of the Notes
- O. Digression on simplified pictures.
- A. In thinking through the logic of a
problem, whether in physics, mathematics, or economics, we
frequently use simplified pictures, designed to bring out the
particular issue we are interested in.
- B. For example, we worth out the logic of
Newtonian motion by analyzing the trajectory of canonballs in a
vacuum--without worrying about the fact that in a vacuum, the
canoneers would die before they could fire their
- C. Similarly, much of what we are doing in
this course involves deliberately simplified pictures, intended
to let us think through the logic of one problem or
- D. After doing so, one is better equipped
to deal with the much messier conditions of real life
- I. Property: The
institution, not "vs liability"
- A. What is special about property?
- 1. Good against the world.
- 2. Unlike contract.
- B. The alternative is commons--things
nobody owns and anyone may use.
- C. Argument for property--why plant if I
- D. Are there arguments against property?
- 1. Should the English language be property?
- 2. Should all inventions, however trivial?
- 3. Fictional characters?
- 4. Air? Water? Oceans? Fish?
- E. Application we will shortly get
- II. Costs: Why everything isn't property.
- A. Cost of defining and measuring: The
- Stack island, which belonged to someone, floated down the
Mississippi (erosion at the upstream end, deposition at the
downstream end), into a strip of the river where all islands
belonged to the owner of the land on the west bank of the
river. Who did it belong to?
- 1. Why fish are not property--despite the obvious
- 2. We could make fishing grounds, streams, etc.
property--which solves the problem if fish stay put.
- 3. What did Morse invent?
- a. His patent application for the telegraph claimed
all ways of using the electromagnetic power to transmit
words or images to a distance.
- b. The point being that ideas do not have obvious and
natural boundaries around them
- c. Which is a problem for patent law, which gives
people property in ideas.
- d. The court found that claim to be over broad.
- B. Enforcement cost--the bionic burglar
- Consider a primitive people trying to
decide whether land should be private property or a commons.
The cost of private property includes the cost of guarding
it--there is no point in my planting wheat if my neighbor is
going to come by at night and harvest it for himself. That cost
was substantially lowered by the domestication of dogs, since
dogs, being territorial can learn to identify their master's
property and bark at trespassers. Perhaps that was what tilted
the balance in favor of private property. If so, we may owe
most of human civilization to the dogs.
- C. Transaction costs: Owning English, a
very quiet story.
- 1. Hunting large animals across small plots.
- a. Foxhunting conflicts in England.
- b. Why you might want sharing rules in a primitive
- 2. Why there are all you can eat salad bars, spaghetti
bars, but ...
- 3. Rarely steak
- 4. Because the deadweight cost of selling something for
zero is larger the larger the cost of the something. See
figure. The grey triangle is deadweight loss on units of
food that are worth less to the consumer than they cost to
- D. Rent seeking costs.
- 1. Patent races. If I make my invention a day before you
do, I get all the rights to it, you get none. So there is an
incentive for an inefficient competition to be first.
- 2. This should not be a problem for copyright. Nor is it
a problem that someone who builds a house or an automobile
in order to end up owning it. What is the difference?
- 3. Crucial difference--homesteading or a patent race
takes something from the commons. It eliminates a valuable
opportunity (to homestead that piece of land or make that
invention) that others previously had. The other examples do
- 4. In other words, such an act confers a negative
externality on others.
- 5. But this may be a good thing if there is a positive
externality to be balanced.
- a. Perhaps the homesteading law was a good idea,
because settlement that was "premature" in terms of the
profit of farming to the farmer was not premature in
terms of total costs and benefits. The first settlers
might provide a "defense externality" by each making it
easier for the others to defend themselves against
Indians (or Canadians in the Pacific Northwest or
Mexicans in the southwest).
- b. Similarly, the inventor generates not only
knowledge that he owns (how to practice his patent) but
also knowledge (how to make other inventions outside of
the patent, by using unpatented parts of his idea) of
value to others. This is an argument for giving him a
benefit in exchange (at other people's expense), but it
is not an argument for making the benefit depend so
heavily on when he makes the invention, since we get very
little extra from his making it a week earlier--which may
be what gives him the patent.
- c. How soon we want something invented depends in
part on how rapidly the cost of inventing it is falling
with time. If it costs the same amount to invent it this
year as next year, we might as well invent it this year;
if it will cost a tenth as much to invent it a year
later, we might be better off waiting. One advantage of
trade secret protection over patent protection is that it
gives qualitatively correct incentives in this regard.
The faster the cost of inventing something is falling the
shorter the period for which you can expect to maintain
it as a trade secret, hence the lower the incentive to
invent it early.
- E. Note that all of these things depend in
part on the relevant technologies:
- 1. Photocopying means that some copyright are not, in
- a. Contrast c. 1900, when you could enforce property
rights you didn't have.(see below--British authors
selling in the American mareket)
- b. Now you can enforce against mass copying and sale,
or against organizations that might have dissatisfied
employees who know Bill Gates' email--but not against
- 2. Ditto in spades for software copyrights
- a.--and it will get worse. Computer networks,
encryption, anonymous remailers, etc. are moving us
towards a world where firms can operate anonymously with
brand name reputation--making it possible to have a
pirate archive, openly selling pirated software for
- b. But technology may come to the rescue. If you can
tag each copy of your work that you sell, you can require
the buyer to be liable if copies of his copy appear on
the market--thus using contract law to replace
intellectual property law.
- 3. If you could tag animals, fish, whales, etc. it might
be practical to make them private property.
- a. You would want a method that included their
- b. Genetic tags?
- c. Own a species? The owner would have an incentive
to pay for research on species diseases, etc. But a hard
property right to enforce, since the members of the
species are not under his eye.
- III. Benefits: Why
- 1. What is the cost of leaving a positive
externality external? That depends on how much the reduced
incentive reduces output.
- 2. I get only part of the benefit from not
dressing horribly or not having a deliberately ugly house. But
since it costs me very little (perhaps less than nothing) to do
those things, even part of the benefit is enough--so few people
have deliberately ugly clothing or houses.
- a. In such situations, a problem arises only when tastes
differ--so that your "deliberately beautiful" (or at least
"desirable in some way") is my "deliberately ugly" (punk
haircuts, for example).
- b. Or when one party is malevolent and wants to hurt the
- c. Or when one party is engaging in extortion--imposing
costs on others in order to be paid to stop doing so. Most
people are strongly committed to a strategy of not giving in
and paying off in such situations.
- 3. Would there be "almost enough"
intellectual property even without protection?
- a. Reputation and other tie-ins provide some incentive.
People wrote books, poems, etc. long before the invention of
copyright (Homer, Dante, ...). The first firm to come up
with a product has a first mover advantage--consumers
identify the product with that firm. The first firm may be
able to establish standards, and consumers are uncertain
whether other firms are successfully imitating them.
- b. c. 1900 the U.S. did not recognize British
copyrights, yet British authors got sizable royalties from
their American sales. With large fixed costs and time delays
due to typesetting, the first publisher (who got the
manuscript from the author) had a sizable advantage over
pirates (who had to wait for the first publisher to print
his edition before they could start pirating it). Lotus has
no patent on the idea of a spreadsheet (which would have
gone to Visicalc anyway), yet has a large first mover
- 4. A related issue is the supply curve of
the copier. A good which is very expensive to copy (paintings,
at least until recently, live lectures--although Hal Holbrook's
Mark Twain performances may be a counter-example) may not need
intellectual property protection.
- 5. A related issue raised by Kitch is
whether it is important to coordinate the production of
intellectual property in some area, in order to make sure six
people are not working on one part of the problem and none on
another. Ownership of the area via a patent is one way of doing
this. The owner can hire everyone else, or subcontract, and
coordinate their efforts.
- IV. Intellectual
Property: The Law
- A. Copyright:
- 1. According to the constitution, copyright protects
"writings." What is a writing?
- a. Is a computer program a writing?
- b. Is a work of music? Yes
- c. Is a drawing? Yes.
- 2. What is protected is the expression, not the idea,
- a. That isn't a clear distinction.
- b. Derivative work--a translation is covered by the
copyright of the original
- c. So is a movie.
- d. Is a superhero like Superman and expression (of
the idea of ?) or an idea? Superman won the suit.
- e. A lot of the recent action is in software
copyright. Is the interface of Lotus 123 an expression or
- 3.The protection is given on request. Anything you write
is automatically copyright. Registering it gives you
statutory damages--otherwise you can sue to make someone
stop violating your copyright, or for actual damages.
- 4. The protection lasts for a long time--life +50 years,
99 years, etc.
- 5. It is not good against an independent creator--but
that rarely happens.
- B. Patent: Protects an idea.
- 1. What is your idea? You answer that question in
drafting your patent application--your claims define the
boundaries of what you are claiming.
- 2. Must be novel, non-obvious
- 3. Meaning (roughly) that someone skilled in the art
could not work it out for himself, on the basis of publicly
available information, and ...
- 4. Nobody has actually implemented your idea
before--which is an argument for narrowing your claims.
- 5. Must be useful:
- a. 19th century interpretation--not pernicious. Cigar
story. Artificially mottling tobacco made consumers
believe it was of high quality, hence a fraud, hence
pernicious--but not illegal. So the infringer argued that
the patent was invalid--and he could commit the fraud
- b. Current interpretation--positively useful. A
process for synthesizing a chemical with no known uses is
- 6. You must have priority--first to invent. Elsewhere in
the world the rule is first to file.
- 7. Protection is short--14-21 years at various points in
- C. The case of computer software:
- 1. Is it a writing, hence copyrightable?
- a. Some early cases said "no," since a machine
language program is intended to control a machine, not be
read by a human being.
- b. They analogized it to a player piano roll in an
early case, which was found not copyrightable.
- c. Hersey (author and head of PTO) analogized it to
an elaborate cam.
- d. But when Congress revised the copyright act, they
- 2. Is it an invention, and patentable?
- a. Early cases clearly held "no" under the mental
steps doctrine. You can't patent the procedure for long
division--and a computer program can be considered a
description of a set of things to do.
- b. But you can patent a machine--which a programmed
- c. Or a process--which a program in some sense is.
- d. The Supreme Court was dragged by the CAFC (Court
of Appeals for the Federal Circuit--a specialized court
created in part to handle patent cases) into effectively
reversing itself, via the idea that although you could
not patent an algorithm, a process using a computer
program could be patented
- e. So that now, in effect, programs are
patentable--you just have to draft the application
- f. An encryption algorithm is a process for
transforming plaintext into cyphertext and back
- V. Intellectual
Property: The Economics
- A. The basic arguments for protection
- 1. Incentive to produce.
- 2. Reduce or eliminate the costs associated with
- 3. Ability of the owner to coordinate further
development--Kitch's prospect theory.
- B. The arguments against protection
- 1. Problem of defining the borders, observing trespass,
- a. Literal copying is easy to define and recognize,
subject to some enforcement problems (i.e. individual
copying is effectively invisible)
- b. Non-literal infringement is more of a problem.
- c. Ideas have much fuzzier borders, hence patent
infringement is a much messier area than copyright
- d. Which is a good reason for giving copyright
protection more easily and for a longer term.
- 2. Depleting the commons problem:
- a. The chance that two people would independently
write the same book is very close to zero, so when I
write a book and copyright it I do not significantly
limit your opportunities, so there is no significant
negative externality, rent seeking problem, etc.
- b. But two people working in the same area might
easily come up with the same (or overlapping) ideas, so
there is a serious commons problem in patent law. Indeed,
there is often ligitation over who has priority when two
labs were working on the same problem.
- c. Hence the revenue from licensing a patent might
well overstate the social value of what was produced.
- d. Which is a good reason for giving patent
protection only to non-obvious inventions (because they
are one where a large part of the value is contributed by
the inventor, not taken from the commons) and for a
limited term (because someone else probably would have
invented the same idea eventually, so the first inventor
should only get rewarded with the benefit of having it
earlier, not the full value of the idea for ever).
- 3. Elasticity, ease of copying issue?
- a. Arguably, copying writings is much easier than
copying ideas, since all you have to do is
photo-offset--no engineering required.
- b. In which case eliminating copyright protection
would reduce writing more than eliminating patent
production would reduce invention.
- c. By the same token, trade secret is much more
practical for patent (Scientology as counterexample--they
claim that their "religious texts" are trade secrets)
- d. Which can be an argument either way--patent is
unnecessary, because there is an alternative, or
necessary, to prevent pushing people to the expensive
- VI. Trade
- A. The
- 1. Trade secret law does not establish a property
right--if someone gets possession of the trade secret
without doing anything wrong (by reverse engineering, for
example) he has a legal right to use it.
- 2. It does establish rights against those who have
gotten the trade secret wrongfully--by theft, or violation
of an employee's duty to his employer, or ... .
- 3. And limited rights against those they transmit the
- a. If you find out that what you have is a stolen
trade secret before you do anything with it, you are not
allowed to use it, but ...
- b. If you have already build the factory to employ
the trade secret, so that not being able to use it would
leave you worse off than you were before, you can run the
- Dupont v Christopher.
- a. Dupont was building a new factory to employ a new
- b. Someone hired an aerial photographer to fly over
the factory and photograph it--presumably in order to
learn the process.
- c. The court found that Dupont had a trade secret
claim, even though the overflight was legal.
- d. The justification was, in part, that it was
unreasonable to require Dupont to keep their factory
covered while they were building it. In other words,
trade secret law as a way of reducing the cost of
protecting trade secrets.
- e. But that ought to imply that reverse engineering
violates trade secret law--and it doesn't.
- f. So this case is an outlier--one that states a
legal principle not accepted by most courts.
- a. The Church of Scientology charges people large
amounts of money for a training process that is supposed
to eventually make them into supermen (with lesser
benefits along the way).
- b. The "scriptures," alias "technology," used in this
training is kept secret--held under lock and key, with
people allowed to read it only on the church's property.
- c. The Church of Scientology has sued people for
publishing copies of this material--as a violation of
trade secret as well as of copyright.
- d. So far they have won their copyright claims but
lost their trade secret claims--not because the material
is not in principle protectable, but because once one
person has posted it on the net it is no longer a trade
secret, and a second poster is therefor not liable. And
things can be (and were) posted anonymously.
- e. On the other hand... current litigation (the CoS
has been involved in a lot of litigation, mainly with
ex-members) has raised the claim that the CoS doesn't
really own the copyrights, due to a variety of
complicating factors irrelevant to this course. If you
are interested in what is really a fascinating story,
part of which is presently playing in a San Jose court
house, read the newsgroup alt.religion.scientology, or
search the web for scientology related material.
- 6. Reverse engineering the ROMs:
- a. Trade secrets are not protected against reverse
engineering (figuring out the trade secret by taking
apart, analyzing, etc. the physical objects embodying
it). Copyright is protected against copying or the making
of derivative works, but not against independent
- b. Suppose I very much want to "independently create"
a copyrighted work.
- c. To be more specific, suppose I want to build an
IBM PC clone. The software build into the PC's read only
memory is copyrighted, so I can't legally copy it. But
the software in my clone has to function exactly the same
way, in order that programs for the IBM will run on it.
- d. The solution is "clean room" reverse engineering.
Team A looks at the IBM ROMs and writes out a detailed
functional specification of exactly what they do. Team B
is never allowed to look at the ROMs. Instead, they read
team A's specifications, and write code that does exactly
what team A says the original ROMs did.
- e. Since copyright protects only expression not idea
(in this case code but not function), this does not
violate copyright law.
- B. Is trade secret law preempted by patent
- 1. In other words, does the fact that the Federal
government controls intellectual property via patent law
mean that the states cannot provide protection through trade
- 2. The general rule is that this depends on whether the
state protection interferes with the objectives of the
- 3. For example by giving inventors an incentive not to
seek patents--since one objective of patent law is to make
inventions public information, so that other inventors can
build on them.
- 4. In two cases (Sears v Steiffel and Compco v
Daybright) the Supreme Court found that state IP
protection that amounted to the equivalent of patent
protection was preempted, and thus invalid.
- 5 But a later case found that ordinary trade secret
protection, as described above, was not preempted and thus
- C. Not entirely--and shouldn't be.
- 1. Trade secret
in the gaps in our one size fits all patent system.
- 2. By providing some protection for inventions that
- a. Are unpatentable.
- b. Or the PTO mistakenly believes are unpatentable,
- c. Are even more non-obvious than the patent law
assumes--and thus deserve longer protection.
- 3. There is no problem of over rewarding, since the
secret is still in the commons--other people can invent it
- D. Plug mold statutes.
- 1. What they are.
- a. Sometimes it is possible to use a physical object
in the process of making a mold to produce a duplicate.
- b. For example, buy a (very well designed and
successful) boat hull, and use it to make (and sell)
- c. Or do similar things with car parts
- 2. Florida passed a statute to prohibit copying boat
hulls in this way, other states passed other plug mold
- a. In effect, they provided copyright protection
against physical copying.
- b. This makes sense, just as copyright for computer
programs are. A boat hull is not a writing, but the
economics of how it ought to be protected is just about
- 3. The court struct down such statutes, holding that
they were preempted by patent law. The theory may have been
that while such laws might be useful, they ought to be done
on a national rather than a state level.
- VII. Coase
Article: Classic article that laymen,
or at least econ majors, can read.
- A. The problem associated with an
externality is jointly caused--the result of actions by both
- B. Farmer and cattleman, outcome does not
depend on who is liable1. But bargaining, attempted extortion,
etc., is possible
- 2. So Coase's result holds when everything has been
- 3. i.e. in a zero transaction cost world.
- C. A bunch more cases with the same
- 1. Confectioner/doctor
- 2. Bleaching coconut matting
- 3. Blocking the draft of a chimney. Who "caused" the
- 4. Each should bear the full cost--and will under either
rule with bargaining.
- 5. Jolly Anglers brewing. Confined channel of air is
presumptively property, byrule of lost grant belonged to the
brewer. So the verdict is the opposite from thatin the
chimney case--which also involved blocking an (unconfined)
channel of air.
- D. Judge's grounds for deciding the cases
seem irrelevant to economist, but ...
- 1. Perhaps all that matters is a predictable rule, (to
reduce uncertainty andrent seeking) and the judges have one,
- 2. Perhaps the rule is a proxy for relevant
considerations, such as
- 3. Coming to the nuisance.
- a. I have a pig farm; the city expands towards it.
- b. When you build a housing development next to me,
can you enjoin my pig farmas a nuisance, or ...
- c. Can I win by arguing that you "came to the
- d. The economic argument is the assymetry of sunk
costs: It is cheaper for youto "move" your housing
development before you build it by building it
somewhereelse than for me to move my pig farm, which is
- e. So the doctrine of coming to the nuisance, which
sounds like a moral argument,may make sense as an
- f. Or at least as a rule of thumb. Consider the case
where, even before you buildyour development, the value
of the land it would be built on is drastically loweredby
the existence of my pig farm.
- g. Of course, that problem may get solved on the
market--as someone buys up thepig farm and the
surrounding land in order to shut down the pig farm and
resell theland at a big profit.
- h. In fact, in modern American law, courts mostly
reject the doctrine. Shouldthey? Not clear.
- E. A firm is one solution to the
transaction costs of the market
- 1. Consider a shopping mall.
- a. The owner provides free parking, and makes his
money back in store rentals.
- b. He figures out what mix of stores, restaurants,
etc. will make people wantto come, and so maximize the
- c. He keeps the public areas clean
- d. In fact, he provides a centralized alternative to
nuisance law, government,etc.
- 2. Whether it makes more sense to solve problems by
putting both actors into onefirm depends on the tradeoff
between administrative costs of the firm and the
- a. A shopping mall is actually a compromise.
b. One firm owns the mall--but it rents out the space to
independently owned stores.
c. The complete single firm solution is not a mall but a
department store--and theyseem to be losing out to
F. Government regulation is another solution
- 1. Which has costs, and errors, and so may give worse
results than the other solutions
- 2. Or better.
- G. And a final solution is to do nothing.
Some problems cost more to cure than the cure is worth.
- 1. That is how we deal with lots of externalities
- 2. Positive ones like beautiful buildings, and
- 3. Negative ones like people wearing ugly clothes.
- H. Where transaction costs are high, court
decisions matter, and cases suggestat least some general
recognition of reciprocal problem and cost/benefit
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