Econ 522
Economics of Law
Dan Quint
Spring 2011
Lecture 24
Logistics
 Fran’s review in section Friday

Extra office hours (Fran and me) TBA
 Final: Thursday May 12


12:25-2:25, 6210 Social Science
Cumulative, more weight on second half of semester
1
Efficiency
revisited
2
What have we done this semester?
 Efficiency

Property law: efficient allocation of rights/resources




Coase Theorem says this is easy…
Contract law: efficient breach, efficient reliance, efficient disclosure
of information, etc.
Tort law: efficient precaution to avoid accidents, efficient levels of
risky activities
Civil and criminal law: minimize combined cost of administering
system and living with its errors
 With each branch of law, we asked:


What would efficient system look like?
How do the rules in place measure up?
3
The focus on efficiency has made our lives
much easier
 We could focus on final outcomes only

No worries about process, procedural fairness, etc.
 We could ignore transfers when considering efficiency


Paying damages has no effect on efficiency ex-post
So we can ignore the “direct” effect of most remedies, consider only
the impact on incentives
 Goal was always to maximize total social surplus (or
total wealth)
4
This leads us back to two questions
 Is efficiency the right goal for the law?
 Is there any reason to expect the law to be efficient?
5
Is efficiency the right goal for the law?
 Simple example of bilateral precaution and car accidents





If nobody takes precaution, $160 in expected harm
Injurer precaution costs $20, cuts expected harm in half
Victim precaution costs $20, cuts expected harm in half
Strict liability  precaution by injurers but not victims
Simple negligence  precaution by both
Expected
payoff,
injurers
Expected
payoff,
victims
Strict liability rule
-100
0
Negligence rule
-20
-60
6
Is efficiency the right goal for the law?
 Posner




Once you’ve already been hit by a car, you’d prefer a strict liability
rule to a negligence rule
But if a negligence rule is more efficient…
…then we’d all have agreed to it ex-ante (before the accident)
“Ex-ante consent” / “ex-ante compensation”
Expected
payoff,
injurers
Expected
payoff,
victims
Expected payoff if you
don’t know which one
you’ll be
Strict liability rule
-100
0
-50
Negligence rule
-20
-60
-40
7
Is efficiency the right goal for the law?
 Even if people are asymmetric…







Consider a law: landlords must pay for heat
Tenants get $1000 value from apartment, minus rent
Landlords pay $100 for heat, $600 in other costs
Without this law, tenants would pay their own heat
Would heat apartment less, get $980 value and pay $60 for heat
Might think tenants would prefer inefficient tenant-friendly law…
But rents are set competitively, would go up to compensate…
 Posner: “everyone would prefer the efficient law”
Landlord pays for heat
Tenant pays for heat
Tenants’
payoffs
Landlords’
payoffs
Tenants
Landlords
1000 – rent
rent – 600 – 100
1000 – 850
= 150
850 – 600 – 100
= 150
980 – 60 – rent
rent – 600
980 – 60 – 760
= 160
760 – 600
= 160 8
Is efficiency the right goal for the law?
 Cooter and Ulen


Society may have goals other than efficiency…
…but it’s cheaper to design law to be efficient, and address the
distribution of wealth through the tax system
 Why is tax system better way to control distribution of
wealth?




More directly targets high/low incomes, rather than rough proxies
(“consumers” vs “investors”, “doctors” vs “patients”)
Effects of changes in legal system harder to predict
Lawyers more expensive than accountants
Redistributive laws would be like taxes on particular activities;
narrow taxes have greater deadweight loss
9
That answers the first question
 Should the legal system aim to be efficient?


Posner: it’s what we’d all have agreed to ex-ante
Cooter/Ulen: if we want to adjust distribution of wealth, better to do
it through taxes
 Second question: should we expect the law be efficient?



Civil law: written at one point in time (late 1700s), meant to be static
Common law: rooted in existing norms/practices, changed by
legislation and new precedents – meant to evolve over time
Some believe this evolutionary process will naturally bring common
law toward greater efficiency
10
Should we expect common law to naturally
evolve toward efficiency?
 Posner

Some believe government, and courts, respond to politically
powerful interest groups

Landlords might be more politically connected than tenants, so
might influence laws…

…but like we just saw, even landlords probably don’t want
inefficient pro-landlord laws, since they’d just lead to lower rents

So well-connected groups generally won’t resist efficient rules
11
Should we expect common law to naturally
evolve toward efficiency?
 Cooter/Ulen: three ways the common law may naturally
tend toward efficiency

By implementing social norms/existing industry practices



Whaling example: industry norms were well-suited to each environment
Common law judges enforced industry norms, making law efficient
Judges may deliberately try to make law more efficient


Hand Rule: incorporated efficiency into legal standard for negligence
Judges may be more willing to reverse inefficient precedents, as in
Boomer v Atlantic Cement
12
Should we expect common law to naturally
evolve toward efficiency?
 Cooter/Ulen: three ways the common law may naturally
tend toward efficiency

By implementing social norms/existing industry practices



Judges may deliberately try to make law more efficient



Whaling example: industry norms were well-suited to each environment
Common law judges enforced industry norms, making law efficient
Hand Rule: incorporated efficiency into legal standard for negligence
Judges may be more willing to reverse inefficient precedents, as in
Boomer v Atlantic Cement
Inefficient laws may lead to more litigation

More opportunities to get them overturned
13
Should we expect common law to naturally
evolve toward efficiency?
 So that’s two yeses:


Posner: even politically influential will want efficient laws
Cooter/Ulen: three ways common law evolves toward efficiency
 But an opposing view:




Gillian Hadfield, “Bias in the Evolution of Legal Rules”
Cases are different, but law must be consistent
So at best, courts can try to be “right on average”
But courts will see a biased sample of all possible cases


Situations that lead to litigation are different from those that don’t
So court will have biased view of what rules are efficient
14
Should we expect common law to naturally
evolve toward efficiency?
 Hadfield, “Bias in the Evolution of Legal Rules”








A given rule will have different effects on different individuals/firms
Some will find it easy to follow rule: compliers
Some will find it very costly to follow rule: violators
(Others may drop out of market entirely)
Being “right on average” means doing what’s efficient given the true
mix of compliers and violators in market
But court will mostly see cases involving violators
So it might choose rule that’s efficient for market containing only
violators…
…which is different than the efficient rule
15
Should we expect common law to naturally
evolve toward efficiency? EXAMPLE
 Four levels of precaution: none, low, medium, high
 Accidents do $1,000 of harm
 Market has equal number of high- and low-cost firms
Level of
Precaution
Cost of Precaution
Total Social Cost
(Accidents + Precaution)
Probability
of Accident High-cost Low-cost High-cost Low-cost “Average”
Firm
Firm
Firm
Firm
Firm
None
20%
$0
$0
$200
$200
$200
Low
10%
$60
$30
$160
$130
$145
Medium
5%
$120
$60
$170
$110
$140
High
1%
$180
$90
$190
$100
$145
16
Should we expect common law to naturally
evolve toward efficiency? EXAMPLE
Level of
Precaution
Cost of Precaution
Total Social Cost
(Accidents + Precaution)
Probability
of Accident High-cost Low-cost High-cost Low-cost “Average”
Firm
Firm
Firm
Firm
Firm
None
20%
$0
$0
$200
$200
$200
Low
10%
$60
$30
$160
$130
$145
Medium
5%
$120
$60
$170
$110
$140
High
1%
$180
$90
$190
$100
$145
17
Should we expect common law to naturally
evolve toward efficiency? EXAMPLE
Level of
Precaution
Cost of Precaution
Total Social Cost
(Accidents + Precaution)
Probability
of Accident High-cost Low-cost High-cost Low-cost “Average”
Firm
Firm
Firm
Firm
Firm
None
20%
$0
$0
$200
$200
$200
Low
10%
$60
$30
$160
$130
$145
Medium
5%
$120
$60
$170
$110
$140
High
1%
$180
$90
$190
$100
$145
 Efficient levels of precaution



High-cost firms: low precaution is efficient
Low-cost firms: high precaution is efficient
One rule for all firms: medium precaution is most efficient
18
Should we expect common law to naturally
evolve toward efficiency? EXAMPLE
Level of
Precaution
Cost of Precaution
Total Social Cost
(Accidents + Precaution)
Probability
of Accident High-cost Low-cost High-cost Low-cost “Average”
Firm
Firm
Firm
Firm
Firm
None
20%
$0
$0
$200
$200
$200
Low
10%
$60
$30
$160
$130
$145
Medium
5%
$120
$60
$170
$110
$140
High
1%
$180
$90
$190
$100
$145
 If we must have one rule that applies to all firms…

efficient rule requires is medium precaution level to avoid liability
 If court only sees cases involving high-cost firms…

it will think it’s to only require a low precaution level
19
Should we expect common law to naturally
evolve toward efficiency?
 Hadfield: this bias will occur in any situation where courts
adjust legal rule based on what appears efficient






Whatever the existing rule, there will be some “compliers” and
some “violators”
Courts will mostly see cases involving violators
Law will evolve toward rule that would be efficient if only
violators existed
But if compliers and violators are different enough, this won’t be
the efficient rule
All this requires is enough heterogeneity in cases…
…and courts that can only learn from the cases that go to trial
20
So… should we expect common law to
naturally tend toward efficiency?
 Posner: yes

Everyone, including the politically connected, wants efficient laws
 Cooter/Ulen: yes



Common law courts enforce existing norms/practices
Courts may be more likely to overturn inefficient precedents
Inefficient laws may lead to more litigation, and have more
chances to be overturned
 Hadfield: no


Courts see biased sample of cases
If they adjust the law based on the cases they see, this will not
lead to efficient laws
21
Unenforced
laws
22
We saw last week…
 Optimal criminal system will not detect/punish every crime,
for two reasons


Some crimes may be efficient (rare)
When cost of deterrence is positive, it’s not worth paying enough to
deter every crime
 But we still assumed most crimes are inefficient, and main
reason not to punish them all is cost
23
However…
 There are a lot of old laws in many states that seem
inefficient


Massachusetts: can’t buy alcohol on Sundays
Many states still have laws passed a long time ago
 In some cases, law is enforced
 Tim Wu, “American Lawbreaking” – many laws that we, as
a society, have basically decided not to enforce at all
24
(Example I found online this weekend)
25
Tim Wu, “American Lawbreaking” (Slate)
http://www.slate.com/id/2175730/entry/2175733/
 Begins with New York prosecutors sitting around office, choosing
celebrities (John Lennon, Mother Theresa) and coming up with obscure
crimes they could be charged with

“obstructing the mails,” “false pretenses on the high seas”
 “Full enforcement of every last law on the books would put all of us in
prison for crimes such as “injuring a mail bag.” No enforcement of our
laws, on the other hand, would mean anarchy. Somehow, officials
must choose what laws really matter.”
 “Tolerated lawbreaking is almost always a response to a political failure
– the inability of our political institutions to adapt to social change or
reach a rational compromise that reflects the interests of the nation and
all concerned parties. That’s why the American statutes are full of laws
that no one wants to see fully enforced – or even enforced at all.”
26
First example doesn’t perfectly fit premise,
but interesting
 “Over the last two decades, the pharmaceutical industry
has developed a full set of substitutes for just about every
illegal narcotic we have.”



Rather than legalizing street drugs…
…society has developed Ritalin, vicodin, oxycontin, clonazepam,
etc…
…which may serve legitimate medical purposes in some instances,
but also mimic highs of cocaine and other drugs
 Marijuana: several cities where police chiefs or DAs have
announced they won’t prosecute possession


Philadelphia law will treat possession as a ticketable offense
Medical marijuana in California and elsewhere
27
Wu’s second example: pornography
 Apparently, there’s porn on the internet
 And it’s basically all illegal
 Federal law prohibits using a “computer service” to
transport over state lines “any obscene, lewd, lascivious, or
filthy book, pamphlet, picture, motion-picture film, paper,
letter, writing, print, or other matter or indecent character.”
28
Wu’s second example: pornography
 In 1968, Congress set up a commission to investigate


Commission recommended we repeal all obscenity laws, replace
them with laws to protect children and control public display
Nixon and other politicians condemned report as “morally
bankrupt”, insisted they would continue war on pornography
 A few well-publicized prosecutions in 70s and 80s, halted in
90s
 2005: Attorney General Alberto Gonzalez tried to pressure
local prosecutors to crack down, but nothing happened

One Miami attorney: “compared to terrorism, public corruption, and
narcotics, [pornography] is no worse than dropping gum on the
sidewalk.”
29
Wu’s second example: pornography
 So pornography is technically illegal, rarely prosecuted
 What’s developed is unofficial zoning system – rather than
prohibiting behavior, it’s regulated





Prosecuted when it crosses certain lines
Ignored otherwise
Super Bowl wardrobe malfunction – when something gets on primetime network TV, people freak out
Child pornography still prosecuted
But “mainstream” porn left alone, so functionally legal
 So as a society, we’ve functionally legalized porn…


Not through legislation or courts…
…but through general concensus among prosecutors, FCC, FBI,
30
local police, etc., to do nothing about it
Wu’s other examples: copyright law, illegal
immigration, Amish and Mormons
 Amish refuse to pay Social Security taxes, do not accept
benefits, do not educate children past eighth grade
 Mormons to some degree still practice polygamy
 Wu discusses history of legal treatment
 Again, what’s emerged is de facto zoning



Mormon polygamist went on Sally Jessy and Springer to discuss
his lifestyle, he was tried and convicted
But when it’s done quietly, in scattered communities outside of big
cities, polygamy still goes on and is basically tolerated
Amish are open about how they live, but keep to themselves, and
nobody worries about it
31
This all doesn’t really fit into our framework
of criminal law
 You’d think crimes are crimes because society wants them
to be crimes
 But in some cases, society doesn’t care whether something
is a crime, but doesn’t care enough to make it legal either
 Or, political system is “broken” enough that some things
can’t be fixed, we adapt by ignoring certain laws
 More obvious example: speeding
 This may support Hadfield’s view that the law won’t
automatically evolve to be efficient!
32
The semester
in review
33
We began and ended with efficiency
 Should the law aim to be efficient?


Posner: yes, ex-ante consent
Cooter and Ulen: yes, better to handle distribution through taxes
 Will common law naturally tend toward efficiency?


Posner: yes, even the politically influential want efficient laws
Cooter and Ulen: yes




Common law enforces norms and industry practices, which are likely
efficient
Judges may be more likely to overturn inefficient precedents
Inefficient laws may lead to more litigation
Hadfield: no

Court gets biased sample of cases, leading to “biased” laws
34
Following efficiency, we got Coase
 Coase: when there are no transaction costs:


Just define property rights and make them tradable…
…then sit back and let people trade till we get efficient allocation
 But with transaction costs, this won’t work; we can either:


try to reduce transaction costs, or…
…try to get the allocation right to begin with
 Some sources of transaction costs





Search costs
Private information
Large numbers of parties
Hostility
Enforcement costs
35
Branches of the law and transaction costs
 Property/nuisance law



Largely deals with situations where transaction costs are low
(especially private nuisances/property disputes)
Clarify peoples’ rights/entitlements so they can enter into voluntary
exchange
Initial allocation matters when transaction costs are high enough
that efficiency isn’t reached “automatically”
 Contract law



Costs of ex-ante negotiations not too high…
…but renegotiation costs enough that we want to avoid it
Aim to reduce transaction costs with efficient default rules,
incentives to share information
36
Branches of the law and transaction costs
 Tort law


Accidental situations, strangers  costs of ex-ante negotiations
prohibitively high
All we can do is generate incentives to avoid harm when possible
 Criminal law


Ex-ante negotiations impossible for many reasons
“Public bad” – many parties harmed, so transaction costs are high
 Next, a few recurring themes from the semester…
37
1. To get efficient outcomes, design the law
to make people internalize externalities
 Determining efficient action/outcome requires comparing
social cost and social benefit of each activity

Activity should occur when social benefit > social cost
 We expect self-interested decision-makers to consider
private cost and private benefit
 If private cost < social cost, activity imposes a negative
externality, and will naturally occur too much



Tragedy of the commons
Breach of contract in a world without remedies
Reckless driving in a world without liability
 If we can set private cost = social cost, people will
naturally take efficient actions
38
1. To get efficient outcomes, design the law
to make people internalize externalities
 If we set private cost = social cost and private benefit =
social benefit, people naturally choose efficient action

Contract law




Tort law



Breach of contract imposes externality on promisee
Expectation damages = anticipated benefit = harm done by breach
So then we get efficient breach
Liability causes injurer to internalize harm his actions lead to
Leads to efficient precaution, efficient activity level
Nuisance law




Suppose I have a legal right to quiet enjoyment of my apartment
You value making noise at $100, I value quiet at $50
If rights are tradable, silence costs me $100 in opportunity cost
Tradable entitlements also lead to internalization, therefore efficient
39
allocation
2. Choosing between protecting a right and
protecting an interest
 A right is protected if nobody can violate it without my
permission


Really, if violation is punished severely
Injunctive relief protects rights
 An interest is protect if violation must be compensated

Interests are protected by damages
40
2. Choosing between protecting a right and
protecting an interest
 Property law generally protects rights



Trespassing on my land is punished severely, as a crime
Theft: if you steal my iPhone, you don’t owe me $300, you go to jail
But there are exceptions


Private necessity
Eminent domain
 Contract law generally protects interests


Expectation damages protect promisee’s interest in performance of
a promise, not their right to performance
But again, there are exceptions

Remedy of specific performance protects promisee’s right to a promise,
is often used for contracts to sell unique good
41
2. Choosing between protecting a right and
protecting an interest
 Tort law generally protects interests


Nobody asks permission to break your arm in a car accident
Instead, they hit you, then have to compensate you
 Key difference between criminal law and civil (tort) law






Crimes are intentional, so we may want to deter them
Give you a right not to get stabbed, protect that right with severe
punishment for assault
Torts are accidental, impossible to eliminate them
Just want to reduce them to efficient level
So we price them, to get injurer to internalize externality
This is same as protecting an interest
42
3. Tradeoff between cheaper/simpler rule
and better incentives
 Designing efficient legal system means maximizing social
surplus
 Which is same as minimizing social costs


Think about starting at most efficient outcome
Costs are any deviations away from that
 Costs typically take two forms:



Direct costs of implementing some part of legal system
Indirect costs: any flaws in system lead to imperfect incentives,
and therefore inefficient outcomes
(“Administrative costs” and “error costs”)
 Often tradeoff between cheaper/simpler system, and
more costly/extensive system giving better incentives
43
3. Tradeoff between cheaper/simpler rule
and better incentives
 Demsetz: private land ownership among native Americans


Private ownership has higher direct costs: boundary maintenance
Public ownership has high indirect costs: inefficient use of land
(overhunting)
 Whaling

“Fast fish/loose fish” – simpler rule, fewer disputes


“Iron holds the whale” – creates more efficient incentives for
faster/more violent whales


Lower direct costs
Lower indirect costs
Which is more efficient depends on situation
44
3. Tradeoff between cheaper/simpler rule
and better incentives
 Injunctions versus damages


Damages more costly for court to calculate – higher direct costs
Injunctions rely on bargaining – inefficient outcomes (high indirect
costs) if transaction costs are high
 Filing fees to initiate a lawsuit


Higher filing fees  fewer lawsuits  lower direct costs
But more harms “unpunished”  weaker incentives to avoid 
higher indirect costs
 Crime


Catching more criminals is more costly (higher direct costs)
But deterrence leads to fewer crimes (lower indirect costs)
45
Most of the semester, we’ve assumed
rational individuals, rational institutions
 But recently, a few counterexamples
 Trial by ordeal

Seemingly irrational institution for dealing with information problem
 Behavioral economics

Ways that peoples’ behavior may differ from perfect rationality
 Unenforced laws

How we deal with imperfect political system which leads to laws we
don’t want but can’t overturn
46
And that’s basically the class
 To wrap up…
47
What do I want you to remember after
May 12?
 Economics is a set of tools, not a set of answers

Friedman: “Economics is neither a set of questions nor a set of
answers; it is an approach to understanding behavior”
 Point of class



Not to memorize which liability rules leads to efficient injurer activity
…but to understand why
To understand how people respond to incentives, and be able to
predict how a law or policy will affect peoples’ behavior
 Santa Monica, CA City Council banned ATM fees in 1999


They were shocked the next day, when ATMs stopped giving money
to other banks’ customers
I’d like to think you all would have been smarter than that
48
Thank you all
for being here
49