Econ 522
Economics of Law
Dan Quint
Fall 2007
Lecture 1 – Sept 4 2007
I’m Dan Quint, welcome to Econ 522
 Lectures
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No class next Thursday (Rosh Hashanah)
 Class Website
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http://www.ssc.wisc.edu/~dquint/econ522
 Syllabus online, with links to additional readings
 Office hours
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Mondays 10-11, Wednesdays 11-12
 If you can’t make these and need to talk to me, email me at
dquint@ssc.wisc.edu for an appointment
 Grading
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2-3 problem sets (20%), midterm (30%), final exam (50%)
 Registration/waiting list
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Readings
 Textbook
Robert Cooter and Thomas Ulen, “Law and Economics”
(fifth edition)
 Website: www.cooter-ulen.com has supplemental material
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 Other readings
A. Mitchell Polinsky, “An Introduction to Law and
Economics”
 Papers listed on syllabus
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Most are available online
I’ll try to highlight the most interesting/relevant
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Outline of the Course
1.
Overview/Introduction
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2.
What is Law and Economics?
Efficiency
Common Law and Civil Law traditions
Review of Relevant Microeconomics
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Price-Taking Behavior: Consumers, Producers
General Equilibrium, Efficiency
Uncertainty, Insurance
Game Theory
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Outline of the Course
3.
Property Law
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What constitutes private property?
What can I do (what can’t I do) with my private property?
Coase. Many externalities are caused by insufficiently defined
property rights
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If a factory pollutes “too much,” it’s because nobody owns the rights
to that air
If those rights were defined and could be bought and sold, the free
market would allocate them efficiently, solving the problem
However, many reasons the Coase Theorem may not hold, we’ll
discuss arguments on both sides
Intellectual property
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Outline of the Course
4.
Contract Law
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Major topic: what is the default rule for circumstances which are
not specified in a contract?
Typical contract: “In exchange for $30,000, I agree to deliver 16
tons of steel to this address on this date.” Now I fail to deliver.
Do I just give back your $30,000? What if you incur losses from
not having the steel – do I pay those? What if those losses are
unusually large, due to circumstances you knew about but didn’t
tell me?
Some things are not contractible. If I give you money for drugs
and you don’t supply them, I can’t sue you for breach of
contract, because the contract was illegal. I also can’t contract
to pay for sex, or to sell one of my kidneys. Why not?
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Outline of the Course
5.
Tort Law
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Who is responsible for accidents, and what type of damages do
they owe?
One theory: allocate responsibility to the “low-cost avoider”
It might be very expensive for parents to test for lead paint in
each toy they buy their children; cheaper for the factory to test
them all at once. If the factory is liable, they have an incentive
to provide safer toys
Under some situations, it may not matter who is liable, since the
market may be able to reallocate liability
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Outline of the Course
6.
Legal System
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Crime and Punishment
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What is the process for getting remedy if I have been wronged?
What makes a legal system more or less costly? More or less
efficient?
Do harsher punishments deter crime? Does a higher probability
of being caught?
Death penalty
“Three strikes” laws
Other Topics (time permitting)
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Any questions?
(Please let me know if I’m going too fast)
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What is Law and Economics?
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Initial answer: “Looking at the law like
an economist”
 Microeconomics is the study of how parties respond to
incentives
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Parties: consumers, firms, workers, governments
Incentives: prices (explicit or implicit)
 Laws
 Expectations about rewards/consequences of actions
 Incentives to behave a certain way
 Changes in behavior
 Changes in outcomes
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How does this differ from looking at the
law in other ways?
 Lawyers generally see a case after the “damage is done”
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Someone has rear-ended your car
Trucking company has failed to deliver 16 tons of steel to a factory
Someone has been murdered
 Usually, what’s left is to assign blame and, if appropriate,
choose a legal remedy
 No value is created or destroyed at this stage (usually) –
just transferred from one party to another
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Very interesting to those two parties, and their lawyers
Not so interesting to economists
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On the other hand,
 When a new law (or a precedent) (or a legal system) is
established, it changes expectations about what will
happen in future situations, and therefore changes
behavior
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A stricter liability rule might lead people to drive more carefully, or
drive less, or not drive after three beers
A rule on breach of contract might cause the trucking company to
behave differently, or take on fewer commitments, or sign a
different agreement in the first place
A harsher penalty for murder might deter criminals, or it might lead
them to go to more extreme lengths to avoid being caught
 Changes to behavior affect what outcomes are reached –
what society as a whole creates, destroys, and consumes
– and is therefore very interesting to economists
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Laws, legal precedents, legal system
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Expectations/incentives
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Actions are taken
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Outcomes are realized
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Litigation occurs
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Damages paid
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Of course, other steps are outside our
realm
Society organizes itself (constitution)
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Governmental/legal system determines process
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Legislators elected, judges appointed or elected
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Legislators enact laws, judges rule
(legislators and judges respond to incentives)
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Laws, legal precedents
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Efficiency
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For the most part, we’ll be judging laws and
legal systems on basis of efficiency
 Not Pareto-efficiency, but a more intuitive notion
 Efficiency – the total value of what society creates and
consumes
 Ellickson: “Minimizing the objective sum of (1) transaction
costs, and (2) deadweight losses arising from failures to
exploit potential gains from trade”
 Posner: “wealth-maximizing”
 Simplest way to think of it: efficiency is maximizing the
overall size of the pie, without regard for how it is divided
up
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Efficiency may conflict with other
notions of “good” outcomes
 A law can be efficient but very unequal
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Laws favoring businesses over consumers, or rich over poor, may
turn out to be efficient, but may not be morally desirable
 A law can be efficient but violate our intuitive notions of
fairness
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2005 Supreme Court case: Kelo vs City of New London
City of New London, CT wanted private firm to launch a
redevelopment plan for a neighborhood (hotel/conf center, state
park, apartments, office, retail space)
Several homeowners refused to sell their land to the developer
City invoked eminent domain – right to seize private property for
public use – and forced them to sell
Supreme Court ruled for city
Using scarce resource for more valuable purpose – likely efficient,
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but may go against what we think of as fair
However, there are several arguments
why efficiency is the right focus
 If resources can be freely transferred between individuals,
first maximize total size of pie, then worry about how to
distribute it
 But what if resources are costly to transfer, or can’t be
transferred, or won’t?
 Posner: hypothetical “ex-ante consent”
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Imagine everyone gets together beforehand, not knowing whether
they’ll be the victim or the injurer in a traffic accident
If everyone agrees that one liability system is cheaper to
implement (more efficient) than another, everyone would agree to
accept that system and live with the consequences
So now imagine they did
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However, there are several arguments
for why efficiency is the right focus
 Another common argument: if you do want to redistribute
resources, the tax system will generally do it better than
the legal system
 So design the legal system to be efficient, then achieve
any redistributive goals through taxes
 Cooter and Ulen give four arguments why taxes work
better than “private laws” for redistribution (see textbook):
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More precisely targets “rich” and “poor,” while laws would target
groups that were imperfect correlated with wealth, like “investors”
and “consumers”
Effects of changes in legal system harder to predict
Higher transaction fees – lawyers’ contingency fees very high
Redistribution via property law would cause larger distortions than
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broad-based taxes
My own feeling: economists are better
at economics than philosophy
 I’ll tend to focus on positive statements – what effect we
expect a law or policy to have…
 …rather than normative statements – what laws or
policies should aim to achieve
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One more note on efficiency
 Basic utility theory: can’t make utility comparisons across
individuals
 To measure efficiency, we need to put everything into a
common unit – money
 So we equate the value someone gets from something
with their willingness to pay for it
 Posner, “Economic Analysis of Law,” points out the
following (somewhat disturbing) dilemma:
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One more note on efficiency
 “Suppose that pituitary extract is in very short supply…
and is therefore very expensive. A poor family has a child
who will be a dwarf if he doesn’t get some of the extract,
but the family cannot afford the price [or borrow the
money]. A rich family has a child who will grow to normal
height, but the extract will add a few inches more, and his
parents decide to buy it for him. In the sense of value
used in this book, the pituitary extract is more valuable to
the rich family… because value is measured by
willingness to pay; but the extract would confer greater
happiness in the hands of the poor family.”
 Efficiency is not the same as maximizing happiness…
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The Common Law and
Civil Law Traditions
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Two major legal traditions emerged from
Europe, spread throughout much of the world
 Common Law tradition – originated in medieval England,
is still the basis for legal systems in many Englishspeaking countries
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Great Britain and Ireland
U.S. and Canada
Australia and New Zealand
Parts of Africa and Asia
 Civil Law tradition – originated following French
Revolution with the Napoleonic Code
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Persists in most of Western Europe, Central and South America,
parts of Asia not colonized by Britain
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Common Law is the grounding for U.S. law
 New laws enacted by legislature; judges interpret laws,
but also rely heavily on precedent
 One version of the story: the English king’s courts were
told to examine life and “find” law as it was already being
practiced
 “Common law” grounded in social norms and practices –
how people were behaving in the absence of well-defined
laws
 Once a court ruled on one case, this established a
precedent that other courts would generally follow when
ruling on related cases
 Common law is thus rooted in common practices, except
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where it’s been replaced by legislation
Civil Law tradition started very differently
 At the time of the French Revolution, revolutionaries felt
the judges, like the king, were corrupt and worthless
 Chose to abandon the common law and start fresh
 Napoleon commissioned a group of legal scholars to draft
a new set of laws, the Napoleonic Code
 These scholars modeled their work on “The Body of the
Civil Law,” compiled in sixth century A.D. for Roman
emperor Justinian
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So…
 The French system which became the Civil Law was
based on “ancient sources and pure reason;” Common
Law based on existing practices of people
 By enacting complete set of laws from a clean slate, Civil
Law shares more with legal systems based on religion
 Under Civil Law, arguments appeal directly to the
meaning of the law itself, and to commentary on the law
which has tried to clarify this meaning
 Under Common Law, arguments often focus on legal
precedents, and why particulars of past cases make them
more or less relevant to the matter at hand
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Whaling
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“A Hypothesis of Wealth-Maximizing Norms:
Evidence From The Whaling Industry”
 Robert Ellickson (1989) gives a nice example of how the
Common Law is responsive to existing social norms…
 …which in turn are responsive to the economics of the
particular situation, and therefore likely to be efficient
 He looks at 12 Anglo-American court rulings (mostly from
1800s) where ownership of a dead whale was contested
 In every case, judges ruled in accordance with whaling
industry’s established norms...
 …and these norms varied across different locations,
consistent with which rule was more efficient in different
situations
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“Fast Fish/Loose Fish”
 British whalers in the Greenland fishery established the
“fast fish/loose fish” rule (quoted in Moby Dick)
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Prey were right whales – relatively slow and docile
Hunting was done with a harpoon attached to the boat by a rope
While the harpoon was in the whale and attached to the boat, the
whale was a “fast fish” and belonged to the boat
But if the whale was not yet harpooned, or broke free, it was a
“loose fish” and other ships were free to go after it
 “Fast fish/loose fish” is a very simple rule, and therefore
cheap to implement; and in this context, gave sufficient
incentives to hunt whales
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“Iron Holds the Whale”
 Sperm whales swim faster, dive deeper, and fight harder
than right whales, and swim in schools
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Hunting them with a harpoon tied to the boat might sink the boat;
hunting was done with harpoons connected to “drogues,” then the
ship would follow the whale till it got tired
When a ship stumbled into a school, more important to kill or
wound as many as possible quickly rather than pausing to secure
the first ones
 In fisheries where sperm whales dominated, norms
developed that “iron holds the whale”
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The first to sink a harpoon into a whale owned it…
…provided they remained in “fresh pursuit”
“Fast fish/loose fish” vs. “Iron holds the whale”
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Finback whales and split ownership
 Finback whales are extremely fast swimmers
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Nineteenth century whalers hunted them with “bomb lances”
Dead whales would sink to the bottom immediately, wash up on
shore some days later
Need to provide incentives to hunt them, but also incentives for
someone to harvest the whale upon finding it
New England coastal norm was to split the whale roughly
according to the effort of each (in other places, there was a
predefined ratio)
 Ghen v Rich decision specifically pointed out that if finder
were entitled to the whole whale, whaling industry would
shut down
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To sum up…
 In each context, norms appeared which provided
sufficient incentives for valuable work
 (Incentives may have worked too well – when these
norms appeared, whales were plentiful and valuable; but
in many cases, whales were hunted to near extinction)
 And in each context, judges deferred to local custom
when making their rulings
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