Economics of Innovation and Intellectual Property KU Leuven
Economics of Innovation and
Intellectual Property [D0T32a]
Course Structure
Reading Guide
Key definition Exam-critical Empirical finding Theoretical result
point
Boxed content throughout the summary uses left-border colour coding: blue border = theoretical model/result;
green border = empirical study finding; orange border = exam-critical conclusion. Yellow highlight = key definition;
cyan highlight = core exam answer.
Contents
LECTURE 1 Innovation & Market Structure
Arrow Model, Replacement Effect, Efficiency Effect, Inverted-U (Aghion et al.)
LECTURE 2 Entry Dynamics, Patent Races & Licensing
Gilbert & Newbery, Reinganum Patent Race, Licensing by Inside/Outside Innovator
LECTURE 3 Market Failures; Appropriability & Spillovers
Knowledge Spillovers, Absorptive Capacity, Teece Framework, Returns to R&D
LECTURE 4 Innovation & Financing Constraints
Modigliani-Miller, Asymmetric Information, Pecking Order, Subsidies, VC
LECTURE 5 R&D Cooperation
D'Aspremont-Jacquemin Model, Alliance Types, Collusion Risk, Industry-Science
LECTURE 6 Intellectual Property Rights
Patent Basics, Nordhaus Model, Breadth, Patents vs. Prizes vs. Secrecy
LECTURE 7 Cumulative Innovation
Scotchmer Bargaining, Research Tools, Royalty Stacking, Patent Pools
LECTURE 8 Internationalisation of Corporate R&D
FDI Motives, HBE/HBA, Offshoring, Archetypes, Intercultural Teams
LECTURE 9 Tax Credits, Subsidies & Other Innovation Policy Tools
Policy Mix, Tax Credits, Patent Boxes, Education/Immigration, Crises
Key Concepts Glossary (Lectures 1–9)
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,Economics of Innovation and Intellectual Property KU Leuven
LECTURE 1 Innovation & Market Structure
The Economics of Innovation and Intellectual Property
1. Course Evaluation & Structure
Component Weight Format / Notes
Final Exam 60% Mainly open questions, closed book. Must score >= 10/20 for other
components to count.
Essay (Group Assignment) 30% Groups of 4-6 students. Apply a course concept to a real-world research
question.
Interim Online Tests 10% Small tests after each lecture. Only the two best scores count. Retakes
allowed until end of semester.
2. Why Economists Care About Innovation
Innovation is not merely a business concern: it is the central driver of long-run economic growth and societal welfare.
2.1 Innovation and Productivity Growth
Solow Growth Model
In the neoclassical Solow model, capital per worker K* stabilises through the interplay of savings rate (s), depreciation
rate (delta), population growth (n) and technological growth (g).
Technological progress A(t) is the only factor not subject to diminishing returns, making it the engine of sustained per-
capita income growth.
Solow treats g as exogenous; later endogenous growth models explain how economic behavior itself drives g.
2.2 Total Factor Productivity (TFP)
Technology is measured as Total Factor Productivity (TFP): the share of output growth not explained by growth in
capital or labor inputs.
• Solow (1957): ~87% of US labor productivity growth (1909-1949) was attributable to TFP growth.
• More recent studies find lower but still substantial TFP contributions.
• TFP captures efficiency improvements in management, organization, training, and process knowledge (not just
high-tech gadgets).
• Dan Wang (2025) distinguishes three layers of technology: (1) tools, (2) explicit instructions (patents, recipes),
and (3) process knowledge: tacit proficiency gained from experience. The third is often most important.
2.3 Empirical Evidence
Despite enormous increases in R&D spending, TFP growth has been slowing in many advanced economies since the
1970s, a major puzzle in innovation economics.
2.4 The Nordhaus Lighting Study
Nobel laureate William Nordhaus (1996) demonstrated that standard price indices vastly understate the true gains
from innovation using lighting as a case study:
• Lighting efficiency improved more than 1,000-fold since ancient times.
• The quality-adjusted price of light fell by hundreds of thousands of times since Babylonian times.
• Standard GDP and wage measures dramatically undercount the welfare gains from innovation.
3. The Innovation Process
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,Economics of Innovation and Intellectual Property KU Leuven
Innovation follows a structured process from basic research to widespread adoption.
3.1 Stages of the Innovation Process
Stage Activities Outputs Agent
1. Basic Research Fundamental scientific inquiry Discoveries, ideas External / firm-level
2. Applied Research Information collation, applied Inventions, blueprints Firm-level
R&D
3. Development Testing, prototyping Prototypes, beta versions Firm-level
4. Commercialization Investment, market launch Innovation (product/process) Firm-level
5. Diffusion Adoption, market penetration Widespread usage Market-level
3.2 Key Definitions
• Invention: Creation of a new idea, product, or process (not yet commercially implemented).
• Innovation: The first commercial introduction of an invention. Turning invention into marketable reality.
• Diffusion: The process through which innovations become adopted and used by others.
Critical Distinction
Not all inventions become innovations. An invention must be commercially developed and successfully introduced to
the market to qualify as an innovation.
3.3 The Diffusion Challenge: The Solow Paradox
Brynjolfsson (1993) documented the Solow Paradox: despite booming IT investment from the 1970s onwards,
productivity growth slowed from ~3% in the 1960s to ~1% in the 1980s. Reasons for diffusion lags include:
• Complementary investments must be made (networks, software, training, organizational restructuring).
• Significant learning costs and inefficiencies during adoption.
• Exponential growth curves start small; early impact is imperceptible.
• Standard price indices undercount quality-adjusted output gains.
4. Who Invests in Innovation?
Sector Role Examples
Business / Private Primary investor; drives applied R&D and Pharma firms, tech companies, industrial
commercialization manufacturers
Government Enables and compensates for market failures; Subsidies, patent systems, public
provides incentives and infrastructure research centers
Higher Education Conducts basic and applied research; trains Universities, university spin-offs
researchers
Empirical Ranking (EU)
By R&D spending volume: Firms (Business Enterprise Sector) > Higher Education Sector > Government Sector
5. Innovation and Market Structure
The core analytical question: How does market structure affect a firm's incentive to invest in R&D?
• How does market structure affect incentives for R&D?
• How can innovation influence market structure?
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, Economics of Innovation and Intellectual Property KU Leuven
• How do firms use R&D strategically?
5.1 Preliminary Definitions
• Process innovation: Reduces the cost of producing an existing product. Modelled as a decrease in marginal cost
(c₀ → c₁).
• Product innovation: Introduces a new product.
• Drastic (major) innovation: Post-innovation, the innovator can act as an unconstrained monopolist (new
marginal cost so low that even the monopoly price falls below competitors' costs.
• Non-drastic (minor) innovation: The innovator gains a cost advantage but is still constrained by competitors.
5.2 Schumpeter's Two Views
• Schumpeter Mark I: Creative Destruction: Innovation is driven by new entrants who displace incumbents,
replacing old technologies with new ones.
• Schumpeter Mark II: Creative Accumulation: Innovation is mainly carried out by large established firms that
build on existing knowledge and heavy R&D investment.
5.3 Firm Size and R&D: Stylized Facts
• The probability that a firm conducts R&D increases with firm size.
• Small firms specialize more in research (early-stage); large firms specialize in development.
• Among firms that do R&D, spending is roughly proportional to size, but R&D productivity falls as size increases.
• Large firms can still benefit due to lower average costs and economies of scale and scope.
6. The Arrow Model (1962): Incentives to Innovate
Arrow (1962) provides the foundational model for comparing innovation incentives across market structures. Central
question: how much is a firm willing to pay for a process innovation it alone can use?
6.1 Model Setup
• Homogeneous product market: inverse demand P = 100 - Q.
• Initial marginal cost: c₀ = 50; innovation reduces it to c₁ = 25.
• Three cases: (1) monopolist, (2) perfectly competitive market, (3) social planner.
• Profit Incentive (PI) = π_post − π_pre.
6.2 Case 1: Monopolist
• Before innovation: Q0 = 25, P0 = 75, profit = (75-50) x 25 = 625.
• After innovation: Q1 = 37.5, P1 = 62.5, profit = (62.5-25) x 37.5 = 1,406.25.
2025-2026 4
Economics of Innovation and
Intellectual Property [D0T32a]
Course Structure
Reading Guide
Key definition Exam-critical Empirical finding Theoretical result
point
Boxed content throughout the summary uses left-border colour coding: blue border = theoretical model/result;
green border = empirical study finding; orange border = exam-critical conclusion. Yellow highlight = key definition;
cyan highlight = core exam answer.
Contents
LECTURE 1 Innovation & Market Structure
Arrow Model, Replacement Effect, Efficiency Effect, Inverted-U (Aghion et al.)
LECTURE 2 Entry Dynamics, Patent Races & Licensing
Gilbert & Newbery, Reinganum Patent Race, Licensing by Inside/Outside Innovator
LECTURE 3 Market Failures; Appropriability & Spillovers
Knowledge Spillovers, Absorptive Capacity, Teece Framework, Returns to R&D
LECTURE 4 Innovation & Financing Constraints
Modigliani-Miller, Asymmetric Information, Pecking Order, Subsidies, VC
LECTURE 5 R&D Cooperation
D'Aspremont-Jacquemin Model, Alliance Types, Collusion Risk, Industry-Science
LECTURE 6 Intellectual Property Rights
Patent Basics, Nordhaus Model, Breadth, Patents vs. Prizes vs. Secrecy
LECTURE 7 Cumulative Innovation
Scotchmer Bargaining, Research Tools, Royalty Stacking, Patent Pools
LECTURE 8 Internationalisation of Corporate R&D
FDI Motives, HBE/HBA, Offshoring, Archetypes, Intercultural Teams
LECTURE 9 Tax Credits, Subsidies & Other Innovation Policy Tools
Policy Mix, Tax Credits, Patent Boxes, Education/Immigration, Crises
Key Concepts Glossary (Lectures 1–9)
2025-2026 1
,Economics of Innovation and Intellectual Property KU Leuven
LECTURE 1 Innovation & Market Structure
The Economics of Innovation and Intellectual Property
1. Course Evaluation & Structure
Component Weight Format / Notes
Final Exam 60% Mainly open questions, closed book. Must score >= 10/20 for other
components to count.
Essay (Group Assignment) 30% Groups of 4-6 students. Apply a course concept to a real-world research
question.
Interim Online Tests 10% Small tests after each lecture. Only the two best scores count. Retakes
allowed until end of semester.
2. Why Economists Care About Innovation
Innovation is not merely a business concern: it is the central driver of long-run economic growth and societal welfare.
2.1 Innovation and Productivity Growth
Solow Growth Model
In the neoclassical Solow model, capital per worker K* stabilises through the interplay of savings rate (s), depreciation
rate (delta), population growth (n) and technological growth (g).
Technological progress A(t) is the only factor not subject to diminishing returns, making it the engine of sustained per-
capita income growth.
Solow treats g as exogenous; later endogenous growth models explain how economic behavior itself drives g.
2.2 Total Factor Productivity (TFP)
Technology is measured as Total Factor Productivity (TFP): the share of output growth not explained by growth in
capital or labor inputs.
• Solow (1957): ~87% of US labor productivity growth (1909-1949) was attributable to TFP growth.
• More recent studies find lower but still substantial TFP contributions.
• TFP captures efficiency improvements in management, organization, training, and process knowledge (not just
high-tech gadgets).
• Dan Wang (2025) distinguishes three layers of technology: (1) tools, (2) explicit instructions (patents, recipes),
and (3) process knowledge: tacit proficiency gained from experience. The third is often most important.
2.3 Empirical Evidence
Despite enormous increases in R&D spending, TFP growth has been slowing in many advanced economies since the
1970s, a major puzzle in innovation economics.
2.4 The Nordhaus Lighting Study
Nobel laureate William Nordhaus (1996) demonstrated that standard price indices vastly understate the true gains
from innovation using lighting as a case study:
• Lighting efficiency improved more than 1,000-fold since ancient times.
• The quality-adjusted price of light fell by hundreds of thousands of times since Babylonian times.
• Standard GDP and wage measures dramatically undercount the welfare gains from innovation.
3. The Innovation Process
2025-2026 2
,Economics of Innovation and Intellectual Property KU Leuven
Innovation follows a structured process from basic research to widespread adoption.
3.1 Stages of the Innovation Process
Stage Activities Outputs Agent
1. Basic Research Fundamental scientific inquiry Discoveries, ideas External / firm-level
2. Applied Research Information collation, applied Inventions, blueprints Firm-level
R&D
3. Development Testing, prototyping Prototypes, beta versions Firm-level
4. Commercialization Investment, market launch Innovation (product/process) Firm-level
5. Diffusion Adoption, market penetration Widespread usage Market-level
3.2 Key Definitions
• Invention: Creation of a new idea, product, or process (not yet commercially implemented).
• Innovation: The first commercial introduction of an invention. Turning invention into marketable reality.
• Diffusion: The process through which innovations become adopted and used by others.
Critical Distinction
Not all inventions become innovations. An invention must be commercially developed and successfully introduced to
the market to qualify as an innovation.
3.3 The Diffusion Challenge: The Solow Paradox
Brynjolfsson (1993) documented the Solow Paradox: despite booming IT investment from the 1970s onwards,
productivity growth slowed from ~3% in the 1960s to ~1% in the 1980s. Reasons for diffusion lags include:
• Complementary investments must be made (networks, software, training, organizational restructuring).
• Significant learning costs and inefficiencies during adoption.
• Exponential growth curves start small; early impact is imperceptible.
• Standard price indices undercount quality-adjusted output gains.
4. Who Invests in Innovation?
Sector Role Examples
Business / Private Primary investor; drives applied R&D and Pharma firms, tech companies, industrial
commercialization manufacturers
Government Enables and compensates for market failures; Subsidies, patent systems, public
provides incentives and infrastructure research centers
Higher Education Conducts basic and applied research; trains Universities, university spin-offs
researchers
Empirical Ranking (EU)
By R&D spending volume: Firms (Business Enterprise Sector) > Higher Education Sector > Government Sector
5. Innovation and Market Structure
The core analytical question: How does market structure affect a firm's incentive to invest in R&D?
• How does market structure affect incentives for R&D?
• How can innovation influence market structure?
2025-2026 3
, Economics of Innovation and Intellectual Property KU Leuven
• How do firms use R&D strategically?
5.1 Preliminary Definitions
• Process innovation: Reduces the cost of producing an existing product. Modelled as a decrease in marginal cost
(c₀ → c₁).
• Product innovation: Introduces a new product.
• Drastic (major) innovation: Post-innovation, the innovator can act as an unconstrained monopolist (new
marginal cost so low that even the monopoly price falls below competitors' costs.
• Non-drastic (minor) innovation: The innovator gains a cost advantage but is still constrained by competitors.
5.2 Schumpeter's Two Views
• Schumpeter Mark I: Creative Destruction: Innovation is driven by new entrants who displace incumbents,
replacing old technologies with new ones.
• Schumpeter Mark II: Creative Accumulation: Innovation is mainly carried out by large established firms that
build on existing knowledge and heavy R&D investment.
5.3 Firm Size and R&D: Stylized Facts
• The probability that a firm conducts R&D increases with firm size.
• Small firms specialize more in research (early-stage); large firms specialize in development.
• Among firms that do R&D, spending is roughly proportional to size, but R&D productivity falls as size increases.
• Large firms can still benefit due to lower average costs and economies of scale and scope.
6. The Arrow Model (1962): Incentives to Innovate
Arrow (1962) provides the foundational model for comparing innovation incentives across market structures. Central
question: how much is a firm willing to pay for a process innovation it alone can use?
6.1 Model Setup
• Homogeneous product market: inverse demand P = 100 - Q.
• Initial marginal cost: c₀ = 50; innovation reduces it to c₁ = 25.
• Three cases: (1) monopolist, (2) perfectly competitive market, (3) social planner.
• Profit Incentive (PI) = π_post − π_pre.
6.2 Case 1: Monopolist
• Before innovation: Q0 = 25, P0 = 75, profit = (75-50) x 25 = 625.
• After innovation: Q1 = 37.5, P1 = 62.5, profit = (62.5-25) x 37.5 = 1,406.25.
2025-2026 4
