Jaros
Law and Economics
Spring 2011
I. Basic Economic Principles
a. Tools, Efficiency & Justice
· Normative
· Positive
· Price Theory =
§ Supply – Quantity of good or service available for sale at each price in a given mkt/location at given time at a range of prices
· HYPO: What is supply of gas from 7 to 9 on Monday in Oscarville?
· Supply curve slopes up from Left to Right
· Increase in price = increase in quantity; Why? Marginal cost – increase in cost associated w/production of one additional unit of output; response to increase or decrease in cost of inputs
· MC and Supply Curves identical b/c producer willing to sell additional unit as long as price for that unit is at lease = to marginal cost of producing that unit
§ Shift in supply means entire curve shifts; response to increase/decrease in cost of inputs
§ Change in quantity supplied occurs when price change = movement to new position on same supply curve
· Increase in cost to produce = increase in quantity for sale = shift up and to the Left
· Decrease in cost to produce = decrease in quantity for sale = shift down and to the right
· HYPO: Total cost of producing 4 units = $4; total cost of producing 5 units = $5; MC = $1
§ Demand – Quantity of good or service person willing AND able to pay in given mkt/location at given time at a range of prices
· HYPO: What is demand for gas from 7 to 9 on Monday in Oscarville?
· Demand curve slopes down from Left to Right;
· Change in demand means entire curve shifts; different quantity demanded at each price
§ Happens when change in preferences/tastes/change in price of other goods
§ HYPO: tennis racket price increase, tennis ball demand decrease (complementary goods)
§ HYPO: tennis racket price increase, jogging shoe demand increase (substitute goods)
· Change in quantity demand DIFFERENT! Occurs when change in price = movement to new position on same demand curve
· Increase in price = decrease in demand. Why? Pple look to buy substitutes AND purchasing power generally lowered
§ Increase in price – decrease in demand = curve goes down
§ Decrease in price = increase in demand = curve shifts up
· Mkt Equilibrium – Combine S and D; equilibrium price and quantity in given mkt at given time – tendency for mkt to gravitate towards this price/quantity; WHY? If supply is more than demand, then surplus, then price will tend to fall
· George v AL (indigent prisoners must pay for appeals)
· Richardson (child porn)
§ Elasticity – how steep are the curves? = how responsive buyers/sellers to change in price?
· Same price increase may have different responses
· % of change in quantity / % of change in price
· Demand: if % of change in Q > % of change in price (ratio is greater than 1) then demand = elastic
§ Buyers are relatively responsive to price changes
· Demand: if % of change in Q<% of change in price (ratio is less than 1) then demand = inelastic
§ Buyers are relatively less responsive to price changes
· Demand: Primary factor for demand elasticity is availability of substitutes
§ More substitutes, more responsive to price changes (diamond necklace-buy cheaper)
§ Less substitutes, less responsive to price changes (emergency medical care-no alternate)
· Supply: same ratio; same steep curve analysis
· Supply: primary factor elasticity is rate at which costs of production increase as output increases
§ HYPO: seller has excess capacity; if inputs relatively cheap, small increase in price result in large increase in output
§ Monge v Beebe (what happens when court changes at-will to for cause? Labor supply elastic/inelastic? How does this effect employees?
§ Incidence analysis – determines who actually pays more when costs of production/taxes increase
· Elasticity important determinant
· Increase in taxes would initially affect supply side; more expensive to sell gas; S curve up and Left by exact increase in taxes (MC)
· How extra $.10 allocated b/w buyers/sellers? Some buyers pay more, others don’t buy as much
§ Increase in price is NOT equal to $.10!!!!
§ If demand curve inelastic (steep), then consumers absorb most of increase
§ If demand curve elastic (flat), then producers absorb most of increase
§ Perfect and Imperfect Competition
· Perfect competition (each seller a price taker and sells all it wants at a mkt-determined price):
· Sellers selling homogenous products
· Buyers and sellers have complete info about prices (and other relevant factors)
· Easy to enter industry
· No seller large enough to effect price by increasing or decreasing output
· Firms tend to make the minimum profit necessary to stay in business (normal profit treated as cost)
§ In perfectly competitive industries, where entry is easy, too high a profit will attract competitors and then drive prices down
· Incidence analysis: additional costs passed on to consumers who continue to buy (firms earning minimum profit to survive can’t absorb additional costs)
· Imperfect condition – if ANY of above conditions absent
· Sellers cease to become passive price takers; able to raise prices above what price in competitive mkt
§ EX: buyer may not have complete info; seller able to differentiate product and charge more
§ Sellers set price that will maximize profit
· Economic profit = profit in excess of normal profit
§ Firms can make long term economic profit
· No longer willing to offer different quantities for sale at different prices; looking for 1 price
· Result: less Q, but higher price
· Will make a profit on each unit sold as long as addition to total revenue from selling that unit exceeds increase in total cost associated w/producing that unit (MC)
§ Extra revenue from selling addition unit = marginal revenue (MR)
· Incidence analysis: cost increase not passed on to consumers absorbed by firms that remain in mkt (lower profits)
· Imperfections a source of mkt power
· Demand/supply analysis loses validity
§ Instead, individual firms will set prices above competitive prices and decrease output to levels below competitive mkt levels
§ Opportunity Costs – next best alternative; value of foregone opportunity (law student’s opportunity cost = full time employment)
§ Discounting and Present Value – impact of time on value
· Primary reason future value is less than present value is risk
Possibility of inflation
Until $ in hand, possibility it will never be delivered
· Discounting means reducing value of future pmt to a current amount using a discount rate
· Discounting in law determines present value of lost earnings or present value of extended period of medical care expenses
D’s insurance co makes 1 current pmt = to present value of all future amounts; rate is discounted b/c it should earn interest through the years to = full amount
Marginal analysis (Rational Approach to Decision-Making)
· Decision-making technique where one compares benefits and costs of decisions
§ Context of CrimLaw: actor will commit crime as long as advantage of committing crime exceeds punishment
· HYPO: motorist will speed as long as advantage from speeding exceeds i
ter off AND no one is made worse off
· Voluntary exchanges best way of assuring “superior” achieved, but still achieve via involuntary exchange
· HYPO: Sally steals the car, but leaves $8500
§ Problem: 3 sources of info as to what amount Jack needs to feel good
Sally, but no guarantee she is correct
Jack, but not clear he is dependable when asked after the fact what Ct should require Sally to pay
Outside sources re: FMV, but Jack may have subjective value greater than FMV
§ If involuntary exchange achieves superiority, then likely a coincidence
§ HYPO: Jack wants to sell car; Sally wants to buy car
· Jack asks for $10K, but willing to accept $8K (he would prefer anything more than $8K than to keep the car)
· He would derive more utility from $8K than he would for the car
· Sally offered $7K, but willing to pay $9K (she would feel better owning the car than she would feel if she possessed anything else for $9K)
· Range of prices where both would feel better: $8K-9K (price w/in this range would increase utility of both parties) range known as “contract curve”
· This range is Parato Superior b/c both Jack and Sally would feel better off
§ HYPO: Car exchanged for $8500, but judge may decide either to 1) make Jack refund $100 or 2) make Sally pay $200 more.
· Either change in price would leave one feeling worse off
· When resources are distributed where they cannot be reallocated w/o at lease one party feeling worse off, then original distribution is Parato Optimal. (Does this mean that the 1st HYP is really “optimal” instead of “superior?”
§ Public policy implications confining b/c strict adherence to these stds would either rule out all involuntary exchanges OR require one to employ unreliable ex post measures of compensation
§ EX: Resources would seem to be better allocated if take $ from rich and give to poor (amount of benefit to poor exceeds amount of loss to rich) BUT economics cannot make assurances about relative gains and losses from redistribution
· Requires interpersonal comparison of utility (Parato stds avoid this comparison)
§ Specialty Tires (not good example of Parato Optimality)
· Kaldor-Hicks Efficiency (Wealth Maximization)
§ Individuals made better off by policy must be made sufficiently better off that they could potentially compensate those who are made worse off
· Key – compensation is potential, not actual
§ 2 critical aspects:
Unit of measurement for well-being is not utility, but wealth, value or price – ability to pay
· What is maximized is imperfect utility substitute and actual well-being
· HYPO: one rich person; one poor person; both want a gallon of milk
§ Poor wants it desperately and willing to give last dollar
§ Rich does not care, but thinks it would be fun to pour on floor; willing to pay $1.50
§ Wealth maximization principles, efficient allocation is to the rich person
