Varying Patent Strength and the Allocation of R&D across Sectors

This paper analyzes the effects of a varying patent strength on the incentives to undertake cost-saving innovations in a product-variety model with hierarchical preferences. If the majority of the agents does not derive profit income from patents, a reduction in patent strength can lead to an increase in overall innovation. The reason for this is that weaker patents transfer some of the cost savings to consumers and allow them to purchase a larger variety of goods which increases the market size and therefore the innovation incentives in sectors that produce more luxurious goods. Agents that do not derive income from patents prefer weaker patents and their preferred extent of patent protection can either increase or decrease in the size of the market.