PARALLEL TRADE,INTERNATIONAL EXHAUSTION AND INTELLECTUAL PROPERTY RIGHTS: A WELFARE ANALYSIS*

This paper analyses the issue of parallel trade (arbitrage) for products protected by intellectual property rights. We discuss a basic trade‐off that arises between the ex post better allocation that typically occurs under parallel trade when demand dispersion is not too high, and the ex ante reduced product quality because of lower investment. We show that the size of the welfare effects is significantly affected by the presence of a ‘generic’ product, which represents a form of competition for the monopolist. The monopolist will introduce a ‘fighting brand’ to compete with the generic, which dilutes but does not eliminate the result on the adverse effects of parallel trade on investments.