Imperfect patent protection, licensing, and Social Welfare

The paper analyzes an entry game where, in the presence of imperfect patent protection, a patent holder of a cost-reducing innovation can propose either an exclusive license, that preserves the incumbent's monopolistic position, or a sole license, compatible with the entry and the duopolistic competition. We prove that, since the threat of imitation reduces the values of the license, the innovator may be forced to enter the market. The impact of low patent protection on expected welfare is twofold: the increased uncertainty, reducing R&D returns appropriability, forces the licensor to enter the market; however, it may reduce the incentive to innovate. As a consequence, a rise in the level of patent protection causes a trade-off between the increased incentive to innovate and the reduced allocative efficiency in the market.