An Economic Take on Patent Licensing: Understanding the Implications of the 'First Sale Patent Exhaustion' Doctrine

51 Pages Posted: 11 Jun 2009 Last revised: 26 Jan 2016

See all articles by Anne Layne-Farrar

Anne Layne-Farrar

Charles River Associates; Northwestern University

Gerard Llobet

Centre for Monetary and Financial Studies (CEMFI); Centre for Economic Policy Research (CEPR)

Jorge Padilla

Compass Lexecon

Date Written: 2009

Abstract

Under the legal doctrine of first sale, or patent exhaustion, a patent holder’s ability to license multiple parties along a production chain is restricted. How and when such restrictions should be applied is a controversial issue, as evidenced by the Supreme Court’s granting certiorari in the Quanta case. The issue is important, as it has significant implications for how firms can license in vertically disaggregated industries. We explore this issue from an economic viewpoint and find that under ideal circumstances how royalty rates are split along the production chain has no real consequence for social welfare. Even when we depart from ideal conditions, however, we still find no economic justification for a strict application of patent exhaustion. To the contrary, we show there are often private and social advantages to charging royalties at multiple stages. Our results advocate for a flexible application of the first sale doctrine, where exhaustion holds as a default rule but can be easily overwritten in patent contracts.

Keywords: patent exhaustion, licensing, royalty base, vertically disaggregated industries

Suggested Citation

Layne-Farrar, Anne and Llobet, Gerard and Padilla, Jorge, An Economic Take on Patent Licensing: Understanding the Implications of the 'First Sale Patent Exhaustion' Doctrine (2009). Available at SSRN: https://ssrn.com/abstract=1418048 or http://dx.doi.org/10.2139/ssrn.1418048

Anne Layne-Farrar (Contact Author)

Charles River Associates ( email )

1 South Wacker Drive
Suite 3400
Chicago, IL 60606
United States
312-377-9238 (Phone)

HOME PAGE: http://www.crai.com

Northwestern University ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

Gerard Llobet

Centre for Monetary and Financial Studies (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
SPAIN
34 91 429 0551 (Phone)
34 91 429 1056 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Jorge Padilla

Compass Lexecon ( email )

Paseo de la Castellana 7
Madrid, 28046
Spain

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