Licensing Probabilistic Patents and Liability Rules: The Duopoly Case

In a market with two homogeneous firms that compete in quantities (Cournot), one firm gets a patented cost reduction innovation. Under this scenario the patent holder has the option to license or not this innovation to the other firm. On the other side, the incumbent firm (without the patent) could be continuing with the backstop technology, could be an infringer of the patent or if a license is offered for the patent holder could become a licensee. When the property rights are probabilistic, injunctions and damage payments play a fundamental role in the interaction between the patent holder and the incumbent firm. Two damage rules are commonly used in the courts to determine the size of the damage payment: Lost Profits and Unjust Enrichment. In this paper a dynamic game is developed to compare lost profits (LP) against unjust enrichment (UE), It’s assumed that the lifetime of innovation is short enough for injunctions not to be important for the players (patent holder and incumbent firm). The results show that UE is at least as good as the LP rule from the point of view of the welfare. Under UE no licensing is chosen by the patent holder and infringement is chosen by the incumbent firm . Under the LP rule and small innovations is observable the same situation as in UE however if the innovation is enough big, Licensing is chosen by the patent holder and the incumbent firm.