BoundedRationalityandIP

WilliamFisherNovember10,2017

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Quantity

The Incentive Theory of IP is founded upon the following conception of the impact of giving innovators exclusive rights

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Profit-maximizing output

MonopolyProfits

ConsumerSurplus

DeadweightLoss(foregoneconsumersurplus)

Marginal Cost

RefiningtheApproach

• Ouraspirationshouldbetoadjustpatentdoctrinethatincreaseitssociallybeneficialeffectsanddecreaseitssociallyperniciouseffects

• Ourabilitytodosowillincreaseifourpredictionsoftheimpactofthesevariousincentivesisfoundeduponamoresophisticatedmodelofhumanmotivations

Rationality1) ExpectedUtilityTheory

a) Concaveutilityfunctionsb) Decisionmaking onthebasisofexpectedutilityc) Generalphenomenonofriskaversion

2) UbiquitousFormsofBoundedRationality3) FormsofBoundedRationalityspecificto

creators

Source:Prakash,EnterpriseandIndividualRiskManagement

StandardUtilityCurve

StandardUtilityCurve

Source:http://economicsconcepts.com/total_utility_and_marginal_utility.htm

Decision-making on the basis of expected utility

• Rationalchoice=selectingpathBoverpathAiffthesumoftheexpectedutilitiesofthevariouspossibleoutcomesofpathBexceedthoseofpathA

• Toillustrate:– pathAleadstocertaingainof20utiles (orunitsofpleasure)

– pathBleadsto25%chanceofgaining100utiles anda75%chanceofgainingnothing

– expectedutilityfrompursuingpathAis20;– expectedutilityfrompursuingpathBis.25(100)+.75(0)=25utiles

– Underthesecircumstances,arationalpersonwillchoosepathB

Rationality1) ExpectedUtilityTheory

a) Concaveutilityfunctionsb) Decisionmaking onthebasisofexpectedutilityc) Generalphenomenonofriskaversion

2) UbiquitousFormsofBoundedRationality3) FormsofBoundedRationalityspecificto

creators

Source:Prakash,EnterpriseandIndividualRiskManagement

StandardUtilityCurve

Statusquo Personisofferedabet:--odds:50/50--ifshewins,gains$2K--ifsheloses,forfeits$2KSherefusesthebet.

Expectedutilityofthegamble

Decision-making on the basis of expected utility

• Rationalchoice=selectingpathBoverpathAiff thesumoftheexpectedutilitiesofthevariouspossibleoutcomesofpathBexceedthoseofpathA

• Toillustrate:– pathA(HarvardLawSchool)leadstocertainlifetimetotalincomeof$20M(discountedtopresentvalue)

– pathB(BerkeleyColleyofMusic)leadsto25%chanceoflifetimeincomeof$100Manda75%chanceof$1M

– expectedbenefitfrompursuingpathAis$20M– expectedbenefitfrompursuingpathBis.25(100)+.75(1)=$25.75M

– Intheabsenceofriskaversion,arationalpersonwillchoosepathB

– ButriskaversionislikelytocausethepersontochoosepathAinstead

Rationality1) ExpectedUtilityTheory2) UbiquitousFormsofBoundedRationality

a) ProspectTheoryb) EndowmentEffectc) PresenceHeuristicd) Overoptimisme) LotteryEffect

3) FormsofBoundedRationalityspecifictocreators

ProspectTheory• Ingeneral,peopleunderweightprospectsthataremerelyprobableincomparisontoprospectsthatarecertain

• Gains:– 100%chanceofwinning$100shouldbetreatedasequivalentof10%chanceofwinning$1000

– butpeoplebehaveasifthelatteris5%– givesrisetoriskaversionforgains– butforareasondifferentfromthatofferedbyclassicaltheory

• Losses:– 100%chanceoflosing$100shouldbetreatedasequivalentof10%chanceoflosing$1000

– butpeoplebehaveasifthelatteris5%-- i.e.,expectedutilityis$500loss

– givesrisetoriskpreferenceforlosses

EndowmentEffect• ThepaincausedbyalossofXistypicallygreaterthanthepleasurereapedbyagainofX– Putdifferently,peopleplacehighervaluesonthingstowhichtheythinktheyalreadyhaverights,thantheydoonidenticalthingstowhichtheythinktheydon’t(yet)haverights.

– Theresult:peoplewilldemandahigherpricetoinducethemtosurrenderanobjectoranentitlementthantheywilloffertoacquirethatobjectorentitlement.

• Thereferencepointfromwhichgainsandlossesareassessedisapsychologicalquestion,onlyindirectlyalegalone

GainsLosses

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EndowmentEffect

• Springsteentickets:https://www.npr.org/2017/11/09/563133762/bruce-springsteen-on-broadway-comes-with-an-economics-lesson?utm_medium=RSS&utm_campaign=business

GainsLosses

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Illustration:ValuationofSolarEasements

GainsLosses

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Illustration:SelectionofInsurance-PolicyProvisions

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Becausetheyarelessconcernedwiththisthanwiththis.

Rationality1) ExpectedUtilityTheory2) UbiquitousFormsofBoundedRationality

a) ProspectTheoryb) EndowmentEffectc) PresenceHeuristicd) Overoptimisme) LotteryEffect

3) FormsofBoundedRationalityspecifictocreators

Rationality1) ExpectedUtilityTheory2) UbiquitousFormsofBoundedRationality

a) ProspectTheoryb) EndowmentEffectc) PresenceHeuristicd) Overoptimisme) LotteryEffect

3) FormsofBoundedRationalityspecifictocreators

Source:http://www.orvfc.org/files/1212/5851/4939/NCAA%20-%20Professional%20Probabilities.pdf

Source:http://www.orvfc.org/files/1212/5851/4939/NCAA%20-%20Professional%20Probabilities.pdf

Levallow &Kahneman,“DelusionsofSuccess: HowOptimismUnderminesExecutives’Decisions”(2003)

“Researchintohumancognitionhastracedthisoveroptimismtomanysources.Oneofthemostpowerfulisthetendencyofindividualstoexaggeratetheirowntalents—tobelievetheyareaboveaverageintheirendowmentofpositivetraitsandabilities.Considerasurveyof1millionstudentsconductedbytheCollegeBoardinthe1970s.Whenaskedtoratethemselvesincomparisontotheirpeers,70%ofthestudentssaidtheywereaboveaverageinleadershipability,whileonly2%ratedthemselvesbelowaverage.Forathleticprowess,60%sawthemselvesabovethemedian,6%below.Whenassessingtheirabilitytogetalongwithothers,60%ofthestudentsjudgedthemselvestobeinthetopdecile,andfully25%consideredthemselvestobeinthetop1%.”

Levallow &Kahneman,“DelusionsofSuccess: HowOptimismUnderminesExecutives’Decisions”(2003)

“Theinclinationtoexaggerateourtalentsisamplifiedbyourtendencytomisperceivethecausesofcertainevents.Thetypicalpatternofsuchattributionerrors,aspsychologistscallthem,isforpeopletotakecreditforpositiveoutcomesandtoattributenegativeoutcomestoexternalfactors,nomatterwhattheirtruecause.Onestudyofletterstoshareholdersinannualreports,forexample,foundthatexecutivestendtoattributefavorableoutcomestofactorsundertheircontrol,suchastheircorporatestrategyortheirR&Dprograms.Unfavorableoutcomes,bycontrast,weremorelikelytobeattributedtouncontrollableexternalfactorssuchasweatherorinflation.Similarself-servingattributionshavebeenfoundinotherstudiesofannualreportsandexecutivespeeches.”

Carden,“Behavioraleconomicsshowthatwomentendtomakebetterinvestmentsthanmen”(2013)

“TerryOdean,aUniversityofCaliforniaprofessor,hasstudiedstockpickingbygenderformorethantwodecades.Aseven-yearstudyfoundsinglefemaleinvestorsoutperformedsinglemenby2.3percent,femaleinvestmentgroupsoutperformedmalecounterpartsby4.6 percentandwomenoveralloutperformedby1.4percent.Why?Theshortanswerisoverconfidence.Mentrademore,andthemoreyoutrade,typicallythemoreyoulose— nottomentionrunninguptransactioncosts….Additionally,menholdontotheirlosersalotlongerthanwomen.They’resurethestockwillcomeroaringback— evenasitsinks.Academicscallitconfirmationbias;investmentadviserscallitboneheaded.”

Goodman-Delahunty etal.,“InsightfulorWishful:Lawyers’AbilitytoPredictCaseOutcomes”(2010)

“Thefindingsextendpreviousresearchonoverconfidenceindefenselawyers(Loftus&Wagenaar,1988;Malsch,1990),byestablishingthatsimilarbiasesariseinpredictionsbycriminalprosecutorsandbycounselforbothplaintiffsanddefendantsincivilcases.Lawyersfrequentlymadesubstantialjudgmentalerrors,showingaproclivitytooveroptimism.Themostbiasedestimateswereexpressedwithveryhighinitialconfidence:Intheseinstances,lawyerswereextremelyoverconfident.Thesefindingsareconsistentwithalargebodyofliteraturedocumentingoverconfidenceinarangeofjudgments(theoreticalexplanationsofmiscalibrationofconfidencearediscussedinGigerenzer,Hoffrage,&Kleinbolting,1991;Kahneman,Slovic,&Tversky,1982;Moore&Healy,2008).”

Goodman-Delahunty etal.,“InsightfulorWishful:Lawyers’AbilitytoPredictCaseOutcomes”(2010)

“Withrespecttothecorrelatesoftheoverconfidencebias,certainresultsweresomewhatcounterintuitive,suchasthefindingthatlawyerswithmoreexperiencewerenotbettercalibratedthanlessexperiencedlawyers….“Withregardtogender,wereplicatedresultsobtainedbyMalsch(1990)thatfemalelawyerswerebettercalibratedthantheirmalecolleagues.Malepractitionersweremoreoverconfidentthanfemalepractitioners.Thesefindingsareinlinewithgenderdifferencesobservedinresearchonmetacognition(Pallier,2003).”

“LotteryEffect”• (Some)peopleoverweightsmallprobabilitiesofreapingverylargegains

• Manifestations– Playinglotteries(Scherer;Crouch)

• Peopleplaylotteries,despite“houserake”of~50%• Achangeintheamountofthepayoutwillaffecttheirwillingnesstoparticipatemuchmorethanachangeinprobabilityofthepayout

– Amateurinvestors(Stout1995)– Entrepreneurialism(Hopenhyn 2003;Astebro2003)

Scherer,“InnovationLottery”

GainsLosses

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Rationality1) ExpectedUtilityTheory2) UbiquitousFormsofBoundedRationality3) FormsofBoundedRationalityspecificto

creatorsa) Unusuallystrongversionof“overoptimism”?b) Areartists“skewness lovers”?c) Theintuitionsunderlyingpersonalitytheoryand

labortheorymayhelptodefineartists’referencepoints

Scherer,“InnovationLottery”

Clapton

MusicianswaitingtablesinNY&LA

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Scherersuggeststhispatternmaybesociallybeneficial

ChrisAnderson,“TheLongTail”

Source:http://www.thelongtail.com/about.html

“hits”

ChrisAnderson,“TheLongTail”

“ThetheoryoftheLongTailisthatourcultureandeconomyisincreasinglyshiftingawayfromafocusonarelativelysmallnumberof"hits"(mainstreamproductsandmarkets)attheheadofthedemandcurveandtowardahugenumberofnichesinthetail.Asthecostsofproductionanddistributionfall,especiallyonline,thereisnowlessneedtolumpproductsandconsumersintoone-size-fits-allcontainers.Inanerawithouttheconstraintsofphysicalshelfspaceandotherbottlenecksofdistribution,narrowly-targetedgoodsandservicescanbeaseconomicallyattractiveasmainstreamfare.”

Source:http://www.thelongtail.com/about.html

Scherer,“InnovationLottery”

Clapton

MusicianswaitingtablesinNY&LA

Thesearethe(relativelyfew)folkswhomakethe(relativelyfew)“hits”

Thesearethe(many)folkswhomakethe(largenumber)ofunpopularworks

IfAndersoniscorrect,weshouldseeashifttowardapatternlikethis.

Clapton

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Rationality1) ExpectedUtilityTheory2) UbiquitousFormsofBoundedRationality3) FormsofBoundedRationalityspecificto

creatorsa) Unusuallystrongversionof“overoptimism”?b) Areartists“skewness lovers”?c) Theintuitionsunderlyingpersonalitytheoryand

labortheorymayhelptodefineartists’referencepoints

TaylorSwift“Inmyopinion,thevalueofanalbumis,andwill

continuetobe,basedontheamountofheartandsoulanartisthasbledintoabodyofwork,andthefinancialvaluethatartists(andtheirlabels)placeontheirmusicwhenitgoesoutintothemarketplace.”“Musicisart,andartisimportantandrare.

Important,rarethingsarevaluable.Valuablethingsshouldbepaidfor.It'smyopinionthatmusicshouldnotbefree,andmypredictionisthatindividualartistsandtheirlabelswillsomedaydecidewhatanalbum'spricepointis.Ihopetheydon'tunderestimatethemselvesorundervaluetheirart.”WallStreetJournal,July7,2014

Swiftv.Spotify• Spotify pays70%ofitsrevenuesinlicensefees• Spotify paysrecordcompaniesinlicensefeesroughly$.01perplay

• Inmid-2014,Spotify paidSwifts’recordcompaniesandmusicpublisherroughly$500Mpermonth

• InNovember2014,SwiftremovedallhermusicfromSpotify

Swift’sIncome($M)

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Sources: http://www.forbes.com/lists/2009/53/celebrity-09_Taylor-Swift_2OIN.html;http://www.forbes.com/profile/taylor-swift/

TimeMagazine,November13,2014“Ithinkthereshouldbeaninherentvalueplacedonart.I

didn’tseethathappening,perception-wise,whenIputmymusiconSpotify.Everybody’scomplainingabouthowmusicsalesareshrinking,butnobody’schangingthewaythey’redoingthings.Theykeeprunningtowardsstreaming,whichis,forthemostpart,whathasbeenshrinkingthenumbersofpaidalbumsales.

“WithBeatsMusicandRhapsodyyouhavetopayforapremiumpackageinordertoaccessmyalbums.AndthatplacesaperceptionofvalueonwhatI’vecreated.OnSpotify,theydon’thaveanysettings,oranykindofqualificationsforwhogetswhatmusic.Ithinkthatpeopleshouldfeelthatthereisavaluetowhatmusicianshavecreated,andthat’sthat.IwroteaboutthisinJuly,Iwroteanop-edpieceintheWallStreet Journal.Thisshouldn’tbenewsrightnow.ItshouldhavebeennewsinJulywhenIwentoutandstoodupandsaidI’magainstit.Andsothisisreallykindofanoldstory.”

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PossibleImplicationsforIPLaw1) Hyper-optimismofcreatorsmaybesociallybeneficial

– argumentagainst“debiasing”(Crouch)2) Ifcreatorsare“skewnesslovers,”weshouldhesitatetoalter

thecurrentdistributionpattern(Scherer)3) Otherthingsequal,weshouldadjustdoctrinestoincrease

payoutsbutreduceprobability(Crouch)-- e.g.KSR’sincreaseinnon-obviousnessstandardmakeseconomicsense

4) Limitsonwork-for-hiredoctrineandpre-employmentpatentassignmentagreementsmaybesociallybeneficial(Scherer)

5) Legaldoctrinehas(partial)controloverthelocationofreferencepoints– andthushowinnovatorsandusersvaluetheirentitlements-- e.g.,rhetoricof“intellectualproperty”-- complication:referencepointsmaynotbefullycomplementary(e.g.,withrespecttofile-sharing)

6) Uncertaintymaynotbesobad(Horowitz)

Ethical?

StevenHorowitz,“Copyright’sAsymmetricUncertainty”

• Assumebothcopyrightowners(creators)andpotentialnonpermissiveusersareindividuals

• Endowmenteffectincreaseswithcertaintyoflegalentitlements

• Uncertaintyprompts:– Creatorstolicensetheirworksmoreoften,becausetheyarelessdeterredbylossaversion

– Userstomakemorenonpermssive usesofcopyrightedworks,becausetheyanticipatecreatorswillbelesslikelytosue

• Botheffectspromotesocialwelfare