A Chicago School Take on Patent Licensing: Understanding the Economics of the Patent Exhaustion Doctrine

Posted: 27 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: February 19, 2009

Abstract

Under the legal doctrine of 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 an important one, as it has important 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, but rather what matters is the total royalty burden. Even when we depart from ideal conditions, however, we still find no economic justification for a strict application of the patent exhaustion doctrine. To the contrary, we that there are often private and social advantages to charging royalties at multiple stages. Overall, our results advocate for a flexible application of the patent exhaustion doctrine, where exhaustion holds as a default rule but one that can be easily overwritten in patent contracts.

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

JEL Classification: O34, O33, O32, O31, O30, K21, L40

Suggested Citation

Layne-Farrar, Anne and Llobet, Gerard and Padilla, Jorge, A Chicago School Take on Patent Licensing: Understanding the Economics of the Patent Exhaustion Doctrine (February 19, 2009). Available at SSRN: https://ssrn.com/abstract=1346558

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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