An Economic Model of Patent Exhaustion

30 Pages Posted: 19 Nov 2019 Last revised: 26 Jun 2020

See all articles by Olena Ivus

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

Multiple version iconThere are 2 versions of this paper

Date Written: November 4, 2019

Abstract

The 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. Courts have considered absolute exhaustion, in which the patent owner forfeits all rights upon an authorized sale, and presumptive exhaustion, in which the patent owner may opt-out of exhaustion via contract. This paper offers the first economic model of domestic patent exhaustion that incorporates transaction costs in licensing downstream buyers and considers how the shift from absolute to presumptive exhaustion affects social welfare. We show that when transaction costs are high, the patent owner has no incentive to individually license downstream users, and absolute and presumptive exhaustion regimes are equivalent. But when transaction costs are at the intermediate level, the patent owner engages in mixed licensing, individually licensing high-valuation buyers and uniformly licensing low-valuation buyers. Presumptive exhaustion is socially optimal when social benefits from buyer-specific pricing outweigh social costs from transaction cost frictions in individualized licensing, which requires sufficiently low transaction costs.

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

JEL Classification: F10, O34, F100, O310

Suggested Citation

Ivus, Olena and Lai, Edwin L.-C. and Sichelman, Ted M., An Economic Model of Patent Exhaustion (November 4, 2019). 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 )

Smith School of Business - 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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