Differences in the legal regulations governing patent protection (and copyright protection) differ significantly between countries, and this has recently led to trade disputes, both between the United States and Japan and between more- and less-developed countries. A patent system generates social benefits by stimulating innovation, but also entails social costs by granting monopoly power. The charging of excessive prices for a patented product may lead to distortions by inducing consumers either to buy similar, but unpatented and hence lower-priced (and presumably lower-quality) varieties of the product, or alternatively to stop buying the product altogether.
In Discussion Paper No. 392, Research Fellow Paul Klemperer explores the trade-off between a patent's `length' (its lifetime) and its `width' (its scope of coverage), in order to establish the conditions under which patents of different `shapes' will allocate a given profit reward to the innovator at the minimum social cost. He finds that the optimal patent design depends on the nature of consumer demand for the product concerned.
Klemperer assumes that all consumers prefer the same variety of a product, but differ both in the strengths of their demand for it and in their costs of substituting to alternative varieties, and that the patent holder produces the preferred variety. He defines the `width' of the patent as the distance from the preferred point beyond which competitors are allowed to produce.
He shows that if all consumers have the same per unit `transport costs' of substituting to a less-preferred variety of the product, then infinitely-lived but narrowly-focused patents are optimal, and the patent holder must set the price to ensure that no consumer switches to an unpatented brand. If, on the other hand, all consumers value their preferred variety by the same monetary amount over buying no variety of the product, then the optimal patent is broad but short-lived, and the patent holder must set the price to ensure that no consumer substitutes out of the product class.
Narrowly-focused patents are desirable when consumers have different levels of need for a product but similar strengths of preferences between its alternative varieties, since they enable the patent holder's competitors to produce close copies, which provides a check on the price it charges. A very long-lived patent must be granted, however, if the innovating firm is to obtain an adequate return on its investment in R&D.
If, on the other hand, different consumers have similar levels of need for a product, and hence of willingness to pay for it, but differ in their strengths of preference between its different varieties, a broader, but probably short-lived, patent is generally required. In this case the patent holder may set prices that are high, but they will be such that most or all potential purchasers will buy the product. The social costs of such a patent will be low, since profit will be rapidly but efficiently transferred to the patent holder, and a relatively short-lived patent will ensure that the innovator receives the appropriate reward for its research achievement.

How Broad Should the Scope of Patent Protection Be?
Paul Klemperer

Discussion Paper No. 392, March 1990 (AM)