Calculating the prize value can be pegged to the invention’s sales

One of the prize system’s fundamental drawbacks compared to intellectual property is that the government must estimate the social value of inventions to set their reward without any direct knowledge of consumers’ willingness to pay for those inventions.160 Social value is notoriously difficult to measure objectively in most circumstances, and measuring the social value of innovations—which are unique goods by definition—may be particularly difficult.161 The prize system requires the government to identify an appropriate measure of social value because the default measure of social value provided by patents—that is, consumers’ willingness to pay—is intentionally eliminated to avoid deadweight loss. Goods are usually valued by way of the market, in which individual consumers reveal their demand for goods through their purchasing decisions. This market-based process for valuing goods works only in the presence of scarcity, however, and since inventions are intangible ideas, they are not scarce goods.162 As discussed above, the patent system introduces artificial scarcity into the markets for inventions in order to force consumers to reveal their demand for them, but in doing so, it prevents consumers from using those inventions at the efficient level. The prize system eliminates the artificial scarcity created by patents and thus avoids the deadweight loss from higher consumer prices under intellectual property.163 However, in the absence of intellectual property, the government will always have limited information about consumer demand. Historically, this was considered by many economists to be the fatal flaw of the prize system.164

Prize advocates have proposed a number of solutions to the problem in the form of alternatives for measuring the social value of an invention. First and foremost, the government can link prize payouts to sales volume,165 which discloses the number of consumers who are enjoying the good and provides a data point for estimating demand.166 The government could then surmise an innovation’s social value by combining the sales-volume data with an estimate of the innovation’s utility to consumers167— perhaps based on evidence from consumer surveys about the nature and frequency of its use,168 declared consumer preferences through voting,169 objective evidence of its utility to the average consumer,170 or observational studies measuring the social value it created.171 An alternative strategy is to introduce a small amount of artificial scarcity into the market from which to estimate consumer demand—such as through an auction172 or by observing profits in a limited test market.173

Each of the alternative mechanisms proposed for measuring social value and setting incentives has problems,174 and even supporters of the prize system acknowledge that the government cannot accurately estimate consumer demand without intellectual property. However, prize advocates correctly point out that the government does not need perfect information about consumer demand to set prizes that equal patents at motivating innovation.175 In the patent system, firms invest in R & D based on their ex ante projections of consumer demand for innovations, which are likely to be imperfect. For the government to offer prizes that rival the incentives from patents, its estimates of consumer demand (which occur ex post) need be only as good as firms’ ex ante projections.176 Additionally, prize advocates note that the government has room for error when it estimates social value for purposes of setting incentives. To the extent that the private returns from innovation under the patent system are systematically (and substantially) lower than the social returns,177 this gap provides the government with a crucial margin of error when calculating prize payouts.178