Market Structure and the Rewards for Patented Inventions

• DOI: 10.1177/0003603X7201700308
• Published date: 01 September 1972
• Date: 01 September 1972
• Author: Raymond Jackson
• Subject Matter: Article

MARKET

STRUCTURE

AND

THE

REWARDS

FOR

PATENTED

INVENTIONS

by

RAYMOND

JACKSON-

Though there is general agreement that market structure and

incentives for technological change are somehow related the area

of agreement is limited to just this result. Kenneth Arrow argues

that the incentive to invent is less under monopolistic than under

competitive conditions while Harold Demsetz concludes that a

competitive industry offers no greater incentive for invention than

amonopoly. 1Much of the apparent disagreement is due to the use

of incomplete models. Arrow neglects the importance of the

elasticity of demand in determining the inventor's reward. Dern-

setz considers an artificial construction where a monopolistic

industry and a competitive industry initially have the same unit

costs and identical outputs. In a recent article Kamien and

Schwartz resolve some of these difficulties but develop no general

model which allows an estimate of the importance of market

structure and demand elasticity on incentives." None of the above

distinguish between the effect of market structure on the develop-

ment of new products as opposed to inventions that lower the

costs of producing existing products.

This paper examines the rewards an inventor can gain from a

patent on a new product and from a patent which enables firms to

lower the cost of goods currentlyin production. The basic approach

*Professor of Economics, Boston University.

1See Kenneth Arrow, "Economic Welfare and the Alloca-

tion of Resources for Invention" in The Rate and Direction

of

Inventive Activity, National Bureau of Economic Research, Prince-

ton 1967, p. 619 and Harold Demsetz, "Information and Ef-

ficiency: Another Viewpoint," Journal

of

Law and Economics,

April 1969, p. 17.

2Morton Kamien and Nancy Schwartz, "Market Structure,

Elasticity of Demand and Incentive to Invent," Journal

of

Law

and Economics, April 1970, pp. 241-251.

911

912

THE

ANTITRUST

BULLETIN

is to calculate the royalty revenue received from a particular

industry under imperfectly competitive and under competitive

market structures." These estimates indicate whether changes in

market structure will significantly affect incentives and therefore

allows us to select industries where a public policy encouraging

competition, such as antitrust, would most likely be useful. Such

information has so far been notably absent in the current debate.

The first section considers the effect of market structure on

the inventor's ability to exploit apatent on a new product. The

second section extends the analysis to cover the rewards for a

patented cost-reducing invention.

MARKET STRUCTURE AND THE REWARD FOR A

NEWPRODUCT

The reward

for

the invention of a new product depends on the

demand for its use and the costs of production. In Figure 1 the

demand for the product is D-D and marginal production costs are

assumed constant and equal to MCo•Aroyalty per unit R charged

by the inventor raises the marginal cost to the licensed firms to

MC

o+R and affects both the market price and unit sales. If the

inventor can license his patent to a large number of firms in a

competitive industry the final selling price would equal MCo+R.

In general he is forced to license a limited number of firms who

will in fact

not

be perfectly competitive. A useful measure of the

competitiveness of a market is the divergence between price and

marginal cost. Denoting k as the index of market power we can

relate the selling price P to the costs of production and the royalty

as P =k(MCo+R). When the market is perfectly competitive k=

1. If the licensed firm (or firms) can achieve pure monopoly

pricing then k=11(1-1171) where

71

is the elasticity of demand for

the new product. In oligopolistic markets k. lies above the lower

limit set by competition depending on the degree of market

power. Bain estimates that an entry preventing price in an

3The graphical analysis used to compare these two types of

inventions follows John McGee, "Patent Exploitation: Some Eco-

nomic and Legal Problems," Journal

of

Law and Economics,

October 1966, pp. 135-162.