THE MARKET ACCEPTANCE AND WELFARE IMPACTS OF GENETIC USE RESTRICTION TECHNOLOGIES (GURTS)

Transcription

1 THE MARKET ACCEPTANCE AND WELFARE IMPACTS OF ENETIC USE RESTRICTION TECHNOLOIES (URTS) MARIANNA KHACHATURYAN AND AMALIA YIANNAKA,* Ph.D. Candidate, Department o Agriultural Eonomis, University o Nebraska-Linoln. Assoiate Proessor, Department o Agriultural Eonomis, University o Nebraska-Linoln, 34D H.C. Filley Hall, Linoln, NE , USA. * Corresponding author yiannaka@unl.edu, Tel. (40) , Fax: (40) Seleted Paper prepared or presentation at the International Assoiation o Agriultural Eonomists (IAAE) Triennial Conerene, Foz do Iguaçu, Brazil, 8-4 August, 0. Copyright 0 by Marianna Khahaturyan and Amalia Yiannaka. All rights reserved. Readers may make verbatim opies o this doument or non-ommerial purposes by any means, provided that this opyright notie appears on all suh opies.

2 THE MARKET ACCEPTANCE AND WELFARE IMPACTS OF ENETIC USE RESTRICTION TECHNOLOIES (URTS) Abstrat We develop an analytial ramework o heterogeneous onsumers and produers to examine the market and welare eets o Tehnology Use Agreements (TUAs) and variety-level eneti Use Restrition Tehnologies (V-URTs). Speiially, we examine an innovator s deision to introdue V-URTs into a new seed variety that oers enhaned agronomi harateristis to produers and desirable untional properties to onsumers, taking into aount heterogeneous onsumer preerenes regarding interventions in the prodution proess and armer harateristis and inentives to engage in unauthorized use o proprietary seed. JEL lassiiation: Q3, Q8. Keywords: eneti use restrition tehnologies; eneti modiiation; Produer and onsumer welare.. Introdution An intelletual property rights (IPRs) system is eetive when inringers an be identiied, suessully sued or damages and deterred rom urther inringement. The eetiveness o IPRs in plant varieties is generally limited. The geographial distribution o armers and the at that seed reprodues naturally makes monitoring the unauthorized use o seed that embodies intelletual property very ostly and a serious problem or seed providers. As a onsequene, seed ompanies perorm limited researh and development (R&D) in sel-pollinating plants mainly beause seed saving limits their ability to reoup their investment. The use o variety level geneti use restrition tehnologies (V-URTs) is a biologial way o restriting the unauthorized use o seed that embodies intelletual property. Speiially, lobally, the largest quantity o seed is produed by armers; about.4 billion armers, mainly in developing ountries, depend on saved seed as their primary seed soure (ETC roup, 007). In India, or instane, 83% o armers use their own arm-saved seeds (Sharma, 005). Even in developed ountries armers rely on saving seed. By some estimates, most North Amerian wheat armers typially rely on arm-saved seeds and return to the ommerial market one every 4-5 years (ETC roup, 998). The perentage o arm-saved seed or UK is 30%, or ermany 46%, or Frane 35%, or Portugal 75%, or Spain 88% (Toledo, 00).

3 V-URTs, whih are ommonly reerred to as terminator tehnology, are tehnologies that an restrit the use o the entire variety through intererene with reprodution resulting in the prodution o sterile seeds.,3 Even though URTs have not been ommerialized yet, their potential introdution inites great ontroversy. The proponents o URTs laim that their introdution will strenhen the protetion o intelletual property and ould work more eetively than other IPR regimes (e.g., patents, breeder s rights or lienses) as an innovation rent appropriation mehanism or innovators/breeders beause they make it impossible or armers to save and re-use seed. As a onsequene, the introdution o V-URTs might enourage innovating irms to invest more in R&D, espeially in sel-pollinating rops where hybrids are not eetive (e.g., rie, wheat, soybean, otton). URTs supporters also laim that their introdution will result in inreased agriultural produtivity through an inreased degree o auray in prodution (e.g., preision agriulture) and in rops with better agro-eologial harateristis; ould be used as a tool that prevents the esape o horizontal gene low into neighboring rops or wild speies, limiting the potential negative environmental eets o genetially modiied (M) rops; and ould be viewed as a lever to enourage ountries to provide greater IP protetion to M rops. 4 On the other hand, a number o ountries (e.g., India, Brazil), onsumer groups and non- Unlike V-URTs that an restrit the use o the entire variety, trait speii geneti use restrition tehnologies (T- URTs) are tehnologies that an restrit the use o a speii trait by regulating its expression. That is, the gene(s) onerring the trait are swithed on or o through speii hemial induers. The seed itsel remains viable, but armers need to buy the induers to take advantage o the speii trait. 3 More than ity URTs patents have been issued to private irms, universities and the US overnment, nineteen o whih relate to V-URTs/terminator tehnology (Pendleton, 004). The irst patent on URTs was granted to Delta and Pine Land Co and the US Department o Agriulture in Marh 998 (US patent 5,73,765, on the Control o Plant ene Expression at This patent desribes a set o interating geneti elements that allows the ontrolled expression o value-added trait or o seed viability in a rop plant (Visser et al., 00, pp. 9). While urrent patent appliations apply to plants, URTs ould be built into any organism (e.g., arm animals, ish and trees) (Visser et al., 00). 4 For instane, bioteh ompanies an threaten to introdue terminator tehnology i a ountry does not improve its IPRs protetion. In this ase, a ountry that hooses to ban the tehnology loses the right to use the potentially valuable proteted trait (Pendleton, 004). 3

4 governmental organizations (NOs) oppose the introdution o URTs. 5 The main argument o the opponents o terminator tehnology is that it is an unethial tehnology that deprives armers o their traditional right to save, use, and exhange seeds. In addition, ritis are onerned about the environmental eets o gene low rom rops whih are sterilized and ould, as laimed, sterilize other plants and have serious eets on the eosystem (Crouh, 998; Jeerson et al., 999). Those opposing terminator tehnology also laim that it would restrit aess to geneti resoures and hinder the eorts o publi institutions and armers, inreasing the barriers between publi and private gene pools and leading to less innovation in the long run. Related to this last onern is the argument that terminator tehnology will reate perpetual monopolies whih would lead to the unequal distribution o eonomi rents between armers, seed ompanies and onsumers (Srinivasan and Thirtle, 00). Finally, there is onern that the introdution o terminator tehnology will lead to an inrease in both horizontal onentration and vertial integration (between the seed breeding and agrohemial setors) reating monopolies in agriultural R&D and a displaement o investment may our away rom biotehnologial options that might be more beneiial to armers in developing ountries. The potential impats o URTs rom an environmental, biosaety and moral point o view have been the ous o early URTs studies whih disuss the possible welare eets o the tehnology or armers, irms and the soiety (Visser et al., 00; ari, 00; Eaton and Tongeren, 00; Eaton et al., 00; Fisher, 00; Pendleton, 004). A group o empirial studies used data rom the introdution o hybrid tehnology that shares some degree o use restrition 5 The Consultative roup on International Agriultural Researh (CIAR) pledged never to use any kind o terminator tehnology seeds and the Food and Agriulture Organization o the United Nations is against the use o terminator tehnology (Pendleton, 004). Among ivil soiety organizations that have expressed opposition and taken ation against URTs are the National Family Farm Coalition, International Center or Tehnology Assessment, Mothers and Others or a Livable Planet, Consumers Union, Consumer Federation, Sustainable Agriulture Coalition and the ETC group (ETC, 999). 4

5 with V-URTs to make inerenes about its potential eonomi eets (Swanson and oeshl, 000, 00a, 00b, 00; oeshl and Swanson, 000, 00a, 00b, 003; Srinivasan and Thirtle, 000, 00, 003). 6 These studies show that hybridization enabled seed ompanies to apture greater proits and has attrated more private investment into plant breeding whih ould also our in the ase o V-URTs. Even though the above studies have shed light into understanding the potential beneits and osts assoiated with V-URTs, they do not provide an analytial ramework that ould be used to examine their eonomi impats. A ew reent studies have made ontributions to this eet. Lene et al. (005) in a study that estimates the impat o hanges in the strenh o the IPR regime on welare and determines a soially optimal appropriability level, assume that the introdution o URTs is similar to a ase where ininite IPR protetion is granted, and, thereore, ind that the optimal appropriability level is muh lower than the one that would exist under URTs. Lene and Hayes (005) ompare patents to URTs as intelletual property protetion mehanisms in the presene o R&D improvements that exhibit spillovers. They show that as long as URTs ontribute to the harmonization o IP protetion among ountries, they an be welare enhaning. Burton et al. (005) use a two-period prinipal-agent model to examine the property rights protetion o M rops and ompare sterile M seed to short and long term ontrats between an innovator and armers in terms o their eiieny in proteting intelletual property and their soial welare eets (where soial welare is the sum irm proits and armer welare). They ind that the innovator always preers, in order, the use o URTs, long term ontrats and short term ontrats while armers preer, in order, long term ontrats, short term 6 Hybridization an be viewed as a weaker version o V-URTs where the germplasm remains available to armers and ompeting breeders or urther breeding but where the rops grown rom saved seed do not exhibit the desirable eatures o the initial seed. The loss rom replanting hybrids is generally 5-30%, while the expeted yield loss rom using V-URTs seeds is 00%. 5

6 ontrats and URTs use. Finally, Ambe et al. (008) develop a two-period model to examine the impat o rop trait durability on a monopolist s priing strategies and swithing deisions rom inbred line seed to hybrid seed. They show that the monopolist an produe tehnologially dominated hybrid seed to extrat more surplus rom armers while the introdution o a ee paid by sel-produing armers improves eiieny. iven the expressed opposition to URTs by various onsumer groups (see ootnote 5) an analysis o the market and/or welare eets o URTs should not ignore onsumers. As we show in this study, onsumer attitudes towards URTs aet an innovating irm s deision to introdue the tehnology as well as soial welare. A major ontribution o our study is that we develop a lexible analytial ramework to examine the system wide eets (or onsumers, armers and the innovator) o two IPRs regimes, Tehnology Use Agreements (TUAs), whih represent the status quo, and URTs, while aounting or both onsumer and produer heterogeneity. 7 In our ramework, onsumers dier with respet to preerenes regarding interventions in the prodution proess (e.g., geneti modiiation and geneti use restrition) and armers dier in the agronomi beneits they realize rom a seed variety and whether they hoose to violate their TUAs or not. Speiially, our study examines an innovator s deision to introdue V- URTs (URTs hereater) into a new M seed variety that oers enhaned agronomi beneits to armers and desirable untional properties to onsumers and ompares its potential market and welare eets to a situation where the new variety is introdued using Tehnology Use Agreements (TUAs), instead. 7 Tehnology use agreements, also known as stewardship agreements, set orth the requirements and guidelines or use o proprietary tehnology, in this ase M seed. All armers that want to purhase a patented seed variety have to sign a TUA whih, among other things, speiies that it is illegal or the armer to save and replant seeds produed rom rops grown rom the patented seed variety. 6

7 Our results show that the monopolist seed supplier does not always preer URTs to TUAs. Even though he is ored to harge a lower prie or M seed when he ompetes with armers that illegally save and replant seed, his proits may be greater under TUAs i onsumer aversion to URTs is high. In addition, armers may experiene greater welare under URTs than under TUAs whih ontradits the indings o Burton et al. (005). Finally, while in most ases aggregate onsumer welare is greater under TUAs than under URTs some onsumers may be better o under URTs; interestingly, those with high levels o aversion to interventions in the prodution proess. The rest o the paper is organized as ollows. Setion two develops the heterogeneous onsumer and produer models, derives the market outome under the TUAs (status quo) and under URTs and examines the seed supplier s proit maximizing deisions. Changes in the market equilibrium outomes when TUAs are replaed by URTs are also onsidered in this setion. The welare analysis is arried out in setion three while setion our summarizes and onludes the paper.. Market eets o TUAs and URTs The model builds on previous work by Fulton and iannakas (004) and iannakas and Yiannaka (008) who study the market and welare outomes o dierent labeling regimes in M produt markets. Our model examines and ompares the market and welare eets o TUAs and URTs when onsumer produts are labeled. These are markets where either M produts have to be mandatorily labeled (e.g., EU) or markets where proessors/retailers have an inentive to voluntarily label the produts to inorm onsumers about untional redene 7

8 attributes or whih onsumers may be willing to pay a premium. 8 Our analysis starts with an innovator who has generated a new M seed variety with enhaned agronomi beneits or armers (e.g., drought resistane) and desirable untional properties or onsumers (e.g., health enhaning properties) 9 and deides whether to insert URTs into the seed or sell the seed using TUAs. 0 We assume that the innovator/seed provider is a monopolist, armers an hoose between the new M seed, its onventional ounterpart or to produe an alternative rop and onsumers an hoose between the onventional or the new M produt. To keep the analysis tratable and the ous on the omparison between the two alternative IPRs shemes we do not inlude an old M seed variety (i.e., irst generation M seed) as an option or armers. Impliitly we assume that the new M seed variety will be introdued in a market where M prodution has not been previously allowed or widespread (e.g., EU) or, alternatively, that the new M seed variety is drasti with respet to the old M seed varieties (i.e., it will push the old varieties out o the market). Relaxing this assumption is disussed in the analysis that ollows. Under TUAs some armers may engage in unauthorized seed use (i.e., save and replant M seed) but the innovator does not know ex-ante who these armers are. Thus, under this ase, in addition to determining the prie o M seed, the innovator also determines the eort she will exert to identiy armers that violate their liensing agreements. Under URTs armers annot save and replant seed sine the tehnology makes 8 This ould be the ase with some seond generation M produts in the US market, where labeling o M produts is not required, like high protein wheat, high olei soybeans or vitamin A enrihed rie and orn. 9 An example ould be drought resistant soybean seed that produes high olei soybeans that, in turn, produe high olei soybean oil. 0 The innovator s deision to invest in R&D and develop the new seed variety has already taken plae and all osts assoiated with it are sunk at this point. Aording to Monsanto, a very small perentage o U.S. armers do not honor their TUAs. The ompany states that it beomes aware o potential inringers either through its own ations or through third parties (e.g., other armers) and lawsuits are rare (45 lawsuits between 997 and 00) as most ases settle beore going to trial. Interestingly, aording to the ompany, many o the inringing armers remain their ustomers (Monsanto, 0). 8

9 the saved seed sterile, and the innovator does not have to inur monitoring/enorement osts to identiy potential inringers. The market and welare outomes assoiated with the two IPRs regimes are determined using bakwards indution; we start with onsumers purhasing deisions, then onsider armers prodution deisions and inally the innovator s proit maximizing deisions.. Consumers The onsumer market examined onsists o a produt whih ould beome available in a onventional, M or M with URTs (M hereater) orm. It is assumed that the physial harateristis o the dierent produt types (i.e., onventional, M and M ) are indistinguishable to onsumers (e.g., olor, texture, smell) while their dierentiating attributes, whih are the proess through whih they have been produed and the additional untional properties o the M and M produt orms (e.g., health enhaning attributes), are both redene attributes. Thereore, onsumers have to rely on labels or inormed onsumption deisions. It is important to note that inserting URTs into the M seed variety does not aet the untional attributes o the M produt that are desirable to onsumers (i.e., the untional attributes are idential to those when the M seed variety does not ontain URTs). To apture revealed and stated onsumer preerenes towards geneti modiiation (see also iannakas and Yiannaka (008)) and opposition by some onsumer groups to geneti use restrition, onsumers in this market are assumed to be heterogeneous, uniormly distributed in the interval, 0 with respet to a dierentiating harateristi A, where A 0,, relets As an example, the market ould be that or soybean oil where the onventional produt will be soybean oil produed rom onventionally produed soybeans, the M produt will be high olei soybean oil produed rom high olei M soybeans and the M produt will be high olei soybean oil produed rom high olei M soybeans whih have been produed with URTs seed. In this ase, the untional property that is desirable to onsumers is the high olei ontent whih is an attribute shared by the M and M produts. 9

10 onsumer aversion to interventions in the prodution proess; the greater is the value o A, the greater is onsumer opposition to interventions in the prodution proess. 3 Assuming that eah onsumer buys one unit o the type o produt they preer and this purhasing deision represents a small share o their budget, the onsumer utility untion o a onsumer with a dierentiating attribute A is given by: U U p A i a unit o the onventional produt is onsumed, U U V p A i a unit o the M produt is onsumed, and gm gm U U V p A i a unit o the M produt is onsumed. () In equation (), U, U gm, and U are the utilities derived rom the onsumption o one unit o the onventional, M, and M produt, respetively. The parameter U 0 is a base level o utility assoiated with the physial harateristis o the produt and is the same or all produts while the parameter V 0 relets the value onsumers plae on the untional attributes o the M and M produt. The parameters p, p gm and p denote the market pries o the onventional, M and M produt, respetively. The parameters, and are nonnegative utility disount ators that are onstant aross onsumers and, along with the dierentiating attribute A, determine the level o onsumer aversion to interventions in the prodution proess; the greater are these parameters, the greater is onsumer aversion to interventions in the prodution proess or a given A value. To apture expressed onsumer opposition to geneti modiiation and geneti use restrition we assume that. 4 To 3 A onsumer with a value o A 0 does not are about interventions in the prodution proess while a onsumer with an A is the most averse to interventions in the prodution proess. 4 Thus, aptures opposition to both geneti modiiation and geneti use restrition. The assumption that aptures expressed onsumer onerns about the environmental risks o seed sterility, biodiversity and the inability o armers to save and replant seed (ETC roup, 998, 006, 009; Pendleton, 004). 0

11 keep the analysis simple and without loss o generality we set 0. iven the above, U, U A and U A measure onsumer willingness to pay or the onventional, M and M produts, respetively. Under TUAs When the monopolist introdues the new M seed without the use o URTs, the produt orms available to onsumers are the onventional and the new M produt. A onsumer hooses rom the available produts, the one that gives her the highest level o utility and as long as U U p 0 all onsumers that partiipate in the market will buy either the onventional or the new M produt. The onsumer with a dierentiating attribute A o suh that, V p pgm U( A0) Ugm( A0) A0 is indierent between onsuming the onventional and the new M produt while onsumers with an A [0, A0 ] will onsume the new M produt and those with an A A, 0 will onsume the onventional produt. iven that onsumers are uniormly distributed with respet to their aversion to interventions in prodution proess and their mass is normalized to one, A 0 determines the market share o, as well as the demand or, the new M produt, given by: d gm V p p gm A0 () The market share o, and demand or, the onventional produt is given by: d V p pgm A0 (3) As equations () and (3) show, the greater (smaller) is the value onsumers plae on the

12 untional attribute o the M produt (V ), the lower (higher) is the prie o the M produt ( p gm ) and the lower (higher) is onsumer aversion to geneti modiiation ( ), the greater is the market share o, and the demand or, the new M (onventional) produt. Figure depits the utility shedules and onsumption deisions o onsumers partiipating in this market when both the new M and the onventional produt o-exist in the market, i.e., when 0 A p p V p p. In igure, the kinked dashed urve o gm gm gives the eetive utility shedule and the area below it gives the aggregate onsumer welare under TUAs. I the onditions or o-existene do not obtain, then either the utility shedule o the new M produt is above (below) the utility shedule o the onventional produt or all A values, i.e., U U Aie.., V p p ( U U Aie.., V p p ) and only the new gm gm M (onventional) produt will be onsumed. Under URTs gm gm When the monopolist introdues URTs into the new M seed variety, the produt orms available to onsumers are the onventional and the new M produt. The onsumer with a V p p A0 U A0 U A0 A0 is indierent between onsuming harateristi : the M and the onventional produt. Consumers with A [0, A0 ] will onsume the M produt while those with A ( A0,] will onsume the onventional produt. The dierentiating attribute A 0 also determines the market share o, and the demand or, the new M produt, given by equation (4), while the market share o, and the demand or, the onventional produt is given by equation (5). d V p p A0 (4)

13 d V p p A0 (5) Equations (4) and (5) show that, the greater (smaller) is the value onsumers plae on the untional attribute o the M produt (V ), the lower (higher) is the M produt s prie ( and the lower (higher) is onsumer aversion to geneti modiiation and geneti use restrition ( ), the greater is the market share o and the demand or the new M (onventional) produt. This outome is depited in Figure (when 0 A0 p p V p p so that the M and the onventional produt o-exist in the market) where the kinked bold urve shows the eetive utility urve and the area below it the aggregate onsumer welare under URTs.. Farmers The market or the arm produt is assumed to be ompetitive. Farmers are making deisions as to whih produt to produe based on the returns they earn, whih depend on the market prie they ae or their produt and the ost o produing eah produt type. With the introdution o the new M seed variety that oers enhaned agronomi beneits to armers, the deision a armer needs to make is whether to produe the new M rop, a onventional variety o the rop or an alternative rop. I the M seed variety is introdued without URTs then a armer that has deided to produe the M rop needs to urther deide whether she will save M seed and replant that seed the ollowing period, violating her liensing agreement (i.e., heat). When the M seed variety ontains URTs (M ), it is not proitable or the armer to save and replant seed as the saved seed is sterile. We assume that armers know whether the M seed ontains p ) 3

14 URTs. 5 Note that the inlusion o URTs into the M seed does not alter its agronomi beneits in any way (i.e., the new M seed and the new M seed with URTs yield idential agronomi beneits to produers). To apture what one observes in pratie, whih is the o-existene o onventional and M rops, armers are assumed to be heterogeneous with respet to the agronomi beneits they realize rom produing the dierent varieties (onventional or M); whih implies that armers dier with respet to the net returns they realize rom produing these rops. Farmer dierenes may stem rom harateristis like management skills, experiene, eduation, soil quality, tehnology used and arm size and loation. We denote by Z where Z [0,] the attribute that dierentiates armers (e.g., skills, experiene, land quality) and assume armers are uniormly distributed in the interval [0,] eah produing one unit o output. The net return untion o a armer with a value o Z is given by: p W Z i a unit o onventional variety is produed, p w Z i a unit o M variety is produed, gm gm gm C p ( ) h Z i a unit o M variety is produed with saved seed, gm gm s (6) p w Z i a unit o the M variety is produed, and a 0 i a unit o an alternative rop is produed. In equation (6) p, p gm and M produts, respetively. The parameter p denote the arm pries o the onventional, the M, and the W denotes an average ost o purhasing 5 Even i a armer were unsure about the inlusion o URTs into the M seed, she would ind out i she saved and replanted that seed and ould adjust/orret her deision the next period. 4

15 onventional seed and hemials and saving and replanting onventional seed. 6 The osts assumed to be exogenous and thus not aeted by the introdution o the new M seed variety (the relaxing o this assumption is disussed throughout the analysis). 7 The parameters w denote the seed and hemial osts o the M and M produt, respetively. The parameters, and a are ost-enhanement ators and are onstant aross armers. To W is w gm and apture the enhaned agronomi beneits o the M and M rops relative to the onventional rop we assume that 0. To apture the at that saved seed may lose some o its germination potential we assume that a and that. All other osts o saving seed are denoted by s. 8 The term h is the expeted penalty armers pay when they are aught violating their TUAs (heating) where is the probability o being aught saving M seed and h is the penalty imposed. The probability o being aught heating is given by where 0, is the eort the monopolist exerts in deteting heaters. To keep the analysis simple we assume that the penalty, h, is determined by the legal system and thus, is exogenous to the monopolist. 9 Also, or simpliity the proits o produing the alternative rop are normalized to zero. iven the speiiation o the net return untions in equations (6), a armer with a Z value o zero realizes higher proits than a armer with a Z value o one. 6 The parameter W ould be given by W w ( ) s where is the portion o seed purhased, w is the prie o onventional seed and s is the ost o saving onventional seed. Please note that saving and replanting onventional seed is not illegal. The deision whether to purhase or save onventional seed is not expliitly onsidered here to keep the analysis tratable. 7 This would be onsistent with a peretly ompetitive onventional seed supply setor and use o a onstant returns to sale tehnology. 8 An alternative interpretation o s ould be the ost o purhasing seed rom unauthorized hannels (e.g., other armers). 9 In some ases, ompanies set their own penalties. For example, Monsanto imposes a penalty o $5 per are or every are planted with Roundup Ready anola seed not overed by the tehnology use agreement and i the grower sells, gives or transers any seed ontaining the Roundup Ready gene or eah are apable o being planted using that seed (Network o Conerned Farmers, Copy o Tehnology User Agreement, 003, available at 5

16 Under TUAs Under TUAs two periods must be onsidered. Period one, reers to the period when the new M seed variety is irst introdued. During this period a armer annot save and replant M seed (or purhase it rom unauthorized hannels) sine the seed has not been previously available. During period one, a armer an produe the onventional rop, the M rop with purhased seed or the alternative rop while in period two, in addition to these options, she an plant M seed saved rom period one. A armer with a dierentiating attribute Z will hoose the option that yields the highest net returns. 0 Period One The period one net returns rom the prodution o a unit o the onventional, M and alternative rop are given by p W Z, gm pgm wgm Z and a 0, respetively. The armer with a dierentiating attribute Z : ( Z ) ( Z ) Z 0 0 gm 0 0 p p w W gm gm is indierent between produing the onventional and new M rop while the armer with a dierentiating attribute pgm wgm Z : gm ( Z) a ( Z) Z is indierent between produing the new M and the alternative rop. Note that, or o-existene o the onventional and new M rop the ollowing onditions must hold, 0 Z0 Z whih implies that pgm wgm ( p pgm wgm ) and W. I the net returns shedule o the onventional rop is above the net returns shedule o the new M rop or all Z values, the onditions or o-existene do not 0 It is important to point out that unlike armers who ae dierent options under the two periods, the options onsumers ae are the same in both periods; a hoie between the onventional and the M produt. This implies that onsumers annot tell whether the M produt they see in the market ame rom armers that violated their TUAs and used saved M seed to produe the produt or rom armers that omplied. What may be dierent or onsumers is the pries o the onventional and M produt in the two periods. 6

17 obtain, (i.e., i gm Z [0,] in Figure 3, panel (i)) then the new M will not be adopted and the new M tehnology will be ineetive. I the opposite is true and gm Z [0,] then the new M will push the onventional rop out o the market and the new M tehnology will be drasti. Co-existene o the new M and onventional rops implies that the M tehnology is eetive but non-drasti. Farmers with a Z value o Z [0, Z0] will produe the onventional rop, those with a Z ( Z, Z] will produe the new M rop while those with a Z ( Z,] will produe the 0 alternative rop. Sine armers are uniormly distributed in the interval 0, and eah produes one unit o the produt, Z 0 gives the supply o the onventional produt, as shown in equation (7), Z Z0 gives the supply o the new M produt, as shown in equation (8), and Z0 gives the supply o the alternative rop, as shown in equation (9). s p p w W gm gm (7) s gm ( pgm wgm ) ( p W) (8) s a w p gm gm (9) Equation (8) shows that the greater is the prie armers reeive or the M rop and the ost o produing the onventional rop and the lower is the seed osts o produing the M rop and the prie o the onventional rop, the greater is the supply o the M rop. Figure 3, panel (i), depits the net returns and the prodution deisions in period one when the onventional and the new M rop oexist. The kinked dashed urve is the eetive net returns shedule and the area below it gives the aggregate produer welare in period one under URTs. 7

18 Period Two The period two net returns rom the prodution o a unit o the onventional, M produed with purhased seed, M produed with illegally saved seed and alternative rop are given by p W Z, gm gm gm C p w Z, p ( ) h Z and 0, gm gm s a respetively. The armer with a dierentiating attribute Z p pgm s W h : ( Z ) ( Z ) Z is indierent between produing the C gm onventional rop and the new M rop with illegally saved seed, the armer with a C dierentiating attribute Z : ( Z ) ( Z ) Z gm gm gm gm gm gm w gm s is indierent ( ) h between produing the new M rop with saved seed and with purhased seed (i.e., violating her gm gm TUAs versus omplying) while the armer with Z p w : gm( Z) a( Z ) Z is indierent between produing the new M rop with purhased seed and the alternative rop. Farmers with a Z value suh that Z [0, Z ] will produe the onventional rop, those with a Z ( Z, Z ] will produe the new M rop with illegally saved seed, those with a Z ( Z, Z ] gm will produe the new M rop with purhased seed and those with a Z ( Z,] will produe the alternative rop. For the o-existene o onventional armers, M armers that heat and M armers that do not heat, the ollowing onditions must hold, 0 Z Z Z, whih implies that s pgm pgm wgm h and gm gm W ( )( s h) ( )w gm ( )(p p gm) must hold. Sine armers are uniormly distributed along the unit lenh interval and eah produes one unit o output, Z also 8

19 gives the supply o the onventional rop, Z gm Z the supply o the M rop produed with saved seed, Z Z the supply o the M rop produed with purhased seed and Z the gm supply o the alternative rop; these supplies are given in equations (0) to (3). s p pgm s W h Z (0) s gm wgm s h s p pgm W h () s gm s ( a) pgm w g m h () a s a wgm pg m (3) Equation () shows that the greater is the ost o M seed and the lower is the ost o saving seed, the probability o getting aught heating (i.e., the eort the monopolist exerts to identiy heaters) and the penalty imposed when aught heating, the greater is the portion o the M produt that will be produed with illegally saved seed (by armers who heat). Note that, the total quantity o M produt produed (with purhased and saved seed) is given by s s s. Figure 3, panel (ii), depits the net returns and prodution deisions in period gmt gm gm two when all rops oexist. The kinked dashed urve shows the eetive net returns shedule and the area below it gives the aggregate produer welare in period two. Under URTs When the new M seed ontains URTs, a armer annot save and replant M seed and the options available to her are to produe the onventional rop, the new M rop or the alternative rop realizing net returns given by p W Z, p w Z and 9

20 0, respetively. When all produts oexist in the market, the armer who is indierent a between produing the onventional and the M rop has a dierentiating attribute Z suh that, Z : ( Z ) ( Z ) Z p p W w while the armer who is indierent between produing the new M and the alternative rop has a dierentiating attribute Ẑ where ˆ ˆ : ( ) ( ˆ ) ˆ p w Z Z a Z Z. Farmers with Z values in the interval Z [0, Z ] produe the onventional rop, those with Z ( Z, Zˆ ] produe the new M rop and those with Z ( Zˆ,] produe the alternative rop. For the o-existene o the onventional and M rop the ollowing ondition must hold 0 ˆ Z Z whih implies that p w and p ( p w) W. The supply o the onventional rop is given by given by Z ˆ Z and the supply o the alternative rop is given by Zˆ by equations (4) to (6). Z, the supply o the new M rop is ; these supplies are given s p p W w (4) s ( p w ) ( p W ) (5) s a p w (6) Equation (5) shows that the greater is the prie armers reeive or the M rop, the agronomi beneits o M seed (i.e., the lower is γ) and the ost o produing the onventional 0

21 produt and the lower is the seed ost o the M rop and the prie o the onventional produt, the greater is the adoption o the new M produt. Figure 4, depits the net returns and prodution deisions under URTs when the onventional and new M rops oexist..3 The Monopolist Having solved or the onsumer and armer optimal deisions under TUAs and under URTs we an solve or the market outome (the derived demand or M and M seed and the retail pries or the M and M produts) under these two senarios. This will allow us to determine the monopolist s proit maximizing deisions and solve or the market equilibrium under TUAs and under URTs. We denote by y gm and y gm the seed sales o the monopolist under TUAs or period one and period two, respetively, and by y seed sales under URTs. We assume ixed proportions between arm and seed prodution whih implies that sgm ygm, sgm ygm and s y. We also assume ixed proportions between the retail and arm level and a onstant marketing margin or the onventional and M produts denoted by mm and mm gm, respetively. The marketing margins are assumed to be the same under TUAs and under URTs sine the produts will be labeled (e.g., identity preservation osts will be inurred) under both senarios. iven the above, the relationship between the retail and arm pries or the onventional, M and M produts are given by p p mm, p p mm and gm gm gm p p mm, respetively. gm We use the above relationships to solve or the market outome under TUAs, in period one, by simultaneously solving the ollowing equations: d s (where d is given by equation (3) with p p and pgm pgm and the supply by equation (7)), dgm sgm (where d gm is given by equation () with p p and pgm pgm and the supply by equation (8)), p p mm,

22 pgm pgm mmgm and sgm ygm. Equations (7), (8) and (9) give the inverse demand or M seed, the retail prie o the onventional produt and the retail prie o the M produt, respetively: w V W mm mm ( ) y (7) gm gm gm p W mm ( ) y (8) gm p V W mm ( ) y (9) gm gm The market outome under TUAs in period two is similarly determined by simultaneously solving the ollowing equations: d s ( d is given by equation (3) when p p and pgm pgm and the supply by equation (0)), d gm sgm sgm ( dgm is given by equation () when p p and pgm pgm and the total M supply by the summation o equations () and ()), p p mm, pgm pgm mmgm and sgm ygm. Equations (0), () and () give the period two inverse demand or M seed, retail prie o the onventional produt and retail prie o the M produt, respetively: w h( ) y (0) gm s gm p W ( ) V ( ) s mm ( ) mmgm ( ) h y gm () p hmm ( ) y () gm s gm gm Finally, the market outome under URTs is ound by simultaneously solving the ollowing equations: d s (equations (5) and (4)), d s (equations (4) and (5)), The sotware program Mathematia 8.0 was used to simultaneously solve the equations.

23 p p mm, p p mmgm and s y. Equations (3), (4) and (5) give the inverse demand or M seed, the retail prie o the onventional and the retail prie o the M produts under URTs. w V W mm mm ( ) y (3) gm p W mm ( ) y (4) p V W mm ( ) y (5) Monopoly deisions under TUAs Under TUAs the monopolist deides how to prie the M seed or, equivalently, how muh to supply in the market, as well as how muh eort to exert to identiy armers that violate their liensing agreements. The monopoly proits are given as the summation o the period one and TUAs period two monopoly proits, m gm r gm, where r is the disount rate. Reall that the monopolist annot tell ex-ante whih armers ould violate their TUAs and illegally save and replant seed. To determine the monopoly proits in the two periods, we assume that the marginal ost o produing M seed is onstant and equal to zero and the ost o enoring the TUAs is inreasing in the eort at an inreasing rate; these osts are given by A where 0, ( ) 0 and ( ) 0 and or simpliity we set. Also note that at this point all ixed A A osts that have been inurred or the prodution o the new M seed (e.g., R&D osts) are sunk. iven the above, in period one, where armers do not have the option to save M seed, the monopolist s proit maximization problem is given by equation (6): I the monopolist ould tell ex-ante whih armers would not violate their TUAs he would maximize proits by prie disriminating; harging non-violators the period one prie in all periods and harging only those that ould violate their TUAs the period two prie. 3

24 max gm wgm ygm ( V W mm mmgm ( ) ygm ) ygm (6) y gm where w gm is the inverse derived demand or M seed given by equation (7). The irst order onditions (F.O.C.) or a maximum o equation (6) yield the optimal quantity o M seed supplied in period one, y * gm V W mm mmgm. Substituting the optimal solution ( ) into equations (7), (8) and (9) and into the monopolist s proit untion gives the equilibrium M seed prie, retail pries o the onventional and new M produt and monopoly proits in period one: * wgm ( V W mm mmgm ) (7)' p * ( ) W ( ) V ( ) mmgm ( ) mm ( ) (8)' * pgm ( V W mm mmgm ) (9)' * gm ( V W mm mmgm ) 4( ) (6)' As one would expet, the greater is the value onsumers plae on the enhaned untional attributes o the M produt (V ), the greater is the prie the monopolist an harge or the M seed, his proits rom selling the seed, as well as the retail prie o the M produt and the arm prie o the M rop (reall that p p mm and * * p p mm ). * * gm gm gm In period two, where some armers may hoose to illegally save M seed, the monopolist hooses the proit maximizing levels o output, y gm and enorement,. The period two proits are given by equation (7): 4

25 Zgm max gm wgmygm A hdz wgmygm h( Zgm Z ) y gm, Z (7) The seond term in equation (8) gives the osts o enoring the TUAs and the third term is the expeted payment reeived rom armers who are aught violating their TUAs. Substituting the derived demand or M seed in period two, given by equation (0), and the supply o M rop produed with illegally saved seed, given by equation () (reall that and s Z Z ) into equation (7) and taking the F.O.C or a maximum o equation (7) yields gm gm the optimal output and enorement levels in period two, y * gm s, ( ) hv ( W ) * s mm mmgm. Substituting the optimal solutions into equations ( h ) (0), () and () and (7) gives the equilibrium M seed prie, retail prie or the onventional and M produt and monopoly proits in period two: w h V W * mm mmgm s gm ( ) ( )( ( )) ( h ) (0)' * p Ns K( V mmgm) ( mm W) M ()' p * gm h ( V W mm mmgm ) ( s mmg m )( ) ()' ( h ) ( VW,,, mm, mm, h,,,, ) (7)' * gm s gm The expressions or the parameters K,,, and and or the period two monopoly proits are given in the Appendix. The greater is the penalty paid by armers who are aught violating their TUAs ( h ), the osts o saving seed ( s ), the seed related osts o produing the onventional produt ( W ) and 5

26 the value onsumers plae on the untional attribute o the M produt (V ), the greater is the prie the monopolist an harge or M seed and the prie onsumers will pay or the M produt in period two (see the Appendix or a proo). As shown in the Appendix, the monopoly proits in period two are inreasing in the penalty h, the value o untional attribute V and the seed ost o the onventional produt W. A omparison o the seed pries the monopolist harges in period one and period two shows that seed pries are greater in period one where the monopolist does not ompete with armers that illegally save M seed (see the Appendix or a proo). Thus, in period two, the monopolist has to redue its seed pries to make seed saving less appealing and apture more o the demand or seed. This inding is onsistent with the literature on monopoly priing o a durable good and the indings o Ambe et al. (008). A omparison between the period one and period two retail pries o the M produt shows that the retail prie o the M produt (and subsequently the prie armers reeive or produing the M rop) is also higher in period one (see Appendix). A omparison o the seed supplier s monopoly proits between the two periods shows that or some parameter values proits in period two an exeed proits in period one. Monopoly deisions under URTs When the monopolist sells the new M seed variety with URTs, he no longer has to ompete with armers that illegally save M seed. The monopolist will thus harge the same seed prie/supply the same quantity o seed in eah period and earn the same level o proit. We assume that the marginal ost o produing the M variety is zero, as in the ase where seed is produed without URTs and the osts o inserting URTs into the new M variety are ixed osts and, thus, sunk at this stage. The monopolist hoses the optimal quantity o seed y that maximizes proits in eah period, given by: 6

27 max m wy ( V W mm mmgm ( ) y) y (8) y where w is the inverse derived demand or M seed given by equation (3). The F.O.C. or a maximum o equation (8) yield the optimal quantity o M seed supplied in eah period under URTs, y * V W mm mmgm. Substitution o the optimal solution ( ) * y and into equations (3), (4), (5) and (8) yields the equilibrium M seed prie, onventional produt and M produt prie and monopoly proits in eah period under URTs: * w ( V W mm mmgm ) (3)' p * ( ) W ( ) V ( ) mmgm ( ) mm ( ) (4)' * p ( V W mm mmgm ) (5)' ( V W ) * mm mmgm m 4( ) (8)'.4 Market equilibrium outomes under TUAs and under URTs We will irst ompare the market equilibrium outomes under TUAs in period one and under URTs sine these two ases share some notable similarities; under both ases produers annot save and illegally replant proprietary M seed, whih implies that, the seed provider does not have to inur monitoring and enorement osts to identiy violators. A omparison o the equilibrium seed pries (equations (7)' and (3)') shows that the seed supplier will harge the same prie or M seed under TUAs in period one and or M seed in eah period under URTs ( w * * gm w 0 ). Consumers will pay the same pries or the M produt in period one and or the M produt in eah period under URTs ( p * * gm p 0 ) 7

28 (equations (9)' and (5)') whih implies that arm pries will also be the same given our assumption that the marketing margin is the same under TUAs and under URTs ( p p ). * * gm iven that arm pries and seed pries are the same or the M rop in period one and the M rop, the produer net returns will also be the same, gm (see equation (6)). Note, however, that the monopolist will sell more seed in period one under TUAs than in eah period under URTs ( y y * * gm ) (see Appendix) whih, given our earlier assumption o ixed proportions in prodution implies that more armers will produe the M rop in period one under TUAs than the M rop in eah period under URTs ( sgm s ). Consequently, the monopoly proits o the seed supplier are greater in period one under TUAs than in eah period under URTs. An examination o the dierene in monopoly proits (see Appendix) shows that this mainly stems rom onsumer attitudes towards URTs. The retail and arm pries o the onventional produt are lower in period one under TUAs than in eah period under URTs ( p p, p p * * see Appendix) whih, given our assumption that the seed related osts o produing the onventional produt stay unhanged, implies that the period one net returns or armers produing the onventional rop are lower than their returns under URTs ( ). It is easy to show (see Appendix) that ewer armers will produe the onventional rop and ewer onsumers will onsume the onventional produt in period one under TUAs ompared to in eah period under URTs ( s s and d d, respetively) while more onsumers will onsume the M rather than the M produt d ( gm d ). The intuition behind these indings is that even though the number o options armers ae is the same under both ases, the nature o the options is dierent. For instane, under TUAs 8

29 some armers (potential violators) may purhase M seed in period one with the intent to save and replant in the ollowing period. Sine under URTs this option does not exist, these potential violators may hoose to produe the onventional rop rather than purhase M seed under URTs. 3 The omparison o the market equilibrium outomes under TUAs in period two and in eah period under URTs is less straightorward. It is easy to show (see Appendix) that the equilibrium prie o M seed in period two under TUAs is lower than the equilibrium prie o M seed in eah period under URTs ( w w * * gm produt is lower than the prie o the M produt ( p ), and the retail and arm prie o the M p * * gm ). However, the dierene between the seed pries is the same as the dierene between the retail/arm pries so the net returns reeived by armers who legally produe the M produt (with purhased seed) in period two are equal to the net returns o armers produing the M produt under URTs ( gm ). As disussed previously, the seed supplier has to lower the prie o M seed in period two, ompared to the prie o M seed to ompete with M armers that illegally save seed. It is not possible to ompare the supply o M and M seed, the monopoly proits and the retail and arm pries o the onventional produt under TUAs in period two and under URTs without knowledge o the magnitude o the exogenous parameters. However, it is important to mention that or ertain parameter values monopoly proits an be greater under TUAs in period two than under URTs. 3. Welare eets under TUAs and under URTs This setion ompares the welare outomes under TUAs and URTs or onsumers and 3 As was previously disussed, we assume that armers know whether the seed they buy has URTs and what that implies or their ability to save and replant seed. 9

30 armers; hanges in the welare/proits o the monopolist seed provider were disussed in setion.4. Sine two periods have to be onsidered under TUAs we ompare the welare outomes o eah period to those under URTs. 3. Consumer welare eets Figure 5 illustrates dierenes in onsumer welare between TUAs in period one and URTs in eah period. As disussed in setion.4, a omparison o the equilibrium outomes under TUAs in period one and under URTs shows that, pgm p, p p. These imply that U ( A0) U ( A0) and sine the slope o the M utility shedule is greater than the slope gm o the M utility shedule ( ), the utility urve U will be below the U gm utility urve or all A values. Also, the U utility urve will be below the U utility urve or A values as shown in igure 5. This implies that welare will be lower or all onsumers with values A (0,] under URTs (onsumers with A 0 do not experiene any welare hange); the welare hange is given by the dotted area between the eetive utility shedules under TUAs (kinked dashed urve) and under URTs (kinked solid urve). The lower aggregate onsumer utility results rom the higher levels o aversion to the URTs produt and the higher prie o the onventional produt under URTs. From the disussion in setion.4 we know that pgm p whih implies that the U gm utility shedule is above the U utility shedule or all A values. iven that the relationship between the retail pries o the onventional produt under TUAs, in period two, and under URTs annot be determined without knowledge o the magnitude o the exogenous parameters the ollowing ases must be onsidered. I p p then the U utility urve will be below the U utility urve or A values and the welare dierenes between the two senarios will be 30