Information Economics and Policy 23 (2011) 270280

Contents lists available at SciVerse ScienceDirect

Information Economics and Policy

journal homepage: www.elsevier.com/locate/iep

Civil and criminal penalties for copyright infringement

Yasuhiro Arai
Aomori Public College, 153-4 Yamazaki, Goushizawa, Aomori-city, Aomori 030-0196, Japan

a r t i c l e i n f o a b s t r a c t

Article history: Copyright violations are subject to both civil and criminal sanctions, but criminal charges
Received 28 July 2010 are relatively rare. Using a theoretical model, this study compares the implications of civil
Received in revised form 14 August 2011 and criminal penalty schemes from the viewpoint of social welfare, where civil and crim-
Accepted 16 August 2011
inal schemes are distinguished by whether penalties are paid to the copyright holder or the
Available online 31 August 2011
government. The analysis suggests that when the costs of developing a copyrighted prod-
uct are low, the socially most desirable scheme is one in which there are no civil penalties
JEL classication:
and criminal penalties are low. Although very severe criminal penalties may lead to the
D42
K39
complete elimination of copyright infringements, they could also result in excessive
L86 monopoly prots for the producer of the copyrighted good. A further nding is that the
number of copyright infringements is smaller under the criminal than the civil law scheme.
Keywords: 2011 Elsevier B.V. All rights reserved.
Copyright protection
Intellectual property right
Piracy

1. Introduction A person whose copyright is violated can take recourse

With the emergence of new computer technologies,
illegal copies of copyrighted goods are becoming increas-
ingly easy to create and obtain. According to the Interna-
tional Federation of the Phonographic Industry (IFPI,
2009), more than 40 billion les worldwide are exchanged
via peer-to-peer software such as Bittorrent and Gnutella,
and 95% of these les are exchanged without the copyright
holders permission. IFPI also suggests that more than one
third of all music discs purchased globally are illegal cop-
ies. The illegal use of copyrighted products has also in-
creased in other media markets. From an economic point
of view, this is problematic because such pirating reduces
the prot of producers of copyrighted goods and thus
undermines the incentive for producing creative works.
Copyrights essentially grant the right holders exclusive
control over their goods and can be used to legally force
others not to use copyrighted goods without permission.
Tel.: +81 17 764 1690.
E-mail address: yasuhiro68@gmail.com
to legal action, but the burden is placed on copyright hold-
ers to actively enforce their rights. If a right holder discov-
ers illegal copies of his work on the market, in most
countries the law provides for two general options. First,
the right holder can demand nancial compensation for
damages under civil law. In the United States, there are
two types of compensation from a copyright infringer: ac-
tual damages (to prots) and statutory damages (U.S.C.
504(a)). Actual damages are quantiable losses suffered
by the copyright holder as a result of the infringement. In-
stead of suing for actual damages, a copyright holder can
also sue for statutory damages that the court considers
just. In the United States, statutory damages range from
$750 to $30,000. Punitive damages of up to $150,000
may be imposed for willful infringement (U.S.C. 504(c)).
In this paper, such damages under civil law, resulting in
monetary transfers from the copyright infringer to the
copyright holder, are referred to as civil penalties. A sec-
ond option is for the right holder to report offending par-
ties to the authorities, which will then prosecute them
under criminal law. The maximum criminal penalty for

0167-6245/$ - see front matter 2011 Elsevier B.V. All rights reserved.
doi:10.1016/j.infoecopol.2011.08.001
 Y. Arai / Information Economics and Policy 23 (2011) 270280
Table 1
Number of cases concerning copyright in US federal district courts. Source:
Annual Reports of the Director, Administrative Ofce of the United States
Courts.
2004 2005 2006 2007 2008 2009
Criminal cases 9 23 56 38 72 48
Civil cases 3007 5796 4944 4400 3234 2192
copyright infringement in the United States is $250,000 in
nes, ve years imprisonment, or both (U.S.C. 506). With
regard to the second option, this study focuses especially
on criminal nes, that is, monetary transfers from the
copyright infringer to the state.1 The government and the
right holder have different roles in protecting a copyright.
It is the right holders responsibility both to monitor illegal
use and to assume the cost of monitoring. The governments
role is to decide the size of the civil or criminal penalty im-
posed when an infringement is brought to its attention. The
purpose of the analysis here is to determine which of the
two copyright penalty schemes is better under this division
of roles.
Copyright violators are potentially subject to both civil
and criminal prosecution, but criminal cases are relatively
rare (Table 1) in practice. If civil penalties deter copyright
violations and maximize social welfare, there is no need
to actually use criminal penalties. However, as this study
will suggest, criminal penalties may be preferable in that
they may result in greater social welfare.
In order to determine an optimal scheme to deal with
copyright infringement, two factors need to be considered.
First, with respect to the optimal penalty, it should be
noted that any copyright protection policy has two contra-
dictory objectives. On the one hand, it has to reward pro-
ducers and provide a reasonable incentive to create new
works. On the other hand, copyright protection that is
too effective provides producers with monopoly power
and reduces the social surplus. This tension amounts to a
trade-off problem that must be solved when designing an
optimal copyright protection scheme. The second issue
that needs to be considered is which penalty scheme is
more desirable from a societal point of view. If the penal-
ties are enforced under civil law, then illegal users will
have to pay damages to compensate the producer. Under
criminal law, the government collects the penalty. In this
paper, civil and criminal cases are distinguished by
whether the sanctions are paid to copyright holders or to
the government. Increasing either penalty tends to prevent
illegal use and reduce the social surplus from illegal copies.
A high penalty thus decreases producers monitoring cost.
On the other hand, producers will tend to set a higher price
when the penalty for infringement is high. It is thus not
immediately clear what the optimal penalty level should
1
There is a substantial literature comparing civil punishment and
imprisonment under the general setting. Becker (1968), for example,
argues that civil punishment is socially more desirable than imprisonment
because civil punishment is the transfer from the offender to the victim,
while imprisonment incurs social costs for the apprehension and conviction
of perpetrators. Polinsky and Shavell (1979, 1984) characterize the optimal
punishment scheme under Becker (1968) cost structure.
271
be. Using a simple theoretical model, this study considers
the optimal copyright protection scheme to take these
two issues into account.
There is a considerable number of studies on copyright
protection that consider the optimal set of government
policies. Yoon (2002), for instance, considers the social im-
pact of increasing the marginal cost of illegal copies
through government policy and discusses the effect of
copyright protection on society. Focusing on the effect that
unauthorized copying increases the circulation of works,
he shows that copyright protection may decrease social
welfare. Similarly, Conner and Rumlet (1991) and
Takeyama (1994) argue that not protecting copyrights at
all could be the best policy in an environment with positive
network externalities. Using a simple theoretical model,
the present study also shows that the optimal copyright
scheme is one that sets the penalty as low as possible.
However, for the most part, the copyright protection liter-
ature does not discuss what kind of penalty is desirable
from a societal point of view. Banerjee (2003), for instance,
simply species that the penalty is a transfer from the of-
fender to the government (criminal penalty). On the other
hand, Banerjee (2006) considers the case where the pen-
alty is a transfer from the offender to the victim (civil pen-
alty). However, these studies do not discuss which penalty
scheme is socially desirable. In contrast, this paper distin-
guishes civil and criminal penalty schemes by whether
penalties are paid to copyright holders or the government
and discusses which penalty scheme is socially desirable.
In addition to that, most of the literature assumes that only
the government tries to protect copyrights. However, in
practice, right holders can also monitor for illegal activity
by investing in monitoring themselves.2 The analysis here
considers the fact that the government and the producer
play different roles in protecting copyrights. In this paper,
it is assumed that the original producer of a copyrighted
good monitors for illegal activity and the government sets
the penalty.
The analysis in this paper yields the following results.
First, the optimal criminal penalty level will be larger than
the optimal civil penalty level. Second, the number of ille-
gal users under the criminal law scheme is smaller than
that under the civil law scheme. And third, imposing small
criminal penalties without civil penalties is socially desir-
able when production costs are low. Very severe criminal
penalties may lead to the complete elimination of unau-
thorized copies but may also lead to excessive monopoly
prots.
The paper is organized as follows. Section 2 sets up the
basic model. Next, Section 3 considers the optimal pro-
ducer strategy under a civil penalty, while Section 4 con-
siders the optimal producer strategy under criminal law.
Section 5 then discusses which protection scheme is better
from a social point of view. Section 6 considers extensions
of this model. Section 7 concludes. All proofs are given in
the Appendix.
2
Banerjee (2006) also takes into account private monitoring by the right
holder, but focuses on strategic entry-deterrence against producers of
pirated products and ignores the impact of piracy on the development of
new products.
272 Y. Arai / Information Economics and Policy 23 (2011) 270280

2. The model Lemma 1. Given penalty g, price p, and monitoring intensity

s, the optimal choice of a consumer is not to obtain the good if
The analysis considers a monopolistic market for copy- and only if
righted products based on the natural-oligopoly model of n sg o
Gabszewicz and Thisse (1980) and Shaked and Sutton v i < min p; :
a
(1983). Consumers valuations of the goods, vi, are uni-
A consumer will make an illegal copy if and only if
formly distributed on the interval [0, 1]. Each consumer
wants to buy at most one unit. If consumer i buys the ori- sg p  sg
6 vi < ;
ginal good at price p, his utility is given by vi  p. Consum- a 1a
ers also have the option of making illegal copies. If but he will buy the original good if and only if
consumer i uses an illegal copy, his utility is given by n p  sg o
avi  sg, where a(0 < a < 1) represents the depreciation of v i P max p; :
the quality of the item due to the fact that illegal copies 1a
A consumers behaviour thus depends on his valuation
are generally of lower quality than the original goods,
of the good, its price, the quality of an illegal copy, and
and sg is the expected penalty for illegal uses3 where g rep-
the expected penalty. In the rst case, the consumer will
resents the penalty set by the government4 and s is the prob-
ignore a good when his valuation of the original is lower
ability of detection.5 The producers monitoring cost
than the price p and his valuation of an illegal copy is lower
function is given by c(s) = ks2(k > 0). If a consumer does not
than the expected penalty sg. In the second case, the utility
use any product, his utility is given by 0. A three-stage game
of making an illegal copy is positive and higher than the
model is used to consider the optimal copyright protection
utility of purchasing the original good. In the third case,
scheme in this monopolistic market. The sequence of events
the consumer prefers the original good to the illegal copy
is:
because the utility of a purchase is positive and higher.
The producer chooses the price p and the monitoring
1. The government chooses a penalty level g P 0.
intensity s at the second stage. The producers strategy is
2. The producer decides whether or not to produce the
considered in the next section.
goods at a xed cost F > 0. If the producer decides to
produce the goods, he chooses a price p and a monitor-
ing intensity s. In this model, it is assumed for simplicity 3. Civil law penalties
that the marginal cost of production is equal to zero.
3. Consumers decide whether they will buy the original In this section, it is assumed that the original producer
product, make an illegal copy, or do nothing. receives the civil law penalty, gc, paid by illegal users, and
4. Caught illegal users pay sanctions.6 that this penalty will form part of the producers prot.
First, the producers strategy is dened as S = {(p,s)jp
Both civil law and criminal law penalties are consid- P 0,1 P s P 0}, where p is the price and s is the monitoring
ered. Under civil law, the producer receives the penalty intensity. For convenience, the strategy space S is divided
paid by illegal users, which will form part of the producers into two sub-sets: S1 = {(p, s)js < ap/gc} and S2 = {(p, s)js P
prot. Under criminal law, the government collects the ap/gc}. For every strategy (p,s) 2 S1, it holds that sgc/
penalty. The governments goal is to maximize a social sur- a < p < (p  sgc)/(1  a). When the producer employs a
plus function (the consumer and producer surplus) by set- strategy in sub-class S1, Lemma 1 predicts the consumer
ting the penalty for illegal use at the optimal level. behaviour illustrated in Fig. 1.
The sub-game perfect equilibrium here is obtained by Consumers with valuations above (p  sgc)/(1  a) buy
backward induction. First, consumers behaviour is the original good, those with valuations between sgc/aand
considered.7 (p  sgc)/(1  a) make illegal copies, and those with valua-
tions less than sgc/a do not consume. The demand for
goods DL and the demand for illegal copies DI are given by
3 p  sg c p  sg c sg c
Producers of pirated products are not considered in this model. DL 1  ; DI  : 1
However, the results remain essentially unchanged if there are a number 1a 1a a
of producers of pirated products in the market and they are engaged in
From Eq. (1), we also obtain the producers prot as
price competition. If this case is considered, sg can be interpreted as the
marginal cost of producing pirated products.
 p  sg c  p  sg sg 
c 2
4 pc1 p 1  sg c  c  ks  F: 2
In reality, in civil cases, the penalty will be calculated based on the 1a 1a a
damages caused by the illegal activity. Here, g is interpreted as the upper
bound of any penalties. The next lemma shows the optimal output in sub-class S1
5
In practice, the probability of detection depends on the producers under civil law.
monitoring intensity. In the model here, it is assumed for simplicity that the
probability of detection is equal to the monitoring intensity.
6 Lemma 2. Assume that the producers strategy is restricted
In practice, the government may determine the probability of convic-
tion. For example, taking into account the probability of conviction r, the to sub-set S1. When goods are produced, the prot of the
expected penalty is given by srg. However, the result here does not change producer under civil law is maximized by the choice
if the probability of conviction is considered since the government controls
rg so as to maximize the social welfare. g 2c ka  ka2 ag c
pc1 ; sc1 :
7
Since the proof of the lemmas is straightforward, although rather 2g 2c ka 2g 2c ka
lengthy, it is not presented here.
 Y. Arai / Information Economics and Policy 23 (2011) 270280 273

Fig. 1. Consumer behaviour under strategies in sub-class S1.

Fig. 2. Consumer behaviour under strategies in sub-class S2.

Under this strategy, the prot of the producer is Essentially, the producer accepts that fewer consumers
will pay for the good in exchange for the prot to be ob-
g 2c ka  ka2
pc1  F: tained from all those consumers infringing on the copy-
4g 2c ka
right. Under the civil law scheme, there are illegal users
   
When F is larger than g 2c ka  ka2 =4 g 2c ka ; pc1 be- for any gc.
comes negative. In this case, no goods will be produced. Next, the optimal level of penalties against illegal users
For every strategy (p, s) 2 S2, it holds that (p  sgc)/ under civil law is considered. The government chooses the
(1  a) 6 p 6 sgc/a. When the producer employs a strategy penalty to maximize the social surplus,8 which is the sum
in sub-class S2, Lemma 1 predicts the consumer behaviour of the producer surplus and the consumer surplus:
illustrated in Fig. 2. Given Fig. 2, the demand for goods DL Z 1 Z pc sc g c
1a
and the demand for illegal copies DI are given by:
pc sc g c
v dv sc g c
av dv  ks2c  F
1a a
DL 1  p; DI 0: 3  
3 a ag 2c g 2c 2ka
From (3), we obtain the producers prot:   2  F
8 8 g 2 ka c
pc2 p1  p  ks2  F: If the producer chooses not to develop any goods, the social
The original producer will maximize his prot subject surplus is zero. Therefore, the social welfare is given by
to s P ap/gc. The next lemma shows the optimal output 8
> ag 2c g 2c 2ka g 2 kaka2
in S2 under civil law. >
< 38 a  2  F; if F 6 4c g2 ka
8g 2c ka c
SW c g c : 4
>
> g 2c kaka2
Lemma 3. Assume that the producers strategy is restricted :0 if F > 4 g2 ka
c
to sub-class S2. When goods are produced, the prot of the
producer under civil law is maximized by the choice The next lemma considers how changes in the civil law
penalty affect the social surplus.
g 2c ag c
pc2 ; sc2 :
2g 2c ka2 2g 2c ka2 Lemma 4. A civil penalty affects the social welfare as
Under this strategy, the prot is follows:

g 2c
pc2  F:    
4g 2c ka2 (1) If 0 6 F 6 g 2c ka  ka2 =4 g 2c ka , then the social
  welfare is a decreasing function of the civil penalty gc.
When F is larger than g 2c =4 g 2c ka2 ; pc2 becomes negative.    
(2) If g 2c ka  ka2 =4 g 2c ka < F, then the social wel-
In this case, no goods will be produced.
fare becomes zero.
The next proposition shows that the producer will
choose a strategy in S1 under the civil law scheme.
The social surplus is a decreasing function of the pen-
  alty because the number of consumers engaging in illegal
Proposition 1. When F is smaller than g 2c
ka  ka = 2
copying decreases as the penalty increases. The producers
4g 2c ka, the prot of the producer under civil law (over the
prot is an increasing function of the penalty because
whole strategy space S) is maximized by the choice
sales from legal users increase as the penalty increases.
g 2c ka  ka2 ag c When the penalty is low and the production cost is high,
pc ; sc ;
2g 2c ka 2g 2c ka the producer may decide not to create the good at all
and the social surplus will be zero. The next proposition
where illegal copies exist. Otherwise, no goods will be
shows the optimal civil law penalty to maximize the social
produced.
welfare.
If the producer chooses a strategy in S2, he has to lower
the price sufciently to eliminate illegal use. Choosing a 8
The denition of social welfare here includes the utility of illegal users.
strategy in S1 greatly increases the number of illegal copies This denition may not seem appropriate from the viewpoint of society.
of the work, so the penalty payments the producer receives However, the main result of this paper that a criminal penalty is socially
from illegal users easily outweighs the cost of monitoring. desirable holds even if the utility of illegal users is not taken into account.
274 Y. Arai / Information Economics and Policy 23 (2011) 270280

Proposition 2. The optimal civil law penalty is as follows: From Lemma 1, the producers prot can be obtained:
 p  sg k  2
(1) If F < (1  a)/4, the government should set the civil pk p 1   ks  F:
1a
penalty equal to zero.
(2) If (1  a)/4 6 F < 1/4, the government should set the This shows that the producers prot under the criminal
civil penalty to a level that makes the producers prot law penalty is different from the prot under the civil
zero. The optimal civil law penalty g c is given by law penalty. The next lemma gives the optimal strategy
r within S1 for a given criminal penalty.
ka4F a  1
g c :
1  4F Lemma 5. Assume that the producers strategy is restricted
to sub-class S1. When goods are produced, the prot of the
(3) If F P 1/4, the producer chooses not to enter the market
producer under criminal law is maximized by the choice
at any level of civil law penalty.
2k1  a2 g k 1  a
The intuition of this proposition is quite straightfor- pk1 ; sk1 :
4k  4ka  g 2k 4k  4ka  g 2k
ward. As discussed in Lemma 4, the government seeks to
maximize the social surplus by setting the civil law penalty Under this strategy, the prot of the producer is
as low as possible. The original producer may decide not to
k1  a2
create goods if the penalty is too low, however, because his pk1 F
4k  4ka  g 2k
prot is an increasing function of gc. If the development
 
cost is low enough (F < (1  a)/4), the government can When F is larger than k1  a2 = 4k  4ka  g 2k , pk1 be-
set the penalty to zero. In the intermediate case ((1  a)/ comes negative. In this case, no goods will be produced.
4 6 F < 1/4), setting the penalty to zero will result in a neg- The optimal strategy within S2 is same as shown in
ative prot for the producer. The government thus gives Lemma 2. The next proposition presents the optimal strat-
the producer an incentive to create goods by imposing a egy for the producer under the criminal law scheme.
penalty. The level of the penalty is set just high enough
to result in a non-negative prot.9 In the last case, the pro- Proposition 3. When the entire strategy space S is consid-
ducer will never create goods because the production cost is ered, the prot of the producer under criminal law is
too high. maximized by the choice

2k1  a2 g k 1  a
4. Criminal law penalties pk ; sk ;
4k  4ka  g 2k 4k  4ka  g 2k
p
In this section, the criminal penalty scheme is consid- where there are illegal copies for g k 6 2ka1  a, and by
ered. The right holder does not prot from a criminal pen- g 2k ag k
alty, gk, but the government does. Again, the previously pk ; sk ;
2g 2k ka2 2g 2k ka2
dened sub-classes of strategies, S1 = {(p, s)js < ap/gk} and p
S2 = {(p, s)js P ap/gk}, are considered. Consumer behaviour where illegal copies do not exist for g k > 2ka1  a.
and the producer prot in S2 are, of course, the same under The interpretation of this proposition is straightfor-
p
criminal law as under civil law since there is no illegal ward. When g k 6 2ka1  a, the producer chooses a
activity. Thus, only strategies in sub-class S1 are strategy in S1 because it is too costly to monitor illegal
considered. use. If gk exceeds this limit, the producer chooses a strategy
The demand for goods DL and the demand for illegal that shuts out all illegal users from the market because un-
copies DI are given by der the criminal law scheme he does not receive any dam-
p  sg k p  sg k sg k ages from illegal users.
DL 1  ; DI  : The optimal criminal penalty that maximizes the social
1a 1a a
welfare is obtained as follows. Under the criminal law
scheme, the social welfare is dened as the sum of the pro-
ducer surplus, the consumer surplus, and the penalty
p
col-
9
The results concerning the optimal copyright protection here are lected by the government. If g k 6 2ka1  a, the sum
intuitively clear from the traditional trade-off problem in a static model
of the producer surplus, the consumer surplus, and the
regarding the producers incentive to innovate and the welfare loss
resulting from monopoly. There are a substantial number of studies penalty is as follows:
considering optimal intellectual property right protection in a dynamic Z 1 Z pk sk g k
1a
context. Boldrin and Levine (2008), for example, obtain a similar result as
this paper. Their study, using a dynamic general equilibrium model, shows pk sk g k
v dv sk g k
av dv  ks2k  F
1a a
that the producer can generate sufcient prot to recoup development
costs without the patent protection. While their study focuses on the role of 3a 1  a4  ag 4k
the rst-mover advantage in the initial period, Denicolo (2007) examines
  2  F:
8 8a 4k  4ka  g 2k
on the relationship between the optimal level of intellectual property right
protection and the elasticity of supply of inventions. Focusing on patent
When no goods are produced the social surpluspis
of course
protection, he empirically examines the elasticity of the number of patents
with regard to research investment and shows that patent protection does zero. Therefore, the social welfare when g k 6 2ka1  a
not over-compensate the producer with respect to the socially optimal is given by
level.
 Y. Arai / Information Economics and Policy 23 (2011) 270280 275

8
1a4ag 4k 2
(3) If F P 1/4, then the producer chooses not to enter the
>
< 38 a  2
k1a
 F; if F 6 4k4k ;
8a4k4kag 2 ag 2
SW k g k k k market at any level of criminal penalty.
>
: 0; k1a
if F > 4k4k :
2

ag2 k
This result can be interpreted in the same manner as
5 Proposition 2. The government seeks to set the criminal
Because the penalty is a transfer from illegal users to the law penalty as low as possible to maximize the social sur-
government, it cancels out when plus. However, the government has to set a penalty that is
calculating the social
p
surplus. When g k > 2ka1  a, the sum of the surplus high enough to prevent the producers prot from being
is given by negative. If the development cost is low, then the govern-
Z ment can afford to set the penalty to zero. In the interme-
1 2
3g 4k 4a4 k 6a2 g 2k k diate case, goods will not be created if the government sets
v dv  ks2k  F  2  F:
pk 8 g 2k a2 k the penalty to zero. Instead, the government sets the pen-
p alty just high enough to prevent the producers prot from
Similarly, the social welfare when g k > 2ka1  a is being negative. When (1  a)/4 6 F < (1  a)/2(2  a), the
8 4 42 2 2 optimal criminal penalty also becomes small. Thus, the ori-
3g 4a k 6a g k g2
>
< k 2 2 2 k  F; if F 6 4g2 ka2 k ;
8 g k a k k
ginal producer chooses the strategy in S1. If (1  a)/
SW k g k 6
>
: 0; g2 2(2  a) 6 F < 1/4, the original producer will shut out all
if F > 4 g2 ka2 k :
k illegal users from the market. If the development cost is
very high, the producer does not create goods at any pen-
In this case, the producers choice of price and monitoring
alty level.
intensity shuts out all illegal users. The next lemma shows
the impact of a criminal penalty on the social surplus.
5. Civil vs. criminal law penalties
p
Lemma 6. When g k 6 2ka1  a, a criminal penalty
affects the social welfare as follows: This section compares the civil law and criminal law
penalty schemes. It is not immediately clear from the anal-
  ysis above which copyright protection scheme is better
(1) If 0 6 F < k1  a2 = 4k  4ka  g 2k , then the social
welfare is a decreasing function of gk. from a social point of view, but the stage is now set to nd
  the optimal scheme. The next proposition compares the
(2) If k1  a2 = 4k  4ka  g 2k 6 F,pthen the social

wel-
fare is equal to zero. When g k > 2ka1  a, a crim- number of illegal users and the penalty level under each
inal penalty affects the social welfare as follows: protection scheme.
 
(3) If 0 6 F < g 2k =4 g 2k a2 k , then the social welfare is a
decreasing function of gk. Proposition 5. A comparison of the two protection schemes
  yields the following results:
(4) If g 2k =4 g 2k a2 k 6 F, then the social welfare is equal
to zero.
(1) The optimal criminal law penalty will be larger than
This result can be interpreted in the same manner as the optimal civil law penalty.
Lemma 4. The social surplus is a decreasing function of (2) The number of illegal users under the criminal law
the penalty, because the number of consumers engaging scheme will be smaller than that under the civil law
in illegal copying decreases as the penalty increases. On scheme.
the other hand, the producers prot is an increasing func-
tion of the penalty because the number of illegal users de-
The intuition of this proposition is as follows. According
creases as the penalty increases. When the penalty is low
to Propositions 2 and 4, the government will set the penalty
and the production cost is high, the producer may decide
either to zero or to a level that makes the producers prot
not to create the goods at all and the social surplus will
zero. Therefore, the criminal law penalty must be larger
be zero. The following proposition considers the optimal
than the civil law penalty in order to cover production costs,
criminal penalty.
since the producer does not receive the penalty as part of his
prot under the criminal law scheme. Under the US Copy-
Proposition 4. The optimal criminal law penalty is as
right Act, the upper bound of the statutory damages range
follows:
is $150,000. Under criminal law, on the other hand, the rst
copyright infringement is punishable by up to $250,000.
(1) If F < (1  a)/4, the government should set the criminal
This suggests that penalties in the United States are based
penalty equal to zero.
on a line of reason similar to the one presented here.
(2) If (1  a)/4 6 F < 1/4, the government should set the
The second part of this proposition focuses on the num-
criminal penalty to a level that makes the producers
ber of illegal users under each scheme. The producer has an
prot zero. The optimal criminal law penalty g k is given
incentive to allow a certain level of illegal activity under
by:
the civil law scheme. Thus, the number of illegal users un-
8 q
>
< k1a4F1a; if; 1a 6 F < 1a ; der the civil law scheme will be larger than that under the
F 4 22a criminal law scheme.
g k q
>
: 4Fka2 ; 1a Next, the socially optimal copyright protection scheme
14F
if 22a 6 F < 14 :
is considered. The social surplus under the optimal civil
276 Y. Arai / Information Economics and Policy 23 (2011) 270280
punishment can be obtained by substituting g c into
Eq. (4):
8 3a
>  F; if 0 6 F < 14 a ;
< 8
2
SW c F 3a  F  4F a 1 4F a114F
> 8a
 4a
; if 14 a 6 F < 14 ;
: 8
0; if 14 6 F:
When 0 6 F < (1  a)/4, the government will set the civil
penalty to zero. Thus, consumers will be able to obtain
illegal copies without any cost. The producer does not
monitor illegal use and sets a low price to reduce illegal
copying. When the development cost is lower than
(1  a)/4, consumers whose valuation is vi 2 [1/2, 1] pur-
chase the product legally, while other consumers use ille-
gal copies. When (1  a)/4 6 F < 1/4, the government has
to set a positive penalty to provide the producer with suf-
cient incentive to develop new products. The producer
tries to discover illegal activity and obtain damages from
illegal users. The sale of legal products increases as mon-
itoring intensity increases. However, excessive monitoring
decreases the penalty collected from illegal users since
the number of illegal users decreases as the monitoring
intensity increases. The producer can increase the retail
price as the penalty increases, since consumers compare
the retail price and the expected penalty. In this setting,
the producer tries to keep the number of legal purchasers
constant, because he tries to maximize the sum of sales
from legal products and the penalty from illegal users.
Consumers whose valuation is higher than 1/2 purchase
the product legally. The number of illegal users decreases
as the penalty increases. The third term of the social wel-
fare Eq. (7) represents the welfare loss resulting from the
decrease in the number of illegal users compared with the
zero penalty case. The last term represents the monitor-
ing cost. When the development cost is larger than the
monopoly prot (F P 1/4), the producer will not develop
the new technology. Therefore, the social welfare will be
zero.
Similarly, the social surplus under the optimal criminal
penalty can be obtained by substituting g k into Eqs. (5) and
(6):
8 3a
>  F;
>
>
>
8 scheme. In addition to that, the monitoring cost under
>
< 3a  F  4Fa12 33a4F4Fa1  F4Fa1 ; if 1a 6 F < 1a ;
8 2a 81a 1a
SW k F
>
> 3a
 F  2aF 2 14F4F11 a
 1  4FF;
>
> 8 8 22a
>
:
0;
When the development cost F is smaller than (1  a)/4, the
social welfare under the criminal scheme and the civil
scheme is the same. When (1  a)/4 6 F < (1  a)/
2(2  a), the government sets a positive penalty. Under
the criminal penalty scheme, the producer chooses a high-
er monitoring intensity than under the civil law scheme,
since he will not receive any damages from illegal users.
Thus, the monitoring intensity and the retail price are
increasing functions of the development cost. The third
term of the social welfare Eq. (8) shows the welfare loss
from a decrease in the number of illegal users. The fourth
term represents the welfare gain from an increase in the
number of legal users. The last term is the monitoring cost.
When the development cost becomes larger than (1  a)/
2(2  a), the producer has an incentive to invest in moni-
toring and remove all illegal copies from the market. Com-
paring the social surplus under the criminal penalty
scheme and the civil penalty scheme yields the following
proposition:
7
Proposition 6. For society, a criminal law scheme is better
when the development cost is in the range 0 6 F < 5(1  a)/
4(5  2a). Otherwise, a civil law scheme is better.
This proposition can be interpreted as follows. When
(1  a)/2(2  a) 6 F < 1/4, the producer, under the crimi-
nal law scheme, tries to shut out all illegal users from
the market by making the probability of detection high
through heavy investment in monitoring. In this setting,
the producer monitors illegal use excessively and the pro-
ducer has considerable market power under the criminal
law scheme. On the other hand, under the civil law
scheme, the producer chooses a monitoring intensity such
that there will be illegal users in the market in order to
obtain damages from illegal users. This diminishes the
producers market power. Thus, from a social welfare per-
spective, the government will prefer the civil law scheme.
When (1  a)/4 6 F < (1  a)/2(2  a), there will be illegal
users under both schemes. From Proposition 5, we know
that the criminal penalty will be larger than the civil pen-
alty. The producer sets a higher monitoring intensity un-
der the criminal law scheme because the number of legal
consumers increases as the monitoring intensity in-
creases. On the other hand, the producer has little incen-
tive to set a high monitoring intensity under the civil law
scheme. In this case, a high monitoring intensity de-
creases the collected penalty from illegal users because
the number of illegal users decreases as the penalty in-
creases. If (1  a)/4 6 F < 5(1  a)/4(5  2a), the welfare
gain by increasing the number of legal users under the
criminal scheme will be large. Thus, the criminal law
scheme is socially desirable. If the development cost is
larger than 5(1  a)/4(5  2a), the number of illegal users
under the criminal scheme will be small. This increases
the producers market power under the criminal law
if 0 6 F < 14 a ;
4 22a the criminal law scheme becomes large. From the view-
if 1a
6F < 14 ; point of society, the government prefers the civil law
if 1
6 F: scheme since it decreases the monitoring cost and the
4
producers market power. Proposition 6 also shows that
8
the range where the civil law scheme is better becomes
larger as a increases.
When a is high, consumers can obtain high-quality ille-
gal copies (Fig. 3). In this case, the government has to set a
high criminal penalty to compensate for the development
cost and the harm to social welfare. On the other hand, if
a is low, the quality of illegal goods in the market is low.
In this case, the producer can easily increase the number
of legal users under the criminal law scheme. Goods with
a high production cost of which the quality of copies is
high should therefore be protected under civil law. Movies
and video games are examples of goods that should be pro-
tected by civil law. On the other hand, goods that can be
 Y. Arai / Information Economics and Policy 23 (2011) 270280
Fig. 3. Optimal penalty scheme.
produced at low cost, and the quality of copies of which is
low, should be protected under criminal law. Art objects
are an example.
6. Extensions
The preceding section compared the two copyright
protection schemes from the viewpoint of society. In
this section, three extensions of this model are consid-
ered: monitoring by the government, dual punishment,
and private settlement before the government gets
involved.
6.1. Public monitoring
So far, it has been assumed that only the producer
makes an effort to discover breaches of copyright. In the
real world, however, there are many producers in the
market and a particular user of illegal products is likely
to infringe on the copyright of various producers. This
gives rise to a free-rider problem in monitoring and
enforcement, meaning that there is a case to be made
for the government to step in order to discover and pros-
ecute illegal users under a criminal law scheme.10 In this
case, the producer only controls the retail price p. The gov-
ernment sets the public monitoring intensity sp and the
2
penalty level, gk. The cost of monitoring, ksp , is borne by
the government.
Given this setup, it can be shown that the combination
of public monitoring and a criminal penalty yields greater
social welfare than private monitoring. The intuition of this
result is as follows. First, the government can control the
cost of illegal copies perfectly through public monitoring.
In addition to that, the government will set the highest
punishment and a correspondingly low monitoring cost
10
The distinction between the civil penalty and the criminal penalty is
close to the distinction between public and private enforcement of law. The
distinction between public and private enforcement is not always clear.
Shavell (1993), for example, assumes that the distinction depends on (a)
who devotes the greatest effort to enforcement, and (b) whether those
enforcing are paid by the state as public enforcement agents. According to
this denition, the analysis so far has focused on private enforcement.
277
to minimize the monitoring cost. This combination makes
the monitoring cost innitesimally small.11
6.2. Settlement
In the real world, the right holder has the option to ar-
range a private settlement before taking a copyright infrin-
ger to court. Let us consider how a settlement option
affects the optimal copyright protection scheme.
It is assumed that the producer, before going to court,
can decide whether to arrange a settlement with illegal
users that have been detected. In this section, it is assumed
for simplicity that the producer can make a take-it-or-
leave-it offer with regard to the settlement amount. If
the settlement fails, they go to court and illegal users pay
damages set by the government. When the settlement is
arranged, the producer can commit not to sue the illegal
users.
Generally, producers and illegal users will prefer a pri-
vate settlement, because a settlement can save time and
litigation costs.12 For example, taking into account the liti-
gation costs, the net damages that the producer receives
from the illegal user is given by g  cp, where cp represents
the producers litigation costs. Similarly, the illegal user will
need to pay g + cu, that is damages to the producer plus his
own legal costs. This means that the settlement will fall
somewhere between g  cp and g + cu. As a results, both
the producer and the illegal user are better off than they
would be from going to court. The model presented above
could be interpreted as a situation where litigation costs
are assumed to be zero, in which case the settlement option
does not affect the amount the illegal user pays or the pro-
ducer receives under the civil law scheme.
On the other hand, under the criminal law scheme, the
producer has a strong incentive to opt for a settlement
even if the litigation costs equal zero. In this case, the
amount that the producer will receive is equal to the crim-
inal penalty. That is, even if the copyright protection
scheme is a criminal one, if there is a settlement option,
the producer can appropriate penalty payments from ille-
gal users by arranging a settlement. Thus, the producer al-
ways tries to arrange a private settlement under the
criminal law scheme. This is another reason the number
of criminal cases for copyright infringement is small. When
the producer employs a strategy in sub-class
S1 = {(p,s)js < a p/gk}, the producers prot with a settle-
ment option pks is given by
 p  sg k  p  sg sg 
k 2
pks p 1  sg k  k  ks  F: 9
1a 1a a
11
Becker (1968) similarly argues that the optimal solution is the
combination of a low probability of detection with a high ne. However,
this result depends on the assumption that there does not exist an upper
bound for the penalty. Polinsky and Shavell (1979) show that the optimal
ne will be equal to its upper bound when there exists an upper bound.
According to Polinsky and Shavells result, a ne that is smaller than the
lawbreakers wealth is not optimal. In a later paper (Polinsky and Shavell,
2007), they noted that this result was unrealistic and showed the
conditions that imply the highest punishment is not optimal.
12
For a discussion of the benets of settlement, see, for example, Aoki and
Hu (1999), Polinsky and Shavell (2007), and Spier (2007).
278 Y. Arai / Information Economics and Policy 23 (2011) 270280
The second term of the right side of Eq. (9) represents
expected settlement money. From Eqs. (2) and (9), it is
clear that the producer will choose his strategy in the same
manner as in Proposition 1, since he faces the same prob-
lem as under the civil law scheme. With the settlement op-
tion, the producer under the criminal law scheme has an
incentive to allow a certain level of illegal activity.
The government sets the optimal criminal penalty by
taking into account the producers strategy. Thus, the opti-
mal criminal penalty with settlement is equal to the opti-
mal civil law penalty obtained in Proposition 2. It is
worth noting that the government tries to control the
amount of settlement by changing the criminal penalty le-
vel to maximize social welfare in this setting. In other
words, the government uses the criminal penalty level as
a leverage in order to control the settlement.
From Proposition 5, the optimal criminal penalty with
the settlement option becomes smaller than that without
the settlement option. The intuition of this result is clear.
With the settlement option, the government has an incen-
tive to decrease the criminal penalty, since the producer
can prot from illegal users.
6.3. Dual penalty
It is also conceivable that illegal activity incurs sanc-
tions both under criminal and civil law. The model devel-
oped in this paper makes it possible to consider this dual
penalty scenario. For example, the producer may receive
part of the penalty paid by illegal users, bg (0 6 b 6 1),
while the government receives the other part, (1  b)g.
Assuming that the government can also control the level
of civil and criminal penalties by setting b, it can be shown
that b = 0 is the socially optimal share that the producer re-
ceives of the penalty paid by illegal users when the devel-
opment cost is low. As the development cost increases, the
socially optimal share b increases to provide sufcient
compensation to provide an incentive for the development
of copyrighted goods.
7. Conclusion
The aim of this paper was to characterize the optimal
copyright protection scheme under a model where (a)
the government sets a penalty to maximize the social sur-
plus; (b) producers must monitor illegal activity; and (c)
only civil penalties are paid to the producer. The following
results were obtained.
First, it was shown that the optimal penalty level is al-
ways either zero or that which sets the producers prot to
zero. A zero penalty may be imposed when the cost of pro-
duction is low enough that prots can be made even in the
presence of illegal activity. When the cost of production is
higher, the government must set a positive penalty to keep
the producers prot from falling below zero. To maximize
the social surplus, however, the government would want
to set the penalty as low as possible. It follows that the
penalty imposed will be that which sets the producers
prot to zero.
Second, two copyright protection schemes were com-
pared. In practice, copyright infringement is often punish-
able under both civil and criminal law, and it is helpful to
determine which scheme does a better job of protecting
copyright. The analysis showed that when the develop-
ment cost is high, the civil law scheme is better from a so-
cial viewpoint (i.e., the producers optimal strategy under
civil law leads to more consumers using the goods). When
the development cost is low, on the other hand, it is better
to apply criminal law. The results, moreover, showed that
criminal law does a better job when it comes to reducing
the number of illegal users.
A few nal remarks are in order. First, in the analysis
presented here, the distinction between criminal and civil
penalties was simply who received the penalty payment.
However, there are many other differences between these
penalty schemes. For instance, under criminal law, illegal
users may be punished by imprisonment. If it is assumed
that imprisonment generates social costs, then the same
result as that by Becker (1968) can be obtained, that is, that
a civil penalty is better than imprisonment. Second, two
monitoring scenarios were considered: monitoring by the
producer and monitoring by the government. In this con-
text, an important issue not addressed in this study is the
optimal combination of private and public monitoring to
prevent copyright infringements. This is left for future
research.
Acknowledgements
I am greatly indebted to two anonymous referees and
an editor of this journal for detailed corrections and sug-
gestions, leading to a substantial improvement of this pa-
per. I would like to thank Reiko Aoki, Dyuti Banerjee,
Taiji Furusawa, Jota Ishikawa, Kohei Kawamura, Keith
Maskus, Toshihiro Matsumura, Akira Okada, Ralph Pap-
rzycki, Suzanne Scotchmer and Yossi Spiegel. The support
of the Global COE program and the Research Unit for Statis-
tical and Empirical Analysis in Social Sciences at Hitotsub-
ashi University is gratefully acknowledged. Of course, any
remaining errors are my own responsibility.
Appendix A
Proof of Proposition 1. The optimal prots obtained in S1
and S2 are compared in order to prove this proposition:
g 2c ka  ka2 g 2c
pc1  pc2     
4 g 2c ka 4 g 2c ka2
2
1  ak a3
 2   > 0;
4 g c ka2 ka g 2c
It can be shown that the producers prot is larger in strat-
egy space S1.
Proof of Proposition 2. From Lemma 4, the social surplus
is a decreasing function of the penalty if goods are being
produced. If F is smaller than (1  a)/4, the development
cost is smaller than the minimum prot of the producer.
 Y. Arai / Information Economics and Policy 23 (2011) 270280 279

In this case, the government should choose gc = 0 because criminal law scheme are compared. The number of the ille-
the producer will create goods even if there is no penalty. gal user is given by
If (1  a)/4 6 F < 1/4, the penalty should be chosen at the
p  sg sg
minimum level that provides an incentive for the producer DI  :
1a a
to work. In the last case, the producer cannot produce the
goods for any gc. The governments optimal penalty is, Substituting the optimal price, the monitoring intensity,
therefore, unconstrained. and the optimal penalty, the number of illegal users in each
scheme can be obtained. When (1  a)/2(2  a) 6 F < 1/4,
all illegal users are shut out from the market. Therefore,
Proof of Proposition 3. From Lemma 5, it can be easily
the number of illegal users when (1  a)/4 6 F < (1  a)/
shown that sk1 will be larger than apk1/gk when
p 2(2  a) is compared. The number of illegal users under
g k > 2ka1  a. Thus, the producer will choose a strat-
the civil law scheme is given by
egy in sub-class S2 when gk is larger than the limit. In order
to prove this proposition, the prot in S1 with that in S2 1  4F
p DIc :
when g k 6 2ka1  a is compared: 2a

k1  a2 g 2k Similarly, the number of illegal users under the criminal

pk1  pk2    law scheme is
4k  4ka  g 2k 4 g 2k ka2
 2 2 2F a  4F 1  a
g  2ka 2ka2 DIk :
 2 k 2  : a1  a
4 g k ka 4k  4ka  g 2k
p From these equations, it is clear that the number of illegal
This equation is positive when g k 6 2ka1  a. The pro-
users under the criminal law scheme is greater than that
ducerp
thus chooses the optimal strategy in S1 when
under the civil law scheme.
g k 6 2ka1  a. Otherwise, the producer chooses the
optimal strategy in S2.
Proof of Proposition 6. Eqs. (7) and (8) for (1  a)/4 6
F < (1  a)/2(2  a) are compared:
Proof of Proposition 4. From Lemma 6, the social surplus
is a decreasing function of the penalty gk when goods are 4F a  15a  5  8F a 20F
produced. In the rst case, the government chooses the SW c F  SW k F :
81  aa
minimum penalty gk = 0 because the producer will create
goods for any value of gk. In the second and third cases, This equation is negative when F is less than 5(1  a)/
the penalty is chosen at the minimum level that provides 4(5  2a). Next, Eqs. (7) and (8) for (1  a)/
an incentive for the producer to work. The producer 2(2  a) 6 F < 1/4 are compared:
chooses a strategy
p
in S1 for F smaller than
pk1 2ka1  a 1  a=22  a, which is the maxi- 4F  12
SW c F  SW k F > 0:
mum prot in S1. The producer chooses a strategy in S2 8a1  a
for (1  a)/2(2  a) 6 F. In the last case, the producer can-
This proves that the criminal law scheme is better than the
not afford to create goods for any value of gk. The govern-
civil law scheme for 0 6 F < 5(1  a)/4(5  2a). On the
ments optimal penalty is, therefore, unconstrained.
other hand, the civil law scheme is better than the criminal
  law scheme for 5(1  a)/4(5  2a) 6 F.
Proof of Proposition 5. First, the optimal civil penalty g c
 
is compared with the optimal criminal penalty g k when
(1  a)/4 6 F < (1  a)/2(2  a): References

ka4F  1 a k1  a4F  1 a Aoki, R., Hu, J.L., 1999. Licensing vs. litigation: the effect of the legal
g 2 2
c  gk  system on incentives to innovate. Journal of Economics &
1  4F F
Management Strategy 8, 133160.
k4F  1 a  3F a4F  1 a Banerjee, D.S., 2003. Software piracy: a strategic analysis and policy
: 10 instruments. International Journal of Industrial Organization 21, 97
1  4FF
127.
This equation is negative since (4F  1 + a  3Fa) becomes Banerjee, D.S., 2006. Enforcement sharing and commercial piracy. Review
of Economic Research on Copyright Issues 3, 5369.
negative when (1  a)/4 6 F < (1  a)/2(2  a). Next, the Becker, G., 1968. Crime and punishment: an economic approach. Journal
optimal civil penalty is compared with the optimal crimi- of Political Economy 76, 169217.
nal penalty when (1  a)/2(2  a) 6 F < 1/4: Boldrin, M., Levine, D.K., 2008. Perfectly competitive innovation. Journal
of Monetary Economics 55, 435453.
Conner, K., Rumlet, R., 1991. Software piracy: an analysis of protection
ka4F  1 a 4Fka2
g 2 2
c  gk  ka1  a < 0: strategies. Management Science 37, 125139.
1  4F 1  4F Denicolo, V., 2007. Do patents over-compensate innovators? Economic
11 Policy 22, 679729.
Gabszewicz, J., Thisse, J.F., 1980. Entry (and exit) in a differentiated
From Eqs. (10) and (11), it can be shown that the civil pen- industry. Journal of Economic Theory 22, 327338.
International Federation of the Phonographic Industry, 2009. Digital
alty will be smaller than the criminal penalty. Second, the Music Report 2009. <http://www.ifpi.org/content/library/
numbers of illegal users under the civil law scheme and the DMR2009.pdf> (accessed 12.01.11).
280 Y. Arai / Information Economics and Policy 23 (2011) 270280
Polinsky, A., Shavell, S., 1979. The optimal tradeoff between the
probability and magnitude of nes. American Economic Review 68,
880891.
Polinsky, A., Shavell, S., 1984. The optimal use of nes and imprisonment.
Journal of Political Economics 24, 8999.
Polinsky, A., Shavell, S., 2007. The theory of public enforcement of law.
Handbook of Law and Economics, vol. 1. North-Holland, Amsterdam,
Boston.
Shaked, A., Sutton, J., 1983. Natural oligopolies. Econometrica 51, 1469
1483.
Shavell, S., 1993. The optimal structure of law enforcement. Journal of
Law and Economics 36, 255287.
Spier, K., 2007. Litigation. Handbook of Law and Economics, vol. 1. North-
Holland, Amsterdam, Boston.
Takeyama, L., 1994. The welfare implications of unauthorized
reproduction of intellectual property in the presence of demand
network externalities. The Journal of Industrial Economics 42, 155
166.
Yoon, K., 2002. The optimal level of copyright protection. Information
Economics and Policy 14, 327348.