provided by Research Papers in Economics
Federal Reserve Bank of Minneapolis
Research Department
Prizes and Patents: Using Market Signals
to Provide Incentives for Innovations
V. V. Chari, Mikhail Golosov, and Aleh Tsyvinski*
Working Paper
October 2009
ABSTRACT__________________________________________________________
Innovative activities have public good characteristics in the sense that the cost of producing, say, the first
unit of a new good is high compared to the cost of producing subsequent units. Moreover, knowledge of
how to produce subsequent units is often widely known once the innovation has occurred and is, therefore,
non-rivalrous. The main question addressed in this paper is whether mechanisms can be found which exploit
market information to provide appropriate incentives for innovation. We consider environments in which
agents other than innovator receive the signals about the quality of innovation. For example, information
from innovators, competitors, and the marketplace can be used to reward the innovator. If such mechanisms
are used, the innovator has strong incentives to manipulate market signals. We show that if an innovator
cannot manipulate market signals, then the efficient levels of innovation can be uniquely implemented without
deadweight losses—for example, by using appropriately designed prizes. We show that patents are necessary
if the innovator can manipulate market signals.
*Chari: University of Minnesota and Federal Reserve Bank of Minneapolis; Golosov: Yale and New Economic School;
Tsyvinski: Yale and New Economic School. The authors thank the National Science Foundation for support. Golosov
and Tsyvinski thank Einaudi Institute for Economics and Finance for hospitality. We thank Daron Acemoglu, Larry
Jones, Matt Mitchell, and Nicolas Werquin for useful comments.