An Economic Model of Patent Exhaustion
39 Pages Posted: 19 Nov 2019 Last revised: 25 Nov 2019
Date Written: November 4, 2019
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 two variants of the doctrine: 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. We model how the shift from absolute to presumptive exhaustion affects social welfare. The paper offers the first economic model of domestic patent exhaustion that incorporates transaction costs in the process of licensing downstream manufacturers and consumers. The results show that when the transaction costs of contracting are high, so that the patent owner has no incentive to contract with downstream users, then absolute and presumptive exhaustion are equivalent. When transaction costs are low, presumptive exhaustion is socially optimal, because it allows for perfect price discrimination via consumer-specific licensing. But when transaction costs are at the intermediate level, presumptive exhaustion is relatively inefficient, because the patent owner's private licensing incentives lead to transaction cost frictions that outweigh any social benefits from price discrimination.
Keywords: Intellectual Property, Patent Exhaustion, First Sale Doctrine, Patent Licensing
JEL Classification: F10, O34, F100, O310
Suggested Citation: Suggested Citation