Business Economics for Lawyers Outline

Business Economics for Lawyers – Masten Fall 2016
 
Normative Rules of Choice
Net-Benefit Principle/Cost Benefit Analysis
Best choice of action from a given set of actions; one which will yield the highest benefit
Buyer = Value – Cost
Seller = Earnings – Opportunity Cost
Opportunity Cost
Cost of taking one course of action is the loss of the net benefits of another course of action; the cost in terms of foregone benefits of taking a particular course of action
All costs are opportunity costs because when you spend the $$ for one course of action you cannot use it for another
Formula: Opportunity Cost = Production Expenses + Net Benefits of Next Best Alternative
Example (Based on Exercise #1): OC = Production Costs – Profit of Alternative K
OC = C – (K’ – C); costs same to produce in both Ks
OC = K’ (using Exercise #1’s numbers OC = $24/ton)
Should never supply for a value below your opportunity cost
Sunk-Cost Principle: Only current and future net benefits should be relevant in decision making (not past costs)
Economic Efficiency:
An outcome is efficient if there are no alternative outcomes that would yield higher gains from trade
But, there must be gains for an outcome to be efficient
An outcome that leaves gains from trade unrealized (ie foregone) is inefficient
Calculate gains from trade by adding the net benefits of all trading parties together
If an arrangement is more efficient, then there is some way the more efficient structure could be rearranged to make parties better off than a less efficient structure
Example from Exercise #2: Az scheme more efficient than Chicago b/c its total gains from trade are greater
While moving from Chi to Az would make the consumer worse off (ie not Pareto), Az scheme could be rearranged in a way to make a move from Chi to Az Pareto
Pareto Optimality: An allocation where it is not possible to make one person better off w/o making someone else worse off
Pareto Improvement: A change in allocation in which no only is made worse off and at least one person is made better off
If further Pareto improvements exist, then an outcome is inefficient
Note: There are some efficient outcomes which are not Pareto optimal, and some efficient allocations brought about with non-Pareto improvements
Outcome vs Changes: An outcome is Pareto efficient when there are no more Pareto improvements possible; but, if further Pareto improvements exist, then the allocation is inefficient
Certain legal arrangements may result in inefficient outcomes
Always Specific Performance: Results in inefficient over performance; one party will be compelled to perform even at points where such performance would be inefficient (ie will be compelled to perform even when value is less than opportunity cost)
No K enforcement: Results in inefficient under-performance; one party will be incentivized not to perform at a point where performance would otherwise be efficient (ie there are points where a party’s profits will be less than zero, but value will still be greater than or equal to opportunity cost
Role of Damages: Generally, parties will perform is their profits > than breaching + paying damages
Buyer performs if: v – k ≥ -δb (Pb ≥ -δb); Seller performs if: k – s ≥ -δs (Ps ≥ -δs)
Efficient Breach: Incentives to perform efficiently if damages for breach are set equal to other party’s lost profits
Buyer Breach: δb = k – s = Ps
Seller Breach: δs = v – k = Pb
Example: If Buyer breaches at Pb < -δb, or v – k < -(k – s) = v < s; then, Buyer breaches only when its value is less than the next best alternative (ie damages), which is efficient The level of damages that would induce breach only if efficient occur when damages equal the other party’s lost profits Just because damages at that level may induce efficient breach does not mean it would be profitable for a party to breach Formula: P performance > P breach
If Buyer: v – k > v – k’ – δb; where k’ = next best alternative contract
– k > – k’ – δb
Pure Lost Profits vs Mitigation
Pure lost profits only looks at k – c; mitigation looks at k – s
B/c opportunity costs include costs of production + alternatives, it will naturally result in mitigation based damages being less than pure lost profits
Therefore, Sellers will try to argue for pure lost profits; Buyers for mitigation-based
Formula: v >s; v – s > 0  where v = value to buyer; s = seller’s opportunity cost
Formula for Profits: Pb = v – k; Ps = k – s
Buyer only wants to exchange if: Pb ≥ 0
Buyer wants v ≥ k