Prizing System isn’t cost efficient and can be dangerous.

The alternative to the patent right is a prize. Under the prize system, the patentee will enter and produce, without the right to exclude others, as long as the prize is at least as great as the breakeven level of profit. Since rivals are not excluded, competition will drive the price down to the competitive level. The entire potential surplus triangle, QXH, is enjoyed by consumers. There are two prize levels to consider. One is the minimum necessary prize, which is the breakeven level of profit. The other is the optimal prize, which is equal to the entire surplus (Shavell and Ypersele). The optimal prize ensures that entry occurs whenever the cost of development is less than the benefit to society. The minimum prize is sufficient to induce entry by the patentee. However, the original problem in the patent setting is that the patent authority does not know the development cost of the patentee; that is private information. Given this, if the patent authority were to choose a prize of a given amount, there would be some innovators who would refuse to enter. Because of the information problem, the minimum or break-even prize is not a workable solution to the entry problem. The optimal prize, equal to the entire surplus, effectively replicates perfect price discrimination. It would require the patent authority to gain knowledge on the market demand for the patentee’s product. This is implausible as a general matter. Patent authorities do not gather information on the market demand for a patented product. Perhaps in the case of a proposed drug that has gone through the Food and Drug Administration (FDA) testing process, it may be possible for the patent authority to gain enough information to determine the market demand for the product, but even this seems unlikely. The FDA determines safety and efficacy for drugs, and makes no attempt to determine market demand. Drug companies, by contrast, surely attempt to determine market demand. A prize system that requires the patent authority to gather information on market demand would leave the patent authority in the hands of the drug companies.