Imperfect patent protection, licensing, and R&D investment

is paper analyzes how imperfect patent protection affects patent holders' licensing decisions, firms' willingness to pay for the innovation, and social welfare. We present two alternative scenarios. In the first, the patent holder of a cost-reducing innovation is an incumbent; in the second, it is a potential entrant. We derive the optimal two-part tariff of the license and compute firms' incentive to acquire the innovation. We show that, when the patent protection is high enough, the potential entrant has a willingness to pay higher than the incumbent's one, licenses in exclusive, acting as a non-practicing entity. Imperfect patent protection has a twofold impact on the market performance. With low patent protection, the threat of imitation discourages licensing agreements. If the patent holder is the potential competitor, it enters the market; if it is the incumbent, the entrant tries to imitate the innovation. In both the cases, duopoly may emerge in equilibrium, increasing allocative and productive efficiency. With high patent protection, in both the cases, firms license the innovation. When the patent holder is the entrant, the license is exclusive, and the monopolistic structure is maintained. When the patent holder is the incumbent, the license is sole, and a duopoly emerges in equilibrium. Therefore, increasing the level of patent protection may decrease the expected social welfare.