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Economic Analysis of Software Patent
Research Fellow: Yasuhiro AraiIn this study, the author focuses on economic differences between copyrights and patent rights thathave not been considered in existing studies, and considers the protection of the intellectual property
rights for “software” that is protected by both of these intellectual property rights. Since the patent right isa right protecting “ideas,” by applying the patent right to software, it can prevent both the “copying ofinnovative ideas among manufacturers” and the “copying of software.” Meanwhile, the copyright protects“expression” so that if the patent right does not apply, it cannot prevent the “copying of innovative ideas
among manufacturers.” Focusing on this point, the author analyzes which right is preferable for protecting
software from the perspective of social welfare, the patent right or the copyright.
The author considers this study to be important not only for the validity of software patents, but also
for distinguishing the patent right and copyright in models from an economic perspective and to consider
the protection of intellectual property rights from a more realistic viewpoint.

Ⅰ Background of the Problem
In recent years, the number of applications
for software patents has been increasing in theUnited States of America. According to Bessen
andHunt(2004),
approximately
25,000applications are filed per year. On the other hand,in Europe, Article 52 of the European Patent
Convention provides that software would not beprotected by patent. As mentioned above, stanceson how to protect intellectual property rights forsoftware may vary greatly in the world.
Consequently, in this study, the author considers
protection systems for the intellectual propertiesof software by using economic theories.
In theoretical economics, analysis isprocessed by expressing reality with simple
mathematical formulas. In order to consider themeaning of mathematical models of theoretical
economics, it is easier to understand by thinking
about a place you have never visited before inyour travels. For example, say you want to know
the way to a famous art museum from your hotel.
The most accurate way to find the way is to takepictures of the actual roads to the destination in
high-resolution satellite imagery. However, thismethod is wasteful for achieving the goal of“learning the way to the destination.” Since
reality is very complicated, if the photos reflectreality as it is, they may show cigarette butts thatwere thrown on the street, a hungry stray dog,
dented guardrails, etc. This information is not
only redundant, but may become an obstacle toachieving the original purpose. Theoretical
economics aims to discuss the essentials of anissue (the way to the destination) by drastically

IIP Bulletin 2009

discarding the phenomena unrelated to thepurpose of “learning the way to the destination”
and creating a “map” that simplifies the reality.
The economic theory model in this study aims tocreate a map as simple as possible for the purposeof examining the “optimal protection of
intellectual properties in the software market.”In the field of theoretical economics, there
have been various maps created to discuss thevalidity of patent rights (Klemperer, 1985; Gallini,1992; Gilbert and Shapiro, 1990; O’Donoghue,
Scotchmer and Thisse, 1998; Tandon, 1982).
However, since software has special features thatare different from normal properties, it is difficult
to apply these arguments to software patents.
The patent right is a right to protect aninnovative “idea.” Consequently, if innovativeideas are included in the software, it is possible toprotect them by patent rights. Moreover, softwareis also an “expression” of source codes; therefore,
it is also subject to copyright protection thatprotects expression. Therefore, when considering
the protection of the intellectual property rights
of software, it is necessary to clarify thedifferences between copyrights and patent rights
in economic terms.
The study of intellectual property rights ineconomic terms establishes a trade-off, where theintellectual property rights “give incentives fordevelopment to companies,” while “causing socialdamages by its exclusive right,” as the subject ofanalysis. However, this trade-off is a commonproblem with all intellectual property rights.
Therefore, there is no study that clearly indicatesthe differences between copyrights and patentrights in the form of a model among existing● 92 ●

documents.
Since the patent right is a right to protect“ideas,” it can prevent both the “copying ofinnovative ideas among manufacturers” and the“copying of software.” The copyright, on the otherhand, only protects “expression” so that it cannot
prevent the “copying of innovative ideas amongmanufacturers.” Focusing on this point, theauthor 、 in this study, analyzed which ispreferable for protecting software from theperspective of social welfare, the patent right, or
the copyright.

policies for intellectual properties against end
users.
Based on the above assumptions, the optimalstrategies for each economic entity (thegovernment, the software companies, andconsumers) shall be considered. As a standard
assumption of economics, the presumption is that
consumers behave reasonably to maximize theirown utility, companies to maximize their profits,
and the government to maximize social welfare.
In these economic models, economic entities areassumed to behave based on the following phases:

Ⅱ Analysis

Phase I:This study analyzes the simplest models. InSection II and III, “cases where a patent right isestablished for software” and “cases where thepatent right is not established for the software,
but the software is protected only by copyright”
are expressed with simple theoretical economic
models. By using these two kinds of models, how
the patent right of software affects the welfare ofsociety as a whole is considered.
For simplification, let us assume that there
are two software companies (Company A andCompany B) in the market. Company A currently
has an innovative idea and can select whether
they develop software by paying a certain amountat a fixed cost. If they do not conduct thedevelopment, the software will not be supplied tothe market. In considering the situation where
the invention of Company A is protected by thepatent right, Company B cannot produce softwareby using the new technology of Company A.
With regard to the consumers of the software,they shall be expressed in the model based on thefollowing assumption. Let us say there are twokinds of consumers: (1) normal users who always
purchase regular products and (2) copy users whoalways use copied products. The normal users
may obtain utility by purchasing the software, andthey still have the option “to purchase nothing;”
assuming that a consumer has “0” utility, if
he/she does not purchase the software. With
regard to the copy users, let us assume that they
can produce copies of the regular product with thesame quality at zero cost (or at very low cost).
This assumption is based on the situation where
increasing numbers of digital copies are made by
end users in recent years. Based on theabovementioned situation, all of the copy users
would copy the software of Company A. It isgiven that the government can control the ratio of
normal users in the market through protective

Phase II:

Phase III:
Phase IV:

The government establishes
protection
standards
forintellectual properties against
end users in order to maximizesocial welfare.
Company A decides whether it
improves the quality of its own
products by spending a certain
amount at a fixed cost.
Company A specifies the price ofthe software.
The normal users select their
behaviors from either “purchasingnothing,” or “purchasing thesoftware of Company A.” The copy
users copy the software in orderto maximize their utility.

Under these assumptions, the author seeks
strategies to balance each economic entity andcalculates social welfare in cases where thepatent right is established for software.
In the same way, the author analyses inSection III the effect on social welfare when thesoftware is only protected by copyright. The basic
assumptions for the analysis are the same as thecase of establishing the patent right for thesoftware; provided, however, that in cases wherethe software is protected only by the copyright,
the treatment of new technologies among
companies is different. In the previous Section,
Company A develops a new technology, but
Company B cannot produce anything based on it.
In this Section, since the innovative ideas
included in the software are not protected by thepatent right, Company B, under the assumptionsof this Section, is able to copy the software ofCompany A to a certain extent. Before starting
the analysis, let us check the assumptions of themodels again.
As in the previous Section, let us assume
that there are two software companies in the● 93 ●IIP Bulletin 2009

market. Company A has an innovative idea andcan select whether they develop software bypaying a certain amount at a fixed cost.
Presuming that if Company A does not conductdevelopment, the software will not be supplied tothe market. In cases where Company A conducts
development, as it is different from above,
Company B can produce software with a slightly
lower quality by copying the idea. For
simplification, Company B can copy the idea atalmost no cost. Similarly, there may be different
cases of consumers’ behavior from those in theprevious Section.
In the assumptions of this Section, thenormal users have three choices: “purchasing thesoftware of Company A,” “purchasing thesoftware of Company B,” and “purchasingnothing.” Each economic entity in this model isassumed to behave based on the following phases:
Phase I:

Phase II:

Phase III:

Phase IV:

The
government
establishes
efor
protection
standards
intellectual properties against end
users in order to maximize socialwelfare.
Company A decides whether it
improves the quality of its own
products by spending a certain
amount at a fixed cost.
Both Company A and B specify theprice of their software at the sametime.
The normal users select theirbehaviors from “purchasing nothing,”“purchasing the software fromCompany B,” or “purchasing thesoftware from Company A.” Thecopy users copy the software in orderto maximize their utility.

Proposition 1
In cases where the software is protected by
the patent right, protective standards for end
users become lower than in those cases where
the software is protected only by the copyright.
The argument for this proposition is asfollows:
Under the assumptions of this model, inorder to maximize social welfare, the protective
standards shall be as low as possible in order togive companies incentives for development. Now,
let us focus on the companies’ profits under bothschemes. In cases where patent rights are
established for the software, the copying oftechnologies among companies is not permitted;
while in cases where the software is protected
only by copyright, it becomes possible forCompany B to copy the new technology ofCompany A. This copying of new technology
makes Company A, which has dominated themarket, to face competition with Company B andreduce the profits of Company A. The
government needs to secure incentives for theproduction of Company A. This causes thenecessity of establishing more severe standardsof protection for intellectual properties topromote development under the copyright
schemes than under the patent right schemes.
Next, the author will argue which schemes
shall be applied to improve social welfare.

Proposition 2

Under these assumptions, the author seeks
the strategies of each economic entity andconsiders social welfare.

Ⅲ Protection by the Patent Rightand by the Copyright
In this analysis, whether the special property,
i.e. software, shall be protected by establishing
the patent right or protected only by thecopyright is considered from the perspective ofsocial welfare. For this analysis, the author hasconstructed a model focusing on the point that if acopyright is granted to the software, it can only
prevent copying by the end user, while if a patent

IIP Bulletin 2009

right is established for the software, it can
prevent not only the copying of software, but also
the copying of ideas among companies. The
following conclusions are obtained.

When comparing social welfare in cases
where the patent right is established for thesoftware and in cases where it is not established,social welfare improves when the patent right is
not established for the software, but the software
is protected only by copyright.
The argument for this proposition is asfollows:
According to proposition 1, when deciding
whether the patent right is established for thesoftware or not, it is found that one trade-off
problem occurs. When a patent right isestablished for the software, the necessary
protective standards for intellectual properties toallow production by another company can belower than under the copyright schemes. This

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enables a greater increase of the number ofsoftware users in society as a whole when
adopting patent right protection schemes thanwhen adopting copyright protection schemes. On
the other hand, if a patent right is established, it
allows Company A, which is a developer, todominate the market. The result is that highquality software is sold at a high price to thenormal users. If the copyright schemes areadopted, Company B copies the software and it
enters into competition so that the price of thesoftware produced by Company A is lowered.
This proposition indicates that the adverse effects
from monopoly are greater by establishing apatent right.

protection against copying by consumers due tothe copying of technologies by rival companies. In
these cases, it becomes very important for thedevelopment of useful technology for society toestablish the patent right for software and toregulate copying by companies. The conclusion
reached by this study supports the EU’s
standpoint in principle; however, it also suggeststhat if the software is innovative and requiresvery high development costs, the software must
be exceptionally protected by the patent right.

Ⅳ Conclusion
In this analysis, the author considered
whether a special property, i.e. software, should
be protected by establishing a patent right orprotected only by copyright from perspective ofsocial welfare. For the analysis, the author
constructed a model focusing on the point that if acopyright is granted to the software, it can only
prevent copying by the end user, while if a patentright is established for the software, it can
prevent not only copying of software, but also thecopying of ideas among companies. The following
conclusions are obtained:
In cases where the new idea developed by acompany is fully innovative, but the development
cost is not so high, the government can provide
better social welfare by applying a copyrightinstead of a patent right (proposition 3). However,when applying a copyright to the new idea, itcannot prevent copying technologies among
companies. Therefore, it requires a stricter
control of the copying by consumers in order togive companies sufficient incentives fordevelopment (proposition 2). Intuitively, this has
great effects on the improvement of welfare by
improving the quality of the software in the wholemarket and on the promotion of competition by
weakening the monopoly power of the developer.
Therefore, as a result, the copyright is more
preferable from the perspective of society. This
study indicates the utility of copyright when
considering the protection of intellectual property
rights for software.
However, this does not directly lead to theconclusion that the patent right is unnecessary.
As proposition 3 indicates, if the development
costs are very high, there are some cases wherethe development costs cannot be covered only by● 95 ●IIP Bulletin 2009