An Economic Model of Patent Exhaustion

38 Pages Posted: 23 Feb 2017 Last revised: 17 Apr 2017

Olena Ivus

Smith School of Business

Edwin L.-C. Lai

Hong Kong University of Science & Technology (HKUST) - Department of Economics

Ted M. Sichelman

University of San Diego School of Law

Date Written: February 21, 2017

Abstract

In the United States, the judge-made doctrine of "patent exhaustion" implies that the authorized sale of patented goods "exhausts'' the patent rights in the goods sold and precludes additional license fees from downstream buyers. However, in some instances, patent owners attempt to contractually restrict downstream buyers in order to preserve their right to collect such payments. Whether and when such contractual restrictions can overcome the doctrine of patent exhaustion has been the subject of many conflicting judicial decisions.

This paper offers a formal economic model of domestic patent exhaustion that explicitly incorporates transaction costs in licensing to consumers, and examines how a shift in patent policy from absolute to presumptive patent exhaustion (in which the patent owner can opt-out via contract) affects social welfare. The results show that when transaction costs are low, the regime of presumptive patent exhaustion is socially optimal, because it allows welfare-enhancing price discrimination via downstream licensing. Conversely, when transaction costs are high, the regime of presumptive patent exhaustion leads to a greater loss of static efficiency, because transaction cost frictions offset the benefits of price discrimination, but dynamic benefits in promoting ex ante investment in product quality may outweigh any static inefficiencies.

Keywords: Intellectual Property, Patent Exhaustion, First Sale Doctrine, Patent Licensing

JEL Classification: F10, O34

Suggested Citation

Ivus, Olena and Lai, Edwin L.-C. and Sichelman, Ted M., An Economic Model of Patent Exhaustion (February 21, 2017). San Diego Legal Studies Paper No. 17-265. Available at SSRN: https://ssrn.com/abstract=2921443 or http://dx.doi.org/10.2139/ssrn.2921443

Olena Ivus

Smith School of Business ( email )

Queen's University
143 Union Street
Kingston, Ontario K7L 3N6
Canada

Edwin L.-C. Lai

Hong Kong University of Science & Technology (HKUST) - Department of Economics ( email )

Clear Water Bay
Kowloon, Hong Kong
China

Ted M. Sichelman (Contact Author)

University of San Diego School of Law ( email )

5998 Alcala Park
San Diego, CA 92110-2492
United States
(619) 260-7512 (Phone)
(619) 260-2748 (Fax)

HOME PAGE: http://https://www.sandiego.edu/law/faculty/profiles/bio.php?ID=795

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