Patents, Research Exemption, and the Incentive for Sequential Innovation

We develop a quality ladder model to study the R&D incentive impacts of intellectual property rights with a “research exemption” or “experimental use” provision. The innovation process is sequential and cumulative and takes place alongside production in an infinite-horizon setting. We solve the model under two distinct intellectual property regimes, characterize the properties of the relevant Markov perfect equilibria, and investigate the profit and welfare effects of the research exemption. We find that firms, ex ante, always prefer full patent protection. The welfare ranking of the two intellectual property regimes, on the other hand, depends on the relative magnitudes of the costs of initial innovation and improvements.