Suzanne Scotchmer 2007 from Innovation and Incentives MIT Press 2004

The (Public Goods) Nature of Knowledge &

Information Goods
Longitude Example: What is the lesson?
What do these have in common:
Knowledge that DNA is a double helix
software
digital music
Public Goods:
Nonrivalness: High cost to create; zero cost to distribute or
use. What is the efficiency conclusion?
Nonexcludability: If the good is nonexcludable, IP will
not work!!
Suzanne Scotchmer 2007 from Innovation and Incentives MIT Press 2004


-
p
Clocks

Demand curve
Marginal cost

Private Goods: The competitive market is efficient
price = marginal cost: Why is that efficient?
What if a template
must be developed?
Suzanne Scotchmer 2007 from Innovation and Incentives MIT Press 2004

Information Goods: the market doesnt work
(What is the price with free entry?)
(What is the price with intellectual property?)
(Isnt public funding better? Why or why not?)






mv




p m


dv




software users

pv
Idea (v,c)
Suzanne Scotchmer 2007 from Innovation and Incentives MIT Press 2004

What does IP do?
First, IP creates (as a legal matter) excludability.
Does this solve the public goods problem?
What about nonrivalness?
Second, IP provides at least a weak efficiency test as to
whether the value of investment exceeds cost
Third, IP does a bad job of delegation
It does not privilege the more efficient firms
It does not regulate entry and duplication
Fourth, IP leads to deadweight loss
Fifth, concentrates costs among the users
Suzanne Scotchmer 2007 from Innovation and Incentives MIT Press 2004

Intellectual Property: Compared to what?
Public Sponsorship?
1840s, photography: A patent buy-out.
1960s and 1970s Super Sonic Transport
Public support for private enterprise.
1700s and 1800s Lyons weavers
Prizes in a guild
Napoleon: Food preservation
Invention for the public good
NIH, NSF: Researcher-initiated projects
NASA: Targeted government objectives

Suzanne Scotchmer 2007 from Innovation and Incentives MIT Press 2004

Prizes
Targeted versus blue-sky research
Lyons (blue-sky)
Napoleons food-preservation (targeted)
Simple model: Invest in a blue-sky idea (v,c)?
Why not make the price depend on cost?
Why doesnt the prize-giver get ripped off?
Needs to make the price depend on value
Why doesnt the inventor get ripped off?
The role of IP as a background for prizes: Photography
Hyatt and celluoid
Suzanne Scotchmer 2007 from Innovation and Incentives MIT Press 2004

Simple Prizes and Scarce Ideas
A single inventor has an idea. He must decide whether to
invest in it, and we want him to make the right decision.
Model: An idea is a pair (v,c) where c is the cost of
making the idea an innovation and v is per-period profit.
(See the market diagram above.)
Investment is efficient if (1/r) v > c .
In the diagram, what is the defect of patents?
If we were going to use prizes instead, what value of prize
should we set?
(How does the optimal prize relate to v? to c?
How does this depend on what is observable? Verifiable?)

Suzanne Scotchmer 2007 from Innovation and Incentives MIT Press 2004

Prizes: Can the prize be linked to value?
How should the value of the prize be chosen?
How was the prize chosen in the case of longitude?
canning? The Lyonnaise silk weavers?
Would it be better to link the prize to cost?
What problems to patents and prize have in common?

Suzanne Scotchmer 2007 from Innovation and Incentives MIT Press 2004

Targeted objectives:
What if there is more than one idea?
Contestants 1,2 have ideas (v
1
,c
1
) , (v
2
,c
2
):
Need to aggregate information and choose the best idea:
Invest in idea-1 if (v
1
/r-c
1
) > (v
2
/r-c
2
)
(Not necessarily the lower-cost idea.)

c
2
v
2
/r
c
1
v
1
/r

How do we choose the best idea?
Depends on what we can observe.
What if we can observe both value and cost?
What if we can observe (verify) value, but not cost?

Suzanne Scotchmer 2007 from Innovation and Incentives MIT Press 2004

Vickrey Auction (mainly for econ fans)
Reminder: Vickrey (2nd-price) auction to auction an item.
Valuations v
1
,v
2,...
(Notice that v means something different.)
Want to make sure that the agent with the highest valuation
gets the object. How does a second-price auction do this?
Application to ideas:
Assume that v
1
,v
2
are observable, but not cost.
Rules: Agents report s
1
,s
2
where s
1
= (v
1
/r)-c
1
(surplus)
Firm 1 wins if s
1
>s
2
(otherwise firm 2 wins)
Firm 1 then pays the auctioneer s
2
(the other guys surplus)
Firm 1 is paid v
1
when it delivers the innovation.
Prove:
Neither firm wants to lie about its surplus s
1
or s
2

The winner makes nonnegative profit.
Suzanne Scotchmer 2007 from Innovation and Incentives MIT Press 2004

Contests: Choosing among Ideas
Fairly easy if value is observable (Vickrey auction)
Really hard if both value and cost are unobservable or
unverifiable. Why wont an auction work? What would you
auction?
Prototype Contest: firms develop prototypes; sponsor chooses
What is the problem if prototypes are solicited without any
commitment as to the price that will be paid?
Suppose that the government can make contingent contracts
before investing -- contingent on choosing the prototype.
Does it solve the problem of (1) ensuring the best idea? (2) at
cheapest cost?