Static Efficiency of Compulsory Licensing: The Role of Limit Pricing

An argument against compulsory licensing of intellectual property is that it may reduce social welfare even in the short run. We study the issue in a model where the innovative firms can choose between quantity and price competition. We show that the risk of a reduction in static welfare due to the entry of highly inefficient firms is avoided if licensing entails a royalty per unit of output and zero fixed fee. The rationale behind this result lies in the fact that patent holders, under the threat of compulsory licensing, react in a welfare enhancing way.