Wonnell Law and Economics Fall 2013
1. Rationality and Scarcity
v Money is the least important thing in econ cuz money collectively isn’t scarce (add zeros)
o What’s the change in incentive structure that brought avg. # of kids down to 1.4?
v Are people rational?
o Most act without all of the available information.
§ Sometimes it’s rational even without full info (reading entire K before signing)
o Selfishness
2. Risk and Uncertainty
v Most actors are risk adverse, why? Because of the diminished marginal utility of income
o The utility of income decreases the more income you have
v Insurance for pain and agony doesn’t make sense—dollars won’t do you good when in misery
o So people generally insure against pecuniary losses
v Uncertainty—certain risks can’t be calculated accurately
3. Supply and Demand
v Elasticity is the extent of which quantity responds to price
o Supply inelasticity: old fine art (finite resources—they’re not making much more of it)
o Demand inelasticity: goods without substitutes (cigarettes, gas, heroin)
o Supply elasticity: something with low barriers to entry (hot dog stands)
o Demand elasticity: Crest toothpaste (too many identical substitutes)
4. Short vs long run
v Gas is very inelastic in the short run but can scale back on driving or insulate house in the long run
v Price Controls
o Low price set in the short run with vertical (inelastic) gas S&D, causes a shortage (more Qd than Qs) that gets worse in the long run as the S&D lines become more horizontal (elastic)
o NY example—huge shortage of housing because of rent controls
5. Cost
v Sunk costs are irrelevant to take into account
v Opportunity costs are relevant
v Prices and Cost
o Tendency for P and C to adjust to each other, why?
o Say C is much lower than P, this creates a magnet to entry that’ll attract others into the industry
o If P drops below cost it’ll create an exit of some people until P goes up or C comes down
v Profit
o There’s no economic profit in equilibrium, but there can be an accounting profit (average ROI on capital)
6. Coase Theorem
v Spark arrestor hypo
o With zero transaction costs resources will always tend to be used in the most efficient way
§ Regardless of the legal rule
v Equip=20 crop damage=100, how can we make them install the spark arrestor?
o Make them liable for crop damages
o Farmers can pay the railroad to install the spark arrestor equipment
o Point was to put a central focus on concept of transaction costs
7. Efficiency Concepts
v Pareto—makes someone better off without making other worse off
o impossible to make any one individual better off without making at least one individual worse off
o outcome is more efficient if at least one person is made better off and nobody is made worse off.
v Caldor-Hicks—arranging sufficient compensation from those that are made better off to those that are made worse off so that all would end up no worse off than before.
o Outcome is more efficient if those that are made better off could in theory compensate those that are made worse off, so that a Pareto improving outcome results.
o In a package of Caldor-hicks transactions, not all changes are efficient or make everyone better off
o Use Caldor-Hicks because Pareto is not useful
§ Hard to identify policy changes where no one is hurt.
§ Easier to identify who the winners and losers are
v Ex ante
o Each person rationally would expect to be better off cuz the policy, but it doesn’t follow that each person would actually be better off
o Insurance K example; enter K/pay premiums with fire insurance comp. Mutually beneficial in ex-ante sense.
§ Ex-post one or the other will find that this transaction was a mistake (wasted premiums vs payout)
ü But it was pareto efficient ex-ante! Everyone felt a benefit.
8. Economics of Property
v Right to exclude
o Farming: $50 investment $80 return. No one will invest if they can’t internalize benefit by excluding (stolen crops)
v Right to transfer
o Why allow transfer? Land may be more efficient in another person’s hands
o Ability to transfer is a way to raise the value of the land by placing it in hands that’ll use it more efficiently
§ More efficient use doesn’t always increase the value
v Pecuniary externality
o Operates through prices rather than through real resource effects
o This is created by property and contract rights between parties—that’s what creates the prices which makes you economize on resources (inputs)
§ Soviet example: two way to produce equal steel; which does the central planner use? Tech question aside.
ü Want to conserve inputs so they can be used on alternative projects
§ Capitalist example: there are prices to help you decide efficiency, don’t need to know why that’s the price
ü Communists just borrowed capitalist world prices
9. Tragedy of the Commons
v Fishing example: incentive to maximize my return by depleting fish because I won’t feel its neg effects that much
v Solutions
o Counter this by privatizing; won’t deplete your own farm completely because it’ll hurt you
o Licensing; only a certain number of fisherman or number of fish can be caught, hard to implement
o Tax; discourage consumption of fish demand, must be worldwide
v Highway example: turn it into a toll load with peak load prices, using it at 5PM puts a huge load on everyone else
o The toll “tax” will cause people to think about how much it’s worth it to them
o Happy hour is a discount to get people in during the off hours
o Buffets: tragedy of the commons problem unless you makes rules
10. Initial Allocation of Property Rights
v First Possession—Pierson vs Post (fox)
v Creates a Race to be 1st
o Oil&Gas: leads to devoting resources to suck hard and fast—may not be efficient way to harvest the resource
v Unitization—taking production at the locations and rates it is most efficient to take it, without disruption of the scheme by the legal rights inhering in competing properties
o Districts
v Government Allocation—can’t have a race, must have rules, who gets what? First possession tried & failed.
o Licensing leads to corruption, lobbying,
v Rent seeking—dissipation of real resources in the pursuit of distributional objectives
o Attempt to obtain econ rent by manipulating social or political environment rather than by creating new wealth
§ Spending money to lobby for a share of wealth that has already been created
v Auctions—can be rigged (you bid low this time I’ll bid low next time)
o Suffers from a distributional point, must have money already (vs homesteading which provided the poor wealth)
11. Intellectual Property
v Patents—why would we give a monopoly? Don’t we believe in competition to drive down prices and cost?
o Spurs invention of items that are expensive to invent but cheap to recreate once invented
o Otherwise price will be driven down to cost of producing so creator will not be able to yield a return = to investment
v Copyrights—costs $$$ to create a movie but pennies to copy the movie. Causes price to drop to cost of copying (pennies)
o So we punish those who are copying the movies
v Trademarks—hostage theory
o Disney hypo: make a low quality toy with my tradename, people will remember and associate quality with name
§ Name is being held “hostage” to the product, retaliation by not buying any other Disney products
o Can’t retaliate if there’s no brand name on a bad product
12. Intellectual Property Continued
v Patent land mines problem—sitting on a patent until you can sue someone for it
v Too many veto points
o Potential holdout problems and costly to negotiate with patentees
v Creation of “worlds”
o Relates more to copyright than to patents
o Creating a character can create an entire “world” (ie star trek, star wars, harry potter)
§ Can benefit from this for a long time by reusing characters and “worlds”
o Our artistic copyright system creates incentive to make worlds (not just a movie but a world that’ll make 50 movies)
v Copyright may give incentive to maximize value of characters once created
o Want to avoid underexploiting or overexploiting—don’t spoil it or let people forget it
o Copyrights, life of author+, have a longer period than patents, 20 yrs—ok to dangle mickey mouse, not cancer.
o Disadvantage
§ Others may have better ideas for your worlds
§ Monopolist doesn’t have as much incentive—neccessity is the mother of invention
13. Incompatible Land Uses
v Occurs when there’s two uses for land,
pensated for value of taking
ü We’ll only make u pay for what you took (pig farm, pay for other’s quiet enjoyment and peace)
§ Inalienability Rule meaning—title can’t be sold or transferred, such as body parts
o Specific Performace is a property rule—can try to get consent of other person to relieve you
o Expectation Damages—liability rule
v Which is better? Property or Liability rules?
o Property rules
§ Benefits
ü Respectful of objective, idiosyncratic value
ü I get specific performance but you can always buy your way out
§ Problems
ü Monopoly problem—holdout problem
o Prop rules go well together with low transaction costs—selling car: not good to just take it then make a deal later
o Liability rules go well with high costs—cars sitting on railroad, not efficient to require consent, just allow damages later
§ Can’t always force someone to get consent if the transaction costs are too high
16. Divided Ownership: Vertical and Horizontal
v Whenever we have divided ownerships we have problems
o Life estate vs. remainder
§ Whoever owns life estate has no incentive to keep up land for later uses (rip up trees, long term maintenance)
§ Conversly, future owner has no stake in present value (keep trees and grass trimmed)
§ Solutions
ü Waste—common law doctrine allowing remainder to sue present life owner for maintenance
ü Contracts—coasian solution; allow remainder to pay life estate owner for what he wants
ü Family Ties—often times life estate belongs to old lady given by husband.
§ This internalizes externality if life estate owner respects/cares about remainder owner
o Landlord vs Tenant Problem
§ Tenant doesn’t care about future and landlord doesn’t care about present, contract solution (lease agreements)
o Horizontal Ownership
§ 3 equal co-owners, expenditure of 1000 return is 2000, but return is split 3 ways
ü No one individually will want to do it—single person’s expense but a joint benefit
§ Solution
ü Restitution actions—I go ahead and do it then sue co-owners for restitution (unjustly enriched)
§ Case law doesn’t always recognize (more for repairs than improvements/upgrades)
ü Co-Owners tend to love each other (relatives or spouses)
ü Partition—sue for this, ask court to partition physically or by value, pays more to whom improved it
§ Conflicts of land use
ü Co-owners have different uses for same land. Law punts—“each co-owner has right to make full use of land”
ü Get a partition of the land
v Restraints on Alienation
o Rules Against Perpetuities
§ Estate is void is it doesn’t vest within a certain amount of time
§ Shelley’s case rule—changed from “A for life, remainder to A’s Heirs” to “A and his heirs for life”
§ Doctrine of worthier title—“To A for life, remainder to O’s heirs”
ü Problem is that you would need consent of O’s heirs in order to sell
§ Court is moving towards a more capitalistic reality where land is easily sellable
o Should you be able to create a form of property that isn’t alienable?
§ Hypo: child 23 yrd old not responsible, if u give them they’ll blow it,
§ Trust issues: creditors can be stiffed if they can’t access the money
o Water Rights
§ Your use may readily return water to river but someone elses may not, so restriction on resale of water rights
v Ostensible Ownership Problem
o O gives painting to T who pays with bad check. T sells to P who pays cash. Who’s entitled? Original owner or bonafide purchaser?
