Patent holders can’t charge monopoly prices because there’s competition between patented products

There is no empirical evidence for the assertion that patent owners systematically earn “excessive” rewards. In any case, there is no intrinsic value of an invention that departs from its market value. Economic analysis has long identified the value of goods and services as being given by market prices. Competition in the market for inventions strongly suggests that patent owners earn market rewards. A patent does not confer an economic monopoly because access to the market for inventions, markets for products, or financial markets remains unimpeded.

The standard Nordhaus argument is incorrect because it assumes that a patent confers an economic monopoly on their owners.168 This now standard assumption in the economics and law literature is inconsistent with reality. Competition in the market for inventions and in the product market that applies inventions means that a patent owner does not receive monopoly rents. This invalidates the standard analysis of patent policy that is based on the economic monopoly assumption.

The standard Nordhaus-style conclusion is that the duration of a patent should be just sufficient for a period of monopoly rents to cover the costs of invention. Even within this overly simplistic framework, it should be noted that more intense competition would dissipate economic rents and therefore would extend the optimal duration of a patent. The duration of a patent is not simply adding up monopoly rewards such that they exactly equal the cost of an invention.

The Nordhaus-style analysis is incorrect for more fundamental reasons. The inventor’s incentives depend on anticipation of the market value of the invention. Patents serve to promote competition among inventors. Greater patent duration increases incentives to enter the market, all other things being equal, which increases competition among inventors. By reducing transaction costs in the market for inventions, patents reduce the costs of entry and operation in that market, also increasing incentives to enter the market and increasing competition among inventors.

Competition in the market for inventions limits inventors’ rewards. Entry of inventors and competition in the market for inventions improves the quality of the best inventions. Entry of inventors also increases competition among inventors, which dissipates economic returns to inventors. This suggests that policymakers may wish to strengthen patent protections and increase their duration to increase competition in the market for inventions. A Nordhaus-style analysis will miss the beneficial effects of inventor entry because it assumes that all patents are economic monopolies.

A patent faces competition from past, present, and future inventions. For example, the USPTO issued 276,788 patents in 2012. Patents filed on or after June 8, 1995 have a term of 20 years from the time of filing, so the stock exceeds two million patents. Table 1.1 shows the number of patents issued in the US from 1963 to 2012.