Welfare analysis of alternative patent policies for software innovations

We present a duopoly model that extends existing patent policy design models in the economics literature to formalize the links among the patent policy levers set by public policy (patent height and width), the strategic decisions made by firms (R&D investments, product development, product imitation, patent decision, and product pricing), the purchasing decisions made by consumers, and the market parameters. This integrated model enables policymakers to better analyze the impact of alternative patent policies on the level of social welfare and the distribution of that welfare among innovators, imitators, and consumers in a range of industry contexts – specifically targeting issues of software patents. Critical results include (1) an increase in patent width unambiguously increases R&D spending to generate a novel idea; (2) an increase in patent height may increase or decrease R&D spending depending on the efficiency with which an innovator can transform the novel idea into a commercial product; (3) while enforced patents will improve innovator profits they may worsen imitator profits, consumer welfare, or both and may even worsen total social welfare; (4) the optimal (social welfare maximizing) policy design is characterized by a relatively high patent height and moderate patent width.