patent breadth, and an increase of litigation costs may neutralize each other.

Chapter 4 analyzes a model of two-dimensional product differentiation in which sequential entry occurs and the potential entrant outperforms the incumbent in innovating a new dimension. For a three-stage entry-variety-price duopoly, a unique subgame-perfect equilibrium is obtained and fully characterized. Most importantly, the entrant will completely utilize its capacity to innovate and achieve the principle of maximum differentiation with respect to the innovated variety. However, it is shown that with a sequentially growing product space, firms will not choose extreme opposite positions in all dimensions in order to soften price competition; the principle of minimum differentiation persists with respect to the traditional variety.