Abstract
We model how risk-neutral firms’ ability to obtain substantial private returns on marginal new technologies causes them to “reach for mediocrity” by investing in socially suboptimal projects, even in the presence of competition and new entrants. Focusing primarily on pharmaceutical innovation, we analyze various policy interventions to solve this underinvestment problem. In particular, we describe a new approach for a “value-based” patent system, which ties patent protection to an underlying invention's social value, and we show how such a system could incentivize socially optimal innovation.
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