Econ 522
Economics of Law
Dan Quint
Fall 2009
Lecture 21
Logistics
 Midterm is graded – pick it up at end of class
 HW3 due next Tuesday (December 8)
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The legal
process
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Tuesday, we…
 Formulated the goal of the legal process
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Minimize social costs, which consist of:
Administrative costs, and
Error costs
 Broke the legal process into a series of steps, and
discussed a couple of them
 Today:
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More on the legal process
A bit on crime and criminal law (more Thursday)
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Stages of the legal process…
decision to pursue a legal claim
bargaining over out-of-court settlements
pre-trial exchange of information
trial itself
appeals process
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Pre-Trial Bargaining
 Plaintiff might accept settlements S when
S > Expected JudgmentPlaintiff – Legal CostsPlaintiff
 Defendant might offer settlements S when
S < Expected JudgmentDefendant + Legal CostsDefendant
 So settlement is possible when
EJP – LCP < EJD + LCD
which is when
EJP – EJD < LCP + LCD
degree of relative
optimism
combined legal
costs
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Pre-Trial Bargaining
 Suppose parties agree on expected judgment EJ
 If bargaining fails and case goes to trial,
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Plaintiff gets expected payoff EJ – LCplaintiff
Defendant gets expected payoff – EJ – LCdefendant
So these are threat points during bargaining
Combined payoffs are – LCplaintiff – LCdefendant
 If settlement is reached, combined payoffs are 0
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So gains from cooperation are LCplaintiff + LCdefendant
 If gains from cooperation are split evenly…
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Plaintiff’s payoff is (threat point) + ½ (gains)
= (EJ – LCplaintiff) + ½ (LCplaintiff + LCdefendant)
= EJ – ½ LCplaintiff + ½ LCdefendant
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Pre-Trial Bargaining
 We just concluded…
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If the two parties agree on expected outcome of trial…
…and successfully negotiate a settlement…
…and divide gains from cooperation equally…
then settlement = EJ – ½ LCP + ½ LCD
 If going to trial is equally costly to both parties, this is just
EJ – the expected judgment at trial
 But if trial is more costly to defendant, this would be more
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Nuisance Suits
 A nuisance suit is a lawsuit with no legal merit
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If it goes to trial, defendant will definitely win (EJ = 0)
Sole purpose of a nuisance suit is to force a settlement
Just found: “reasonable settlement” = EJ – ½ LCP + ½ LCD
So if LCP = LCD, nuisance suit is pointless – reasonable settlement
would be 0
 But suppose going to trial is very costly for defendant
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Publicity would be bad for defendant’s reputation
Or, developer has to settle lawsuit to avoid delaying construction
LCP is just legal fees
But LCD includes legal fees plus other costs
So even if lawsuit has no merit, defendant might feel forced to pay
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a settlement
Nuisance Suits
 Example
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Cost of going to trial is $5,000 for defendant, $1,000 for plaintiff
Expected judgment = 0
Threat points are -5,000 and -1,000
Gains from cooperation are 6,000
If gains are split evenly, plaintiff’s payoff is
(threat point) + ½ (gains)
= -1,000 + ½ (6,000)
= 2,000
So nuisance suit might lead to a settlement of $2,000, even though
expected judgment at trial is 0
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Failures in negotiations
 Even without relative optimism, settlement negotiations
may fail due to private information
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Ex: defendant made a faulty product, which injured lots of people
Some sustained minor injuries, say $2,000
Some sustained major injuries, say $10,000
Before trial, defendant can’t tell scope of plaintiff’s injuries
Suppose legal costs are $500 for each side
If ½ of plaintiffs had major injuries, average injury = $6,000
So reasonably settlement offer might be $6,000
But if all defendants are offered a settlement of $6,000, the ones with minor
injuries will take it, and the ones with major injuries will go to trial
Defendant has two choices:
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Offer settlements large enough that everyone will accept
But then even people with very minor injuries, or none, might sue
Or offer only small settlements, and get stuck going to trial in many cases
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Stages of the legal process…
decision to pursue a legal claim
bargaining over out-of-court settlements
pre-trial exchange of information
trial itself
appeals process
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Trial
 In Europe…
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Judges in civil trials take active role in asking questions and
developing case
“Inquisitorial system,” since judge asks questions
 In U.S…
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Lawyers’ job to develop case
Judge is more of a passive referee
“Adversarial system,” since competing lawyers are adversaries
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Incentives
 Lawyers have a strong incentive to win at trial
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May be working on contingency
Value reputation for winning
 Judges have no stake in outcome of the trial
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Judges will (we hope) generally do what is right…
…but have less motivation to work hard
 “Judges have incentives to do what is right and easy;
lawyers have incentives to do what is profitable and
hard.”
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Who pays the costs of a trial?
 In U.K., loser in a lawsuit often pays legal expenses of
winner
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Discourages “nuisance suits”
But also discourages suits where there was actual harm that may
be hard to prove
 In U.S., each side generally pays own legal costs
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But some states have rules that change this under certain
circumstances
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Who pays the costs of a trial?
 Rule 68 of Federal Rules of Civil Procedure
“At any time more than 10 days before the trial begins, a party
defending against a claim may serve upon the adverse party an
offer [for a settlement]…
If the judgment finally obtained by the offeree is not more
favorable than the offer, the offeree must pay the costs
incurred after the making of the offer.”
 “Fee shifting rule”
 Example
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I hit you with my car, you sue
Before trial, I offer to settle for $6,000, you refuse
If you win at trial, but judgment is less than $6,000…
…then under Rule 68, you would have to pay me for all my legal
expenses after I made the offer
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Who pays the costs of a trial?
 Rule 68 does two things to encourage settlements:
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Gives me added incentive to make a serious settlement offer
Gives you added incentive to accept my offer
 But not actually as generous as it sounds
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Attorney’s fees not always included in fees that are covered
 Asymmetric
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Plaintiff is penalized for rejecting defendant’s offer
Defendant is not penalized for rejecting offer from plaintiff
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Who pays the costs of a trial?
 Kathryn Spier, “Pretrial Bargaining and the Design of FeeShifting Rules”
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Game-theory analysis of Rule 68 and similar rules
Shows that when parties have private information, fee-shifting rules
like this increase probability of settlement
Then considers designing “perfect” rule to maximize number of
cases that would settle out of court
Ideal rule is similar to two-sided version of Rule 68
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Take each side’s most generous settlement offer
Compute a cutoff
If eventual judgment is below this cutoff, plaintiff pays both sides’ legal
fees; if above cutoff, defendant pays both sides’ fees
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Unitary versus Segmented Trials
 Trial has to answer two questions:
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Is defendant liable?
If so, how much are damages?
 Unitary trial considers liability and damages at same time
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Economies of scope
 Segmented trial considers liability first, then damages
later (if necessary)
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Damages phase may not be necessary
 In U.S., judges have discretion over which type of trial
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Burden of proof
 Burden of proof: who is responsible for showing what at
trial
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In criminal case, prosecutor’s burden to show defendant is guilty,
not defendant’s burden to show he’s innocent
Similarly, in civil case, plaintiff’s burden to make case
Under negligence rule, plaintiff has to prove defendant was
negligent (rather than defendant having to show he was not)
Under contributory negligence, once defendant is shown to be
negligent, it’s defendant’s burden to show plaintiff was also
negligent
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Standard of proof
 Standard of proof: degree of certainty to which something
must be shown in court
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In criminal cases, “beyond a reasonable doubt” – very high
standard
In civil cases, plaintiff usually has to prove case by “a
preponderance of the evidence”
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Much lower standard –interpreted as anything over 50% certainty
For punitive damages to be awarded, high standard of proof is often
required: “clear and convincing evidence”
 Efficient level depends on relative costs of two types of
errors
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Finding someone liable when they should not be
Finding someone not liable when they should be
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Rules of evidence
 Rules for what evidence court can pay attention to
 Textbook gives examples where rules seem inconsistent, if
goal is simply to maximize probability of “right outcome”
 When we focus on efficiency, we care only about
outcomes, not about process
 But in real-world legal system, process is important in its
own right
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Stages of the legal process…
decision to pursue a legal claim
bargaining over out-of-court settlements
pre-trial exchange of information
trial itself
appeals process
22
Appeals
 In U.S., three levels of federal courts
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District courts, circuit courts of appeals, Supreme Court
(Many state court systems also have three levels, but this varies by
state)
Parties in district court cases have right of appeal
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Circuit court is required to consider their appeal
Parties in circuit court cases do not
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Supreme Court has discretionary review – chooses which cases to
hear
 In common law countries, appeals courts tend to only
consider certain issues
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Appeals generally limited to matters of law
Matters of fact generally not considered
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Appeals
 Recall goal of legal system
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Minimize administrative costs + error costs
 Clearly, appeals process increases administrative costs
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So only efficient if it reduces error costs
 Reasons why appeals process may reduce error costs
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Appeals courts are more likely to reverse “wrong” decisions than
“right” decisions…
…which leads to losing parties appealing more often when decision
was “wrong”
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Criminal
Law
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Criminal law differs from civil law in several
ways
 Criminal intended to do wrong
 Case brought by government, not individual plaintiff
 Harm done tends to be public as well as private
 Standard of proof is higher
 If found guilty, defendant will be punished
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Crime in the U.S.
 As of 2005, over 2,000,000 prisoners, nearly 5,000,000
more on probation or parole
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Up from ~500,000 in 1980
93% male
In federal prisons, 60% are drug-related
Incarceration rate of 0.7% is 7 times that of Western Europe
 Cooter and Ulen estimate social cost of crime
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$100 billion spend annually on prevention and punishment
1/3 on police, 1/3 on prisons, 1/3 on courts, prosecutors, public
defenders, probation officers, etc.
Estimate another $100 billion on private crime prevention
Estimate total social cost to be $500 billion, or 4% of GDP
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Crime in the U.S.
 Crime rates (relative to population) in the U.S…
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Decreased steadily from mid-1930s to early 1960s
Increased sharply in 1960s and 1970s
In 1980s,
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Nonviolent crimes committed by adults dropped sharply
Violent crimes committed by adults dropped slightly
Violent crimes by young people went up
Violent and nonviolent crime rates dropped sharply in 1990s,
continued to drop more slowly since 2000
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Nonviolent crime rate in U.S. now similar to Europe
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Crime in the U.S.
 Criminals in the U.S…
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Disproportionally young males
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Crime rates generally follow trend in fraction of population age 14-25
Both violent criminals and victims disproportionally African-American
Relatively small number of people commit large fraction of violent
crimes
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Tend to come from dysfunctional families…
…have relatives who are criminals…
…do poorly in school…
…be drug- and alcohol-abusers…
…live in poor/chaotic neighborhoods…
…and being misbehavior at young age
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Do harsher punishments deter crime?
 Hard to answer empirically, because two effects
 Deterrence
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When punishment gets more severe, crime rates may drop
because criminals are afraid of being caught
 Incapacitation
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When punishment gets more severe, crime rates may drop
because more criminals are already in jail
 Kessler and Levitt: natural experiment
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Voters in California in 1982 passed ballot initiative adding 5 years
per prior conviction to sentence for certain crimes
Found immediate drop of 4% in crimes eligible for enhanced
sentences
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Imprisonment
 Imprisonment has several effects:
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Deterrence
Punishment
Opportunity for rehabilitation
Incapacitation
 When is incapacitation effective?
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When supply of criminals is inelastic
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(When there isn’t someone else waiting to take criminal’s place)
And when it changes number of crimes a person will commit,
rather than just delaying them
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Imprisonment
 Direct costs of holding someone in maximum-security
prison estimated at $40,000/year
 In some states, prisoners do useful work
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Attica State Prison (NY) had metal shop
Minnesota firm employs inmates as computer programmers
Medium-security prisons in Illinois make marching band uniforms
But legal limitations
 1980-1990: most state and federal courts moved away
from judicial discretion toward mandatory sentencing
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Recent move in opposite direction
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Why did U.S. crime rate fall in 1990s?
 Sharp drop in crime rate in U.S. in 1990s
 Several explanations:
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deterrence and incapacitation
decline of crack cocaine, which had driven much of crime in 1980s
economic boom
more precaution by victims
change in policing strategies
 Donohue and Levitt give a different explanation: abortion
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Why did U.S. crime rate fall in 1990s?
 Donohue and Levitt
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U.S. Supreme Court legalized abortion in early 1973
Number of legal abortions ~ 1,000,000/year (compared to birth rate
of 3,000,000)
Violent crimes largely committed by males of certain ages
Donohue and Levitt argue legalized abortion led to smaller “cohort”
of people in high-crime age group starting in early 1990s
Evidence:
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Most of drop was reduction in crimes committed by young people
Five states legalized abortion three years before Roe v Wade, saw
drop in crime rates begin earlier
States with higher abortion rates in late 1970s and early 1980s had
more dramatic drops in crime from 1985 to 1997, no difference before
Argue this explains 50% of drop in crime in 1990s
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Half of that from cohort size, half from composition
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Thursday…
 Model of criminal law, what does efficient criminal system
look like?
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Second midterm
 Mean 73, median 74.5, std dev 12
 Again, in very approximate terms…
> 80
roughly AB or A
70-80
roughly B
60-70
roughly BC
below 60
roughly C or worse
last names A-L
last names M-Z
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