Econ 522 Economics of LawLast Wednesday…Our experiment…Slide 4Slide 5Slide 6Slide 6Dynamic games and sequential rationalityDynamic gamesWe can put payoffs from this game into a payoff matrix…Slide 11The key assumption behind subgame perfect equilibrium: common knowledge of rationalitySlide 12Intellectual PropertyInformation: costly to generate, easy to imitateInformation: costly to generate, easy to imitatePatents: one way to solve the problemComparing the two outcomesPatents solve one inefficiency by introducing anotherPatents: a bit of historyPatent breadthSlide 22Patent lengthDo the details matter?Slide 25Slide 26Alternatives to patents for encouraging innovationSlide 27CopyrightSlide 30Slide 31Slide 32Slide 32TrademarksTrademarks – exampleTrademark dilutionSlide 36Trade SecretsSlide 38Econ 522Economics of LawDan QuintSpring 2011Lecture 72Established properties of an efficient property law systemPrivate goods are privately owned, public goods are notOwners have maximum liberty over how they use their propertyInjunctive relief used when transaction costs are low,damages used when transaction costs highWe also gave some thought to “testing Coase”In-class experiment: can UW undergrads allocate poker chips efficiently?(Cost me $118)Last Wednesday…3Take 1: Full Information (values on nametags)Our experiment…24/28 = 86%566032purple chip2purple chip4purple chip46purple chip6purple chippurple chip8red chippurple chipred chip8purple chippurple chip10purple chippurple chip10purple chipred chip12fraction of potential gains realizedactual final allocationefficientallocationstartingallocation4Take 2: Private Information (values hidden)Our experiment…20/24 = 83%444824purple chip2purple chip3purple chip3purple chip4purple chippurple chip4purple chip6purple chipred chip6purple chippurple chip8purple chippurple chip8red chipred chip10fraction of potential gains realizedactual final allocationefficientallocationstartingallocation5Take 3: Uncertainty Take 4: Adverse SelectionOur experiment…100%12128chip2 X die roll(actually 8)chipchip3 X die roll(actually 12)fraction of potential gains realizedactual finalallocationefficientallocationstartingallocation100%664chip2 X die roll(actually 4)chipchip3 X die roll(actually 6)fraction of potential gains realizedactual finalallocationefficientallocationstartingallocation6So…Coase seems to work pretty wellMy guess: if we redid the asymmetric information case a bunch of times, we wouldn’t get trade very oftenComparing “uncertainty” to “asymmetric info”…Seller’s value was 2 X die roll, buyer’s value was 3 X die rollIf nobody knows die roll, no problem – they can trade based on the expected valueBut if seller knows die roll, problemIn strategic settings, information can have negative value – the seller could be worse off for having information!Our experiment…7SequentialRationality8Game theory we’ve seen so far: static games“everything happens at once”(nobody observes another player’s move before deciding how to act)Dynamic gamesone player moves firstsecond player learns what first player did, and then movesDynamic games and sequential rationality9Dynamic gamesFIRM 1 (entrant)Enter Don’t EnterFIRM 2(incumbent)Accommodate Fight(10, 10) (-10, -10)(0, 30)A strategy is one player’s plan for what to do at each decision point he/she acts atIn this case: player 1’s possible strategies are “enter” and “don’t”, player 2’s are “accommodate” and “fight”1010We can look for equilibria like beforewe find two: (Enter, Accommodate), and (Don’t Enter, Fight)question: are both equilibria plausible?sequential rationalityfirm 1 asks, “once I’ve entered, would he really choose to fight?”We can put payoffs from this game into a payoff matrix…10, 10 -10, -100, 30 0, 30Accommodate FightEnterDon’t EnterFirm 2’s ActionFirm 1’s Action11Dynamic gamesFIRM 1 (entrant)Enter Don’t EnterFIRM 2(incumbent)Accommodate Fight(10, 10) (-10, -10)(0, 30)In dynamic games, we look for Subgame Perfect Equilibriaplayers play best-responses in the game as a whole, but also in every branch of the game treeWe find Subgame Perfect Equilibria by backward inductionstart at the bottom of the game tree and work our way up12Firm 1 knows firm 2 is rationalSo he knows that if he enters, firm 2 will do the rational thing – accommodateSo he enters, counting on firm 2 to accommodateThis is the idea of sequential rationality – the assumption that, whatever I do, I can count on the players moving after me to behave rationally in their own best interestThe key assumption behind subgame perfect equilibrium: common knowledge of rationality13Applications ofProperty Law14Intellectual property: broad term for ways that an individual, or a firm, can claim ownership of informationPatents – cover products, commercial processesCopyrights – written ideas (books, music, computer programs)Trademarks – brand names, logosTrade SecretsIntellectual Property15Example: new drugRequires investment of $1,000 to discoverMonopoly profits would be $2,500Once drug has been discovered, another firm could also begin to sell itDuopoly profits would be $450 eachInformation: costly to generate, easy to imitateup-front investment: 1,000monopoly profits: 2,500duopoly profits: 450 each16Solve the game by backward induction:Subgame perfect equilibrium: firm 2 plays Imitate, firm 1 playsDon’t Innovate, drug is never discovered(Both firms earn 0 profits, consumers don’t get the drug)Information: costly to generate,easy to imitateFIRM 1 (innovator)Innovate Don’tFIRM 2 (imitator)Imitate Don’t(-550, 450) (1500, 0)(0, 0)up-front investment: 1,000monopoly profits: 2,500duopoly profits: 450 each17Patent: legal monopolyOther firms prohibited from imitating Firm 1’s discoverySubgame perfect equilibrium: firm 2 does not imitate; firm 1 innovates, drug gets developedPatents: one way to solvethe problemFIRM 1 (innovator)Innovate Don’tFIRM 2 (imitator)Imitate Don’t(-550, 450) (1500, 0)(0, 0)up-front investment: 1,000monopoly profits: 2,500duopoly profits: 450 each450 – P18Comparing the two outcomesFIRM 1 (innovator)Innovate Don’tFIRM 2 (imitator)Imitate Don’t(-550, 450) (1500, 0)(0, 0)up-front investment: 1,000monopoly profits: 2,500duopoly profits: 450 eachFIRM 1
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