Patent Prospect Theory and Competitive Innovation

Abstract

In his seminal “prospect theory” of patents, Edmund Kitch contends that patents should be relatively broad in order to promote post-grant follow-on innovation and development. The argument rests critically on the assumption that post-grant competition will diminish such efforts. This is just a special case of the more general claim that a market will be more innovative when it is less competitive. When an innovator invents a new technology, it enters (or creates) a market for the relevant technology class, and the breadth of its patent determines how competitive this market can become. Prospect theory asserts that this post-grant market should involve little or no competition, and infers from this that patents should be broad. However, economists have long debated the relationship between competition and innovation. A leading view among contemporary economists – the inverted-U hypothesis – contends that aggregate innovation is maximized somewhere in between monopoly and perfect competition; that is, the market should be relatively competitive, but not too competitive. This hypothesis is strongly supported by recent theoretical and empirical economic research, much of which suggests that the socially optimal market structure is in fact closer to perfect competition than monopoly. Although this theory has not previously been related to the question of optimal patent breadth, it provides perhaps the best economic machinery for addressing this problem. In particular, it suggests that, in contrast to the teachings of prospect theory, patent breadth should be fairly modest in order to elicit a relatively significant degree of post-grant competition.