Question

Consider a situation in which an investment of $10 million in research that yields a pioneering invention that has no commercial value, and a subsequent investment of $5 million in development that yields an improvement that has commercial value of $100 million. Assume that Firm A is uniquely situated to do the pioneering research, and Firm B is uniquely situated to develop the application. Predict the difference in investment resulting from a broad patent law and narrow patent law.

In making your prediction, distinguish between (1) a situation in which transaction costs prevent Firm A and Firm B from bargaining with each other and (2) a situation in which transaction costs of bargaining are zero.

Answer 1

Whether the patent should be put into broad patent category or under narrow patent category will depend on the social value. If social value of investment on fundamental research exceeds the social value of investment on developing applications, then patents should be broadened. Conversely, if the social value of investment on developing applications exceeds the social value of investment on fundamental research, then patents should be narrowed Accordingly, the law under the broad patents, requires the research and development of application under one firm. So when there is no transaction cost, the total investment for fim A would be S150,000 and the retum on this investment would be $1,000,000. It would come under the broad category if the value of development of application in firm EB is less than $8500,000. However, if the value of development of application in firm B is more than S8500,000, then the development should be narrowed If there is cost in bargaining that exceeds $850,000, then it will prevent firm A and Firm B to bargain And, if the transaction cost is zero, then the bargaining would not take place when social value of developing the application in firm B exceed S850,000