Optimal Patent Breadth in a Two-Sector Economy

We consider an endogenous growth model with two sectors: an intermediate input (or "upstream") sector and a final product (or "downstream") sector. Innovation takes place in both sectors. Following Gilbert and Shapiro (1990), we define patent breadth as the ability of the innovator to reap profits as a result of the patent protection. Greater patent breadth in the downstream sector increases the incentives of agents to do R&D in that sector but discourages innovation in the upstream sector because of a market size effect. As a result, patent protection in upstream and downstream sectors have opposite effects on GDP growth: patent protection in the upstream sector accelerates growth while patent protection in the downstream sector slows it down. We show that regardless of parameter values, welfare maximizing, rate of innovation maximizing and output growth maximizing patent breadths are the same in the upstream sector but not in the downstream sector where they can be ranked. We also show the welfare maximizing patent protection is larger in the upstream