Counterfeiting in primary markets

Toshihiro Atsumi
Faculty of Economics, Meiji Gakuin University

Discussion Paper No.16-01
April, 2016

Counterfeiting in primary markets

Abstract
This paper studies counterfeiting in primary markets, that is, deceptive counterfeiting in which
consumers unwillingly purchase substandard counterfeit goods. Using monopolistic competition,
counterfeiting is shown to occur under lax intellectual property rights law enforcement and/or
large markets of existing legitimate goods, as a general equilibrium outcome. Even though thecounterfeiters themselves may lose along with all legitimate agents, once counterfeiting is
conducted, it prevails. Strengthening of IPR law enforcement has no effect on the amount ofcounterfeiting conducted unless it is strengthened enough to totally eliminate counterfeiting.

Keywords: counterfeit, primary market, entrepreneur, monopolistic competition, generalequilibrium
JEL classification: D21, D43, K42

1

1. Introduction
All sorts of things are counterfeited in various ways today. According to a comprehensive survey
on counterfeiting and piracy by the OECD (2008, p. 66), “the scope of products being
counterfeited and pirated is broad and expanding,” and “a notable shift is occurring from luxury
to common products.” The OECD survey raises concerns regarding health and safety risk basedon their finding that substandard counterfeits of common products are spreading. WHO (2006),
for example, estimates that counterfeits occupy more than 10% of the global medicines market,
and constitute an estimated 25% of the medicines consumed in developing countries.
The broadening of items counterfeited also refers to there being two different types ofpurchases, or sub-markets: the primary market and the secondary market. In the primary market,
consumers purchase counterfeits believing that they have purchased genuine products, whereas
actually the consumers have been deceived and are buying substandard fakes. The health andsafety risks associated with some of the counterfeits in the primary markets, such as food andmedicine, can be life-threatening. In the secondary market, consumers knowingly buy
counterfeits, which are usually cheaper than genuine products. The latter type of counterfeiting
typically occurs in snob or status goods.
Previous studies have focused on counterfeiting in secondary markets. Higgins and Rubin(1986) considered counterfeiting of snob goods. In their model, low-income consumers look for
low-priced counterfeits. Grossman and Shapiro (1988a) analyzed status goods which arecounterfeited by foreign suppliers. Grossman and Shapiro (1988b) also studied a situation where
foreign companies supply counterfeits and low-quality goods. Choi (2008) studied a mixed
market in which genuine brand producers compete with firms that produce counterfeits.
Changes are also seen in the distribution of counterfeits and pirated goods. Previously, they
were distributed largely through informal markets. As Higgins and Rubin (1986) assumed in theiranalysis, the markets of genuine products and counterfeits used to be separated. However,according to the OECD survey mentioned above, counterfeits today are increasingly infiltrating
legitimate supply chains, and they are now appearing in the shelves of well-known retail shops.
This suggests that consumers are now more liable to purchasing counterfeits in the primarymarket, due to being deceived. Further, the OECD survey reveals significant evidence of the roleof criminal networks and the involvement of organized crime in counterfeiting today.

2This paper departs from the existing analyses in two ways. The first is on the market ofcounterfeiting. While previous studies on counterfeiting focused on the secondary markets ofsnob or status goods, this paper focuses on the primary market in which deceptive counterfeiting
is conducted. This is motivated by the OECD’s reporting on the growing concern of people
unwillingly purchasing goods of substandard quality, through formal, legitimate distribution
channels. The second departure is on the type of analysis. In contrast to previous studies based onpartial equilibrium, this paper attempts to consider counterfeiting in general equilibrium. It is
motivated by the observation that counterfeiting is no longer confined to a particular sector but it
has spread into a large variety of goods that are consumed daily. Its aim is to complement theexisting studies by studying the primary market of counterfeits and to clarify in what way suchcounterfeiting harms societies.
Technically, the approach of the theoretical analysis in this paper is to use the entrepreneur
formulation of monopolistic competition, which assumes that each firm is set up by anentrepreneur who earns profits. This formulation has been used in macroeconomics and in new
economic geography. Frank (1990) and Clemens (2006, 2008) applied this formulation ofmonopolistic competition to study the impact of entrepreneurial behavior on macroeconomic
fluctuations and economic growth. Forslid and Ottaviano (2003) analyzed a model ofmonopolistic competition in which geographically mobile skilled workers are needed to set up
firms. Their model is now known as the footloose entrepreneur model and it explains the relation
between inter-regional trade costs and agglomeration created by the migration of skilled workers.
In this paper, I extend the entrepreneur formulation of monopolistic competition to incorporate
acts of counterfeiting.
Previewing the results, it will be shown first that, consistent with intuition, counterfeiting
occurs under lax intellectual property rights (IPR) law enforcement and/or large markets ofexisting legitimate goods, implying larger profit opportunities for potential counterfeiters. Whenfound profitable, some of the ‘legitimate’ people become counterfeiters or ‘shadow’entrepreneurs and start producing fakes of existing brands. By studying the counterfeiting
equilibrium in which all brands are counterfeited by such counterfeiters, it will be shown that
(unsurprisingly) all legitimate people lose, while the counterfeiters can gain if the outputs of thebrands they counterfeit are sufficiently large. Otherwise, nobody gains in the counterfeiting
equilibrium. In either case, the counterfeiting equilibrium is found to be stable, implying that3

once counterfeiting spreads, it prevails. Finally, it will also be shown that strengthening of IPR
law enforcement has no effect on the amount of counterfeiting conducted unless it is strengthened
enough to totally eliminate counterfeiting. These findings may help to increase our understandingof the general equilibrium welfare deteriorating effect of counterfeiting in primary markets, aswell as the difficulty of eliminating counterfeiting.
The rest of the paper is organized as follows. In the next section, I review standard resultsfrom the entrepreneur formulation of monopolistic competition. This will be the benchmark of
the study. In Section 3, I present the assumptions of counterfeiters and derive the conditions
under which counterfeiting is conducted. Section 4 analyzes changes in behaviors whencounterfeiting is conducted, to derive equilibrium under counterfeiting. Then the equilibrium
under counterfeiting is compared with the benchmark equilibrium. Impact of a change in the levelof IPR law enforcement is also analyzed. Section 5 concludes.

2. Entrepreneur formulation of monopolistic competition, the benchmark
The population mass of the economy is denoted as L . Members are either entrepreneurs or
workers. The share of the entrepreneurs within the population is denoted as e

0  e  1 . 1

Correspondingly, the share of the workers is 1  e . The firms run by the entrepreneurs are
assumed to be monopolistically competitive. Each entrepreneur sets up an original brand, and it isassumed that c units of workers are needed per unit output.
The same population also comprises the consumers. The assumption for consumer behavior
is a standard one, originally developed by Dixit and Stiglitz (1977). All consumers have the same
preferences, which are defined byn
U   mi di 
 0




1

,

which is the composite of all the differentiated varieties. Here, n is the mass of brands, mi is theconsumption of brand i , and  is the substitution parameter. It is assumed that 0    1 toensure that the brands are imperfect substitutes.   1 1     1 represents the elasticity of
substitution between any two brands. Higher (lower)  means weaker (stronger) love of variety.
Denoting the price of a brand as p i , a price index

1

In the Forslid and Ottaviano (2003) model, this share is fixed.

4 n 1 
G   p i di 
 01 1 

(1)

is introduced such that total expenditure is GU . G is an overall level of prices that each firmtakes as given.
In the above setting, consumers’ utility maximization leads to demand for each brand being
p  G  1Y , where Y is aggregate income. (Hereafter subscript i is omitted.) Demand therefore

depends not only on p and Y but also on G . Y consists of total profits earned by theentrepreneurs and total earnings of the workers. When  is the profit of each firm and eachworker’s wage is set equal to one,Y  eL  1  eL .

(2)On the supply side, entrepreneurs of monopolistically competitive firms will set their prices
so that marginal revenues equal marginal costs:p1  1    c .

(3)This is known as mark-up pricing, in which firms always set their prices above their marginal
costs, c . However, since rival brands are producing more or less substitutable varieties, the markup depends on  : when the varieties are close substitutes (or consumers’ love of variety is weak),i.e., when  is high, then consumers are sensitive to prices and the prices become closer to c . By
substituting Eq. (3) into (1), we find that the mark-up pricing by each firm leads to the priceindex beingG  n 1 1 

c
,
 1

(4)

where
n  eL .

(5)

Further, denoting the output of each firm as q , since the profit of each firm (  ) is pq  cq , using(3), we have


c
q.
 1

(6)

We can now consider equilibrium. Equilibrium is defined as a situation in which the goods
and the factor markets clear (i.e., supply equals demand), under free entry. The goods market
clearing condition isq  p  G  1Y ,5(7)

and the factor market clearing condition isL  n  ncq ,(8)which means that the population ( L ) needs to match the amount of entrepreneurs and workers,
i.e., those other than entrepreneurs must be fully employed as workers.
Solving (7) and (8) simultaneously after substituting in (2) through (6), we have
q

1 e
.
ec

(9)

Substituting (9) into (6), the entrepreneurial profit is


1 e

e  1.

(10)

Free entry, however, drives  down to the workers’ wage, which is one. That is,   1 inequilibrium. Then, using (10), we havee 1  ,(11)nL  .

(12)

which, using (5), implies

Substituting (11) into (9), the equilibrium output of each brand isq    1 c .

(13)

Substituting (12) into (8) gives the equilibrium mass of workers, which is L  1  . These aresummarized in Table 1 as the benchmark equilibrium.

3. Counterfeiting
3.1. Incentive for counterfeiting
Assumptions
Before proceeding to analyzing counterfeiting, it is necessary to define what counterfeits are andto lay out some assumptions on counterfeiting. As mentioned at the outset, the subject of thispaper is counterfeiting in primary markets. In the present analysis, therefore, a counterfeit isdefined as something that appears to be the same as an original but does not function and offers
no utility to a consumer. That is, the consumer cannot distinguish between the original and thecounterfeit until they ‘open the box’. Consumers, however, know the share of counterfeits, or the
probability that their purchases turn out to be successful/unsuccessful. Agents are homogeneousand anyone can become a counterfeiter. Counterfeiters can produce fakes in a costless manner6

(using, say, wild plants or trash to produce fake medicine and food), and deceive consumers bygetting their fakes through legitimate distribution channels, as reported by OECD (2008). Being
sold in legitimate channels means that the counterfeits are sold at the same prices as the originals.
There exist IPR laws but they are imperfectly enforced. Counterfeiters know theirprobability of being caught, which is positively associated with the amount of counterfeit
production. If caught, they lose all their income from counterfeiting. Increasing involvement oforganized crime, as reported by OECD (2008), is also taken into account: once agents becomecounterfeiters and establish their ‘territory’ of counterfeiting particular brands, they ‘turf out’ anyothers who attempt to counterfeit the same brands, thereby monopolizing on their activities. Thisimplies that each counterfeiter can only produce fakes of a particular brand; they ‘specialize’ on
counterfeiting of specific brands as ‘shadow’ entrepreneurs, creating an entry barrier.
Both consumers and counterfeiters face uncertainty. Because of counterfeits, consumers’
utilities from their purchases become uncertain. In addition, the counterfeiters face uncertainty intheir incomes because of the risk of being caught for IPR infringements.
The assumptions on counterfeiting mentioned above are summarized as follows:
1) Counterfeited goods do not offer any utility to the consumers.
2) Any individual, i.e., entrepreneur or worker, can become a counterfeiter.
3) Everyone behaves so as to maximize expected utility in the presence of uncertainty.
4) Each counterfeiter produces counterfeits of a particular brand. That is, each counterfeiter can
only produce counterfeits of one brand.
5) Counterfeits can be produced without cost.
6) Counterfeits are distributed through legitimate distribution networks and are sold at the same
price as their originals.
7) Counterfeiters can be caught; the probability of being caught is positively related to theamount of counterfeit production, and this probability as a function of the amount ofcounterfeit production is known to everyone.
8) When caught, the counterfeits are confiscated and discarded, so the counterfeiter loses all
his/her income from counterfeiting.

7Incentive to counterfeit
Under the above-listed assumptions, would any individual have an economic incentive to conduct
counterfeiting? Let x  0 be the size of counterfeit production relative to that of the original,
which means that the counterfeit output is xq . Also, to facilitate the analysis by specifying
assumption 6, we assume that the probability of being caught is 1   x 0    1 , which is shownin Figure 1. This simply means that the larger the production of counterfeits, the greater the
likelihood of being caught. Parameter  indicates the degree of law enforcement: the smaller the , the stricter the law enforcement. Then the expected counterfeiting income is pqx x . From thebenchmark result, it is known that p  c   1 and q  F   1 c . Then expected counterfeiting
income ( pqx x ) can be written as x x , which is illustrated in Figure 2. The expected (indirect)
utility from counterfeiting is
x x G0 .

(14)

Since G0 is given for everyone, maximizing (14) is equivalent to maximizing the expected
counterfeiting income, x x . In this sense, the population is risk-neutral. Given that theprobability of being caught is ( 1   x ), the optimal level of x to maximize x x is  1 log  .
Hence, the expected counterfeiting income is   1 log log  , as indicated in Figure 2.

1
1  xlower higher x0
Figure 1. Probability of being caught ( 1   x )8  1 log log 

x x

0

x
1 log 

Figure 2. Expected counterfeiting income ( x x )In the benchmark equilibrium, everyone earns income equal to one. Therefore, everyone has
an economic incentive to turn to counterfeiting if the expected counterfeiting income(   1 log log  ) exceeds one. Hence, it is necessary that   1 log log (15)

for individuals to start counterfeiting. Otherwise, there is no economic gain to be expected fromcounterfeiting, and counterfeiting does not occur.

Result 1. Given assumptions 1 to 7 above, individuals conduct counterfeiting of the existing
brands if  and  are sufficiently large to satisfy condition (15).

Inspecting the right-hand side of (15), it can be confirmed that  1 log log   0 ,









d 2   1 log  log d   1 log  log 0, 0 , and
d
d 2

(16)

so Result 1 can be shown diagrammatically as in Figure 3. Result 1 implies that, consistent withintuition, at a given level of  , the stricter the law enforcement (  ), the lower the incentive tocounterfeit. Also, at a given level of  , the larger the  , the higher the incentive to counterfeit.

9Recalling that the equilibrium output of each brand is   1 c , this means that the larger the
output of a brand, the higher the incentive to counterfeit the brand.

  1 log log 

counterfeiting

No counterfeiting

1



0

1
Figure 3. Incentive for counterfeiting

3.2. Counterfeiting equilibrium
Counterfeiters in the counterfeiting economy
As derived in Result 1, if condition (15) is satisfied, then everyone has an economic incentive tocounterfeit. However, not everyone can become a counterfeiter because the mass of varieties islimited. Denoting the total mass of brands in the counterfeiting economy as n  , this implies thatin equilibrium the total mass of counterfeiters will also be n  . (Hereafter, the endogenous
variables in the counterfeiting economy that already appeared in the benchmark economy are
given asterisks.) Denoting the legitimate supply of each brand as q  , taking into account theprobability of being caught, the expected supply of counterfeits of each brand is q  x x , where
the counterfeiters optimally choose x  1 log  .

10Consumers in the counterfeiting economy
The existence of counterfeits for all brands symmetrically means that whichever brands
consumers purchase, they have the same probability of purchasing counterfeits, which areassumed to be valueless. Then their expected utilities can be written as11

 n   
 n


E U   mi di  or   mi di  ,
0
0



 





(17)

where  0    1 is the share of legitimate products in the total supply including counterfeits ofeach brand:q.
q   q  x x

(18)

Because the counterfeiters choose x  1 log  ,


log 
1

log    log  

.

(19)

Utility, therefore, is expected to be discounted by a factor of  . Because  is given to theconsumers, their utility maximization behavior is the same as in the benchmark case. Demand for


 1

each brand is therefore p  G  Y  , where p  is the price, G  is the price index, and Y  is theaggregate income in the counterfeiting economy.

Entrepreneurs in the counterfeiting economy
The elasticity of substitution (  ) and correspondingly the price elasticity of demand do notchange under the existence of counterfeits. The pricing behavior of entrepreneurs, therefore, does
not change: their profit maximizing prices are the same as in the benchmark case, that is,p  1  1    c .

(20)

L  2n   n  cq  ,(21)   p  q   cq  .

(22)Equilibrium under counterfeiting
The full employment condition is now

and the entrepreneurial profit (   ) is

Substituting (20) into (22), as in the benchmark case, the zero profit condition leads to11q     1 c .

(23)n   L   1 .

(24)

Substituting (23) into (21), it is found that

This result is confirmed to satisfy the market clearing condition, which isq   q  x  p  G 

 1

Y,

(25)

where Y  , the aggregate income in the counterfeiting economy, is the sum of the entrepreneurial
profits,

theworkers’





wage

income,andthecounterfeiters’

income,thatis,Y   n   c L  2n   n  p  q  x x . Using (22) to substitute for   ,Y   n  p  q  1  x x .

(26)

In the counterfeiting economy, the expected (indirect) utility of entrepreneurs and workers in
the counterfeiting equilibrium is
E U LE    G  ,(27)where subscript LE stands for ‘legitimate’. For convenience, denoting a typical counterfeiter’s
expected income as EI CF  , we have, using (20) and (23),EI CF   p  q  x x   log 1log  1 .

(28)

Then the expected (indirect) utility of counterfeiters in the counterfeiting equilibrium is
EU CF   EI CF  G  ,(29)where subscript CF stands for ‘counterfeit’. The two equilibria are shown in Table 1. Incomparison to the benchmark equilibrium, in the counterfeiting equilibrium, the prices ( p ) andoutputs ( q ) of the individual goods are unchanged. However, there are fewer brands ( n ) in the
counterfeiting equilibrium, which itself is welfare decreasing for everyone.
EU LE  and E U CF  can be compared with the level of utility in the benchmark equilibrium,

U 0 . Then it is found that  E U LE  U 0   
1   

1  1  1.

(30)

Result 2a. All (legitimate) entrepreneurs and workers lose in the counterfeiting equilibriumcompared to the benchmark equilibrium where there is no counterfeiting.

12The result that all legitimate people lose can be explained in more detail by inspecting (30).
The first term,  , is the expected share of legitimate products or the probability of ‘successful’purchase. The second term represents the increase in the price index due to reduction in the total
mass of brands. The total mass of brands decreases in the counterfeiting equilibrium becausesome people quit legitimate occupations and turn to counterfeiting. In other words, some of theresource is used in counterfeiting, which leads to a reduction in the total mass of brands. The
welfare loss, therefore, comes from two sources: one is from counterfeiting itself reflected in thefirst term of (30), and the other is from the reduction of brands reflected in the second term of(30): the lower the  and/or the lower the  , the larger the welfare losses of the legitimate
people. That is, as the probability of purchasing counterfeits increases and/or the love of variety
strengthens, the welfare loss in the counterfeiting economy becomes larger compared to thebenchmark.
Eq. (30) is also diagrammatically shown in Figure 4, as the dotted upward sloping curve.
EU LE  U 0 increases with  (because the larger the  , the smaller the love of variety, andtherefore reduction in variety matters less), but it is always lower than  (the horizontal line at is the asymptote) and clearly lower than one, indicating that the legitimate people never gain in
the counterfeiting equilibrium compared to the benchmark.
Next, by comparing EU CF  and U 0 , it is found that  E U CF  U 0   
1   

1  1

E I CF  .

(31)Result 2b. Whether counterfeiters gain or lose in the counterfeiting equilibrium depends on thelevel of the elasticity of substitution between the brands,  . Counterfeiters lose when  is small
1and sufficiently close to  log  log  .

The first and the second terms in (31) are the same as in (30). However, in the case ofcounterfeiters, they expect to earn EI CF  , which, from Result 1, must exceed one. Therefore,
counterfeiters can gain from their acts in the counterfeiting equilibrium if EI CF  is sufficiently
large, and EI CF  is positively related to  . The intuition is as follows.  also represents thesizes, that is, the equilibrium outputs of legitimate brands as derived in (23): the larger the  , the13larger the output of each brand. This means that the counterfeiters’ production is also
proportionally larger and their expected income from counterfeiting is larger. Hence, larger 
implies higher expected income from counterfeiting. In contrast, counterfeiters lose if  is1

sufficiently close to   log  log  .
Eq. (31) is also diagrammatically shown in Figure 4, as the upward sloping curve. It isshown that at higher levels of  , EU CF  U 0 exceeds one, but at lower levels of  , it is less thanone. This result and Result 2a together imply that it is possible that nobody gains in the
counterfeiting equilibrium.
Result 3. If the level of the elasticity of substitution between the brands (  ) is sufficiently low,then everyone (including the counterfeiters) loses in the counterfeiting equilibrium.
1

Further, comparing (30) and (31), at any level of  larger than   log  log  ,EU CF   EU LE  . It can also be confirmed in Figure 4 that EU CF  U 0 always exceeds
EU LE  U 0 whenever counterfeiting is conducted. Therefore, no counterfeiter finds it profitable toquit counterfeiting and return to legitimate occupations.

Result 4. The counterfeiting equilibrium is stable.

Result 4 means that once counterfeiting spreads in an economy, there is no individual
incentive that eliminates counterfeiting. In other words, the economy is locked-in tocounterfeiting prevailing.

14

Table 1: Comparison of equilibria
Benchmark economy
p0 

q0 

n0 

Counterfeiting economy

c
 1

p 

  1

q 

c

L

n 


1

  1
c

L
 1
1

 L  1 c
G0   
 1
 

U0 

c
 1

 L  1 cG   1
   1U LE 

1GG  log  log  U CF 
G
1

1

EUCF  U0

1

EU LE  U 0

0  1 log log everyone loses

only counterfeiters gain

counterfeiting is conducted

Figure 4: Welfare in a counterfeiting economy

15Changes in the level of law enforcement
How would stricter IPR law enforcement work to change the situation? The effect of changes in
the level of law enforcement on the counterfeiting economy can be analyzed by the following~

comparative statics. Consider stricter law enforcement, that is, reduction in  from  to  .
This reduces the probability of consumers’ purchasing counterfeits, which raises the level of  .
As shown in Figure 5, the increase in  implies an upward shift of the EU LE  U 0 curve.2 On theother hand, the lower  reduces the counterfeiters’ expected income, EI CF  . Therefore, theEU CF  U 0 curve shifts downward, which is also shown in Figure 5. 3 Then, as illustrated in

Figure 5, when  is within range A, then EU CF   EU LE  , so counterfeiters find it profitable toquit counterfeiting and return to legitimate occupations, which will restore the benchmark
equilibrium. However, if  is larger (range B), then EU CF   EU LE  still holds, so
counterfeiters will stay as counterfeiters.
In this sense, therefore, stricter law enforcement, that is, lower  , does not always work tostop counterfeiting. If  is small and law enforcement is not sufficiently strengthened, it will
have no effect on the amount of counterfeit conducted. Only sufficiently strict enforcement works
to eliminate counterfeiting.

Result 5. Strengthening of IPR law enforcement has no effect on the amount of counterfeiting
conducted unless it is strengthened enough to totally eliminate counterfeiting.
Less strict enforcement, that is, higher  , works oppositely. The EU LE  U 0 curve shifts
downward, while the EU CF  U 0 curve shifts upward. Less strict enforcement, therefore, always
worsens the situation in the sense that it lowers the welfare of legitimate people by increasing
their probabilities of purchasing counterfeits, and raises the welfare of counterfeiters. This alsomeans that economic inequality between the legitimate people and counterfeiters increases.

2

Using (19), d d   e  e  log    0 .

3

Using (29), E I CF     e log    0 .

2

2

16

EUCF  U0

1

EU LE  U 00stricterenforcement~ ~~  1 log  log   1 log log range A

range Bcounterfeiting
eliminatedcounterfeiting continues(not eliminated)

Figure 5. Enforcement and elimination of counterfeiting

5. Conclusion
Applying the entrepreneur formulation of monopolistic competition, this paper analyzed
counterfeiting in primary markets, that is, deceptive counterfeiting, in general equilibrium. It first
showed that counterfeiting occurs when the elasticity of substitution between existing brands was
sufficiently large and/or IPR law enforcement was lax (Result 1). By studying the counterfeiting
equilibrium in which all brands were counterfeited by ‘shadow’ entrepreneurs, it was shown thatall ‘legitimate’ people lose (Result 2a), while the counterfeiters can gain if the outputs of thebrands they counterfeit are sufficiently large (Result 2b). Otherwise, nobody gains in the
counterfeiting equilibrium (Result 3). There were two sources of welfare loss. One was, of course,
the possibility of purchasing counterfeits that offer no utility. The other was the reduction in themass of varieties available, as a result of people turning to the counterfeiting business. Regardlessof whether counterfeiters gain, the counterfeiting equilibrium was found to be stable, implying

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that once counterfeiting spreads, it prevails (Result 4). This was because, in relative terms, theexpected utilities of the counterfeiters always exceed those of the legitimate people. Finally, it
was shown that incremental strengthening of IPR law enforcement may not work to eliminate
counterfeiting (Result 5).
The analysis helps to describe the basic economic situation of a society damaged bydeceptive counterfeiting, and explains persistent counterfeiting as reported by OECD (2008) as
well as the difficulty of eliminating counterfeiting.
In contrast to existing studies that cover secondary counterfeiting markets, since the focus of
this study is on deceptive counterfeiting, unsurprisingly all legitimate agents lose fromcounterfeiting. However, the general equilibrium analysis points out that the counterfeiters
themselves can lose, and shows the difficulty of combating counterfeiting both because there isno individual incentive to stop counterfeiting once it is conducted, and because strengthening of
IPR law enforcement will have no impact on counterfeiting unless it is strengthened enough tototally eliminate counterfeiting.
The limitations of the analysis should also be noted, however. First, the subject of theanalysis is deceptive counterfeiting in primary markets, which is a particular kind ofcounterfeiting observed today. Second, a long list of assumptions is necessary to generate thecounterfeiting equilibrium. In particular, the counterfeiting equilibrium in the present analysis
requires a kind of an entry barrier to counterfeiting, since it is assumed that once a brand iscounterfeited no other agent can counterfeit the same brand. Third, monopolistic competition, on
which the analysis is built, is a particular type of market structure. Fourth, the agents in the model
are risk-neutral.

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