Well-designed and enforceable intellectual property rights (IPRs) provide economic incentives for research and development (R&D). Despite the apparent benefits to the existence of strong IPRs, many countries have a poor record in IPR protection. This paper develops a game-theoretic model of heterogeneous producers and endogenous innovators to analyze the causes and consequences of IPR infringement. Analytical results show that IPR infringement affects pricing and welfare in the market. The optimal IPR protection for the government depends not only on the pricing decision of the innovator, but also on its country size and its conjecture about the policy of other governments. A government can only use IPR protection as a strategic trade policy tool if the innovator can price discriminate.