Law & Economics Outline
I. Introduction
A. Why Care about Law & Econ?
§ Maximizing welfare (amount of pleasure) can mean maximizing utility or minimizing disutility.
Costs:
· Accounting- looks backward.
· Opportunity- what you could have done instead.
· Sunk costs- already paid for something (football tickets, factory destroyed).
· Hidden costs- buy a burger, bad effect on nutrition is hidden cost.
B. Rationality and Behavioral Economics
Assumption – Rationality Behavioral Economics
· Rationality: goal in life is to maximize utility (pleasure, satisfaction) subject to various constraints on their resources and information. Are consumers really rational? Shopping spree, generic product, altruism, crime.
· Rational decision v. conscious decision: Economic theory is not a theory about consciousness. Behavior is rational when it conforms to a model of rational choice whatever the state of mind (people react to incentices).
· Rationality and the absence of information: rationality does not mean the consumer has full information. It means that the cost of info outweighs the benefits if it is acquired. Check the engine when you purchase a car?
· BLE: How do real people differ from homo economics?
· Endowment effect- A buys a house for 90K, market value is 100K, won’t sell for less than 120K. Informational value- product is more valuable. Hidden costs. Social capital- friends. Surplus- pay less than what they value the product for.
· Bounded rationality-
1.Judgment errors: bad (but predictable) rules of thumb. Hindsight bias- people assign high probabilities to events
simply because they occurred. Optimism bias- individuals believe that their own probability of facing a bad outcome is lower. Other biases- a belief that members of a racial or other group will do worse than others.
2. Bounded willpower- people often take actions they know to be in conflict with their own long-term interests.
Midnight snacks. Not irrational, preference.
3. Bounded self-interest- most people care about both receiving and giving fair treatment (tips). Feel better, feel better
when the waiter feels better, repeater customer, signaling mechanism. Maximize your own utility when you help someone else. Fear of retaliation.
· Utility and Pleasure= f(my enjoyment, signaling issue, person you can about) People are rational because they are concerned with their own pleasure.
Value, Utility, and Fairness:
· Usually, value and utility are the same. Same in this course, except for the following.
· Poor family- dwarf child, can’t afford drug. Rich family- child of normal height, will get a few inches, will buy drug. Econ says the drug is more valuable to the rich family because they have the willingness to pay for it. Poor family will have more happiness (utility) because a dwarf will become a normal person.
· Competing Interests: plaintiff/victim (free of risk) vs. injurer/defendant (free to act). Society also in the mix- want to maximize everyone’s utility.
C. Efficiency and Contracts
(see handout)
· Pareto improvement makes at least one person better off without making anyone worse. Ex. Willing buyer, willing seller. Every agreement. Not workable overall.
· Kaldor-Hicks- an action that benefits one party by more than it injures another so the first party can fully compensate the second party and still be better off. Factory- pollution. Can be potential Pareto solution. If society benefits more than it is being hurt, we will allow that activity. No need to compensate. Making the social pie bigger.
· Assumptions- consumers are rational. Seek to max their own utility. Rational decision vs. Conscious/informed.
· Property moves to the person who values it more. The right to exclude others.
· Person plays Britney outside apartment, wants money. Officious intermeddler, no recovery. Transaction cost is low. Better if parties negotiated. Pareto improvement. Negotiation extracts info on value. Legal system is expensive and a waste of resources. Law seeks to foster negotiations that lead to Pareto efficiency.
· ER example- get to the ER unconscious. Cannot know how much the patient values his service. Mimicking the market. Duty to provide services. Does it really lead to Pareto efficiency? What about Christian Scientists?
· KH efficient- cost, population, value. Pareto is basically limited to contracts. KH is out working tool.
· When
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compensation for benefits given to others. Negative- not paying the cost conferred upon others. Solutions: Property rights (over-grazing) or cooperation (over-fishing).
3. Whaling Convention- tries to conserve whales so stock won’t be depleted. Externality- get the benefits
without costs. No one owns the ocean, so have to cooperate (privatization is not an option).
4. Hard to use the cooperation method with enclosure because so many people, hard to enforce.
· Low Value to High Value (wealth): used car example. Resources tend to gravitate toward their most valuable use if voluntary market is permitted. The result: maximize society’s wealth/welfare. Should all resources be owned? Social welfare is the aggregate amount of individual’s welfare.
· Property rights are expensive- legal costs. Opportunity costs. Registration system. Negotiation costs. If the resource is not scarce, not reason for property rights (air). Alternative to property rights- regulations, fines, social norms.
iii. Resource Allocation over Time (Periods): Developing drug without patents? No incentive. Need a property right for crops, to
actually get people to invest.
B: What are the social justifications, if any, for PRs?
C: What are the costs created by the property system?
A. Tragedy of The Commons
§ Enclosure article: Eighteenth-century England. Contributed significantly towards increasing the productivity of English agriculture, but hard to measure. Two to ten times. Rents higher, leases annulled. 17th C. benefited more than the 18th. Externalities. (property vs. cooperation) Resource allocation over time and investments (farmer). Property + price system: property gravitates to low to high user.
§ Problem of the anti-common: too many property rights. Solution- pools.
