An Economic Model of Patent Exhaustion

41 Pages Posted: 19 Nov 2019

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 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 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: F100, O310

Suggested Citation

Ivus, Olena and Lai, Edwin L.-C. and Sichelman, Ted M., An Economic Model of Patent Exhaustion (November 2019). CESifo Working Paper Series No. 6638. Available at SSRN: https://ssrn.com/abstract=3039926

Olena Ivus (Contact Author)

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

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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