Patentability Requirements and the Direction of Innovation

ABSTRACT We model a duopolistic game where firms first choose the direction of their innovation, then invest in the chosen direction, and finally, compete in the product market. Investments occur either in overlapping or non‐overlapping territories. We show that, in the presence of a generous patent regime that allows the protection of innovations of little value, firms tend to invest in overlapping technologies; stricter requirements for patentability may induce firms to operate in different technological areas, thereby increasing market efficiency. We illustrate our general theory using two stylized models of Cournot competition with product and process innovations, respectively.