Suggested Answers
In-Chapter and End-of-Chapter Questions
Cooter & Ulen, Law and Economics (6th ed.)
Chapter 2
In-Chapter Questions
2.1. (p. 17) Remember that the slope of the line is the coefficient of x. When that coefficient is positive, there is a direct relationship between x and y. The second equation says
that there is an inverse relationship between x and y: When x increases in value, y decreases in value.
2.2. (p. 19) Think about transitivity over time. Is it necessarily true that a hot dog at
lunch is the same good as a hot dog at dinner on the same day? Why would this not be
the case? It surely is not the case that our tastes do not depend on what has happened in
the recent past (even in the distant past) and the context in which we find ourselves.
2.3. (p. 20) As you reduce x from x0 to x1, notice that if the amount of y remains constant
at y0, then the consumer will be on a lower indifference curve, U2. To return the consumer to the higher level of well-being represented by U3 the amount of y in bundle must
increase. How much? Draw a vertical line upward from the intersection of y0 with U2
until you reach indifference curve U3. Then, draw a horizontal line from that intersection
point over to the y-axis. That will give you the amount of additional y that must be given
the consumer to make up for the loss of x.
2.4. (p. 21) Increases and decreases in income will shift the curve, while a change in the
price will cause the line to rotate.
2.5 (pp. 22-23) Compare the marginal costs with the marginal benefits. If the initial level
is greater than the optimum, then marginal costs are higher than marginal benefits. That
is, the cost of the final unit exceeds the benefit received from it. The decision-maker will
continue to decrease the amount being maximized until marginal benefit equals marginal
cost.
2.6. (p. 24) Another way to ask this question is, “At what point does society stop receiving benefits from additional units of pollution reduction?”
2.7. (p. 24) Refer to your answer to question 2.6. In Figure 2.7, show the area that constitutes the net benefits. That’s the triangular area above the MC curve and below the
MB curve.
The technological change that lowers the MC of achieving any given level of pollution will lower the MC curve – that is, it will rotate downward. Therefore, its intersection with the MB curve will be further to the right. So, the socially optimal amount of
pollution will be less than what it was before the technological innovation.
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If it turns out that the health or environmental costs of pollution are greater than
previously thought, then the marginal benefit (MB) of less pollution is greater at every
level of pollution. As a result, the MB curve shifts upward. The intersection of the MB
and MC curves will, therefore, be further to the right, suggesting that the new social optimum will have less pollution.
2.8. (p. 40) Given the technology used by this firm, external costs will always exist under any positive level of production. Think of an extreme case: This might be one in
which the social cost of the activity was always above the social benefit. First-degree
homicide might be an example. In those instances, the socially optimal amount of the
activity is 0. But for non-extreme cases, where there is a range in which the social costs
are below the social benefits, a nonzero amount of the activity is socially optimal, with
some external costs being generated.
End-of-Chapter Questions
2.1. Economists generally assume that economic decisionmakers are attempting to maximize something subject to constraints. Thus, consumers are assumed to maximize utility subject to an income constraint, and firms are assumed to maximize profits subject to
a production function constraint. Maximization helps to posit the goal or end that the
economic decision-maker seeks. Equilibrium is a state of rest, the condition from which
no further endogenous change will occur. The notion of equilibrium helps to specify the
point (e.g., the quantity of output produced, the amount of bananas consumed) toward
which the maximizing behavior of economic decision-makers tends. [p. 52]
2.2. Efficiency describes a point of equilibrium with particular characteristics. A productively efficient equilibrium describes the condition of a firm or firms in which it is impossible to produce a given level of output at lower cost or, alternatively, to use a given
combination of inputs to produce a greater level of output. An allocatively efficient equilibrium describes an equilibrium distribution of goods and services among consumers. A
particular distribution of goods among consumers is allocatively efficient if it is not possible to redistribute the goods so as to make at least one consumer better off without
making another consumer worse off. (That, of course, is the Pareto criterion.) [p. 52]
2.3. In microeconomic theory consumers are assumed to maximize utility subject to an
income constraint. The income constraint or budget line is described by the consumer’s
income and the relative prices of goods and services. The consumer’s utility is maximized when she achieves the highest attainable indifference curve. This occurs at the point
at which the highest attainable indifference curve is tangent to the budget line. At that
point, the benefit (i.e., the utility) from spending an additional dollar on any given good
is equal for all commodities. That is, at the consumer’s constrained maximum the marginal benefit (in terms of the increase in utility) of an additional dollar spent on any good
is exactly equal to the marginal cost (i.e., the dollar) of any good. [p. 52]
2.4. The partner who has the children is assumed to have a utility function of u • cv ,
where c equals the weekly child support payment from the other partner, and v equals
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the number of days per week that the children spend with this partner. Initially, c = 100
and v = 4 days, so that u = 400. If the partner paying child support payments wishes to
reduce the weekly support payment to $80, then the number of days that the children
spend with the other partner must increase to 5 in order for utility to remain unchanged
at 400.
2.5. Price elasticity of demand measures the responsiveness of consumer’s quantitydemanded to changes in relative price. Mathematically, price elasticity is defined as the
percentage change in the quantity-demanded of a commodity divided by the percentage
change in the commodity’s price. Because quantity-demanded and price move in opposite directions (when price declines, quantity-demanded increases; when price increases,
quantity-demanded decreases), the sign of price elasticity will be negative. To avoid
having to remember whether 25 is greater or less than 24, economists drop the sign from
price elasticity and talk about it as if it were simply a positive number. The ranges of
value of price elasticity of demand are inelastic (price elasticity has a value less than 1),
unitary elasticity (price elasticity equal to 1), and elastic (price elasticity has a value
greater than 1). When price elasticity is greater than 1, the percentage change in quantity-demanded is greater than the percentage change in price—for example, a 10 percent
drop in price gives rise to a 23 percent increase in quantity demanded. Can you compute
the price elasticity of demand for this good?
There is an interesting relationship between a commodity’s price elasticity of
demand and total consumer expenditures (price times quantity-demanded) on that commodity. When price elasticity of demand is less than one, an increase (decrease) in price
will lead to an increase (decrease) in the total amount that consumers spend on the
commodity. When price elasticity of demand is unitary, consumers will spend the same
total amount on the commodity regardless of the price. When price elasticity of demand
is greater than one, an increase (decrease) in price will lead to a decrease (increase) in
the total amount that consumers spend on the commodity.
We shall use this last relationship between price elasticity and consumer expenditures in Chapter 12 to suggest a troubling relationship between drug addiction and
crime.
2.6. The expression “There is no such thing as a free lunch” is one of the most famous
quotes in all of economics. Its origins are interesting. In order to encourage customers to
drink, taverns used to post a sign saying “Free Lunch.” The implication was that those
who had purchased drink were entitled to eat from the bar’s buffet at no extra charge.
Clearly the bar expended real resources providing the luncheon buffet, and the explicit
and opportunity costs of these resources figured in the bar’s determination of the costs of
doing business and, therefore, in its calculation of its profits. But what about the bar’s
customers? Was the lunch really free to them if they purchased a drink? No. The bar
included a charge for the costs it incurred in putting on the buffet in the prices it charged
its customers for drink. The fact that the charge for the buffet is hidden in the price of
drink does not make the lunch free.
On many commercial airplane flights, passengers used to be offered meals, music,
and movies at no apparent price. Were these entertainments really “free”? If they were
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free, why do you think that many of these enhancements have disappeared from airline
travel?
2.7. Use your answer from 2.6 to think about this issue. Hint: There is an opportunity
cost to a vacation. What could you be doing with your time instead of relaxing?
2.8. Firms are assumed to maximize profits, which are defined as the difference between
total costs (including opportunity costs) and total revenues. A firm maximizes profits by
choosing that output level for which the marginal cost (the addition to total cost of the
last unit of output produced) equals the marginal revenue (the addition to total revenue
of the last unit of output produced). (Note that if we call marginal revenue “marginal
benefit,” then the rule to maximize profits by choosing the output level for which marginal cost equals marginal revenue is exactly equivalent to our general maximization
rule of equating marginal cost and marginal benefit.) If the firm finds itself producing an
output level for which it is the case that marginal revenue exceeds marginal cost, then by
producing more output it can add more to total revenue than to total cost and thereby increase its profits. Alternatively, if marginal cost exceeds marginal revenue, the firm
should cut back on production: the revenue lost from lower output will be less than the
cost savings.
2.9. In a perfectly competitive industry there are a large number of buyers and sellers, so
large that no single buyer or seller can influence the market price by his or her individual
decisions. Entry and exit of resources into and out of the industry is free. These are the
core characteristics of perfect competition about which there is general agreement
among economists. There are several other conditions about which there is less widespread agreement—for example, that all buyers and sellers have perfect and complete
information and that products are homogeneous. It is often said that the stock market
and the market for agricultural commodities (such as wheat) are examples of perfectly
competitive industries.
Monopoly occurs when there is only one seller. (For more on monopoly see the suggested answer to the following question.) By comparison to a perfectly competitive industry, a monopolist produces too little and charges too much.
Oligopoly holds where there are only a few sellers, so few that they recognize the interdependence of their decisions. That is, what is optimal for firm A to produce or to
charge for its output depends not just on market price, marginal revenue, and the firm’s
own costs but on what firms B and C produce and charge. This interdependence gives
rise to strategic considerations that are best analyzed through the use of game theory and
such notions as a Nash equilibrium. The television programming market may be an example of an oligopolistic market.
An imperfectly competitive industry shares some of the aspects of perfectly
competitive and monopolized industries. As in perfect competition, there are a large
number of sellers, although the number is not as large as in perfect competition. Entry
and exit are free. As in monopoly, each seller has some limited market control over the
consumers of his output. Sellers distinguish their product by brand name, quality, and
other characteristics. The market for breakfast cereals is probably imperfectly competitive. [pp. 52-53]
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2.10. A monopoly occurs when there is only one seller. There are technological conditions, known as “natural monopoly,” that can give rise to monopoly. There are also social welfare conditions that may make a case for the government’s granting a monopoly—as with the patent, copyright, and trademark systems. (See the discussion of intellectual property in Chapter 5).
A monopoly can be sustained only if other resources are prevented from flowing into
the industry to set up competitive firms. This might happen when a monopolist gains
control of the only input that can be used to produce a particular output. Far more common are cases in which the government permits the monopoly to endure by forbidding
lawful entry into the industry. Where entry is not so restricted, it will eventually occur,
leading to the demise of the monopoly.
A special kind of monopoly is a cartel, which is collusion among otherwise competitive firms that seek to operate as a joint profit-maximizing monopoly. An example is the
Organization of Petroleum Exporting Countries (OPEC). OPEC illustrates very well the
difficulties that monopolies have in forestalling entry. The more successful the monopoly initially is in raising the price above the competitive level, the greater the incentive to
others to enter the industry. After OPEC’s success in raising the price of oil to nearly
$33 per barrel (from $3 per barrel) in the early 1970s, the entry into the petroleumextracting industry by other countries was substantial, so much so that the OPEC countries now account for less than half of world petroleum output. (Later, the high price of
oil induced a substantial amount of cheating by OPEC member countries, too.)
2.11. We discussed the adverse effects of a price ceiling with respect to rent control. The
price ceiling is set below the equilibrium price so that there is an excess demand for the
price-controlled product. Suppliers can make more money supplying unregulated goods
and services and so transfer their efforts and resources elsewhere. Those suppliers that
remain attempt to keep their profit rates at normal levels by letting the quality of their
product (and therefore its costs of production) decline and by insisting on secret payments from consumers over and above the controlled price. Consumers of the controlled
product may also alter their behavior in inefficient ways: they may, for example, inefficiently substitute other goods and services for those whose price is controlled.
2.12. Refer to your answer to 2.11. Instead of placing a ceiling above which prices cannot rise, the government sets a floor below which they cannot fall. The effect of a price
floor is that too much is produced and not enough demanded. The simplified outcome in
the labor market is that minimum wage constraints cause unemployment—that is, an
excess labor supply.
2.13. The interaction between a minimum wage law and a law forbidding firing would
play out at many subtle levels. Among the many issues to consider are: the decision to
hire new workers, the use of overtime, and the decision to declare bankruptcy.
2.14. All other things equal, the implicit price of divorce would fall under a no-fault divorce law, thus leading to more divorce. (Exactly how much depends, of course, on the
price elasticity of demand for divorce.) This fall in price might also influence the deci5
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sion to marry. Perhaps there would be less hesitation to marry, knowing that the decision
to marry was easily reversed.
2.15. The effort associated with acquiring information concerning interest rates effectively raises the price of obtaining a loan. With lower costs faced by consumers, all else
equal, one would expect more lending activity. The profits to the lenders depend on the
cost of supplying the information to consumers and the market power they exhibited before the Act was passed. The more competition in the lending industry, the closer the
interest rate should reflect the true risks and costs to the lender.
2.16. General equilibrium is the condition in which all markets are in simultaneous equilibrium. The conditions under which this will happen are that all markets are perfectly
competitive and that there are no sources of market failure. (See the answer to the next
question.) Given the resources available to the economy, it is not possible for the economy to be productively or allocatively more efficient than it is in general equilibrium.
(As we argue in the text, distribution is another matter.)
2.17. Market failure can arise from five sources. The first is non-competitive market
structures, such as monopoly (the condition of one seller) and monopsony (the condition
of one buyer). We have already examined the reasons why monopoly leads to suboptimal results. In general, policies of regulation (in the case of natural monopoly) and
of antitrust enforcement (in the case of collusion and artificially sustained monopoly)
will help to correct for the social costs of monopoly. The second is external effects, costs
and benefits involuntarily imposed on others. In the case of external costs, such as water
pollution that results from a firm’s discharge of waste chemicals into a nearby stream,
the externality-generator does not take into account the costs he has involuntarily imposed on others. As a result, his output costs him less to produce than it should in terms
of the social resources his production really uses. So, someone who is generating external costs produces too much. To correct for these social costs, he must be induced to “internalize” these external costs, in which case he will reduce his output to the socially optimal level. Policies of taxation and subsidization, of exposure to legal liability, and of
prior regulation can help to minimize the social costs of externalities. (In Chapters 4 and
5 we discuss how property law can help in this internalization, and in Chapters 8 and 9
we show how tort law helps to internalize risks of injury.)
The third source of market failure is the presence of public goods. These are goods
for which the cost of excluding non-paying consumers are so high that no private profitmaximizing firm can earn enough to justify producing the socially-optimal amount of
the public good. The market fails in respect to public goods in that it produces too little
of them. A policy of subsidization of private producers or of public provision of the public good can correct for this failure.
The fourth source of market failure is extreme informational asymmetries. Because
of the special characteristics of information, where access to information is highly
skewed or where the ability to process information is highly unequal, questions arise
about the optimality of otherwise voluntary transactions. (In Chapters 6 and 7 we discuss
how contract law, and in Chapters 8 and 9 we discuss how tort law, can help to correct
for problems arising because of informational asymmetries.)
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The fifth source of market failure is collective and coordinated decisionmaking.
There are circumstances—nicely illustrated by the Prisoner’s Dilemma in the text—in
which individuals are led to do things that may be in their own narrow interest but are
not in the interest of the collectivity or group of which they are a member. The prisoners
in the famous game could both do better if they could coordinate their behavior and not
confess, but because it so costly to engage in believable coordination, the prisoners both
confess.
2.18.
a. A swimming pool large enough to accommodate hundreds of people does not
seem to have either of the characteristics of a public good non-rivalrous consumption or costliness of excluding non-paying consumers. A fence and charging an entrance fee through a central entrance dispose of the costliness issue. Only when the pool is congested does the amount of the pool that one person can
consume depend on the amount that others consume. The swimming pool does
not seem to be a public good, and it there-fore follows that a private profitmaximizing firm could provide the optimal pool.
b. A fireworks display is clearly a public good. Consumption is non-rivalrous in
the sense that one person’s enjoyment does not diminish the amount available for
another to enjoy. And it is costly to exclude non-paying consumers; they may,
after all, simply stand on a hill away from the display and enjoy it without
charge. For those reasons it is not surprising that it is municipalities, not private
firms, that provide fireworks displays on the 4th of July and that they are generally financed from general tax revenues, not from a user fee.
c. A heart transplant is clearly a private good. Nonetheless, many will shy away
from the conclusion that this particular private good should be allocated according to the usual rules prevailing in the market for private goods—presumably because transplants are extremely costly. For an interesting discussion of this issue
and of other issues where high cost is an important component of choice, see
GUIDO CALABRESI & PHILIP BOBBITT, TRAGIC CHOICES (1978). We also have a
discussion of the situation for organ transplants in a box in Chapter 5 and in the
Web Notes.
d. Vaccination against a highly contagious disease is a private good but one that
has such strong external benefits that the market will provide sub-optimal
amounts of it – that is, in deciding whether or not to receive inoculation, people
are likely to take into account only their own well-being and that of their immediate friends and neighbors and not the public health benefits that their inoculation will confer on others. Thus, either public provision of vaccination or public
subsidization of private provision is called for.
e. A wilderness area could conceivably be a private good. But today wilderness
areas and national parks are federally owned and operated, presumably on the
theory that these areas should be held in trust for future generations and that private owners would not do that. But there are a few examples of private owner7
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ship of natural resources that do work. A private organization called the Nature
Conservancy attempts to preserve bird sanctuaries, wilderness areas, and other
significant natural resources by using the contributions of its members to purchase and hold these areas.
f. (Also, g and h.) All three examples of education given here are largely private
goods with trace elements of public goods in the sense that they contribute to societal well-being by giving those trained a sense of worth and a set of skills.
There is general agreement that elementary education has such strong external
benefits (in that all citizens are better off when their fellow citizens can read and
write and reckon) that it should be subsidized or publicly provided.
2.19. Pareto efficiency (or Pareto optimality) describes a situation of equilibrium from
which it is impossible, given the economy’s resources, to produce more of one commodity without producing less of another or to make one person better off without making
another worse off. Although Pareto efficiency is to be desired, we saw that it does not
define a unique distribution of resources among the members of society. The set of Pareto efficient distributions that results from voluntary exchange depends crucially on the
initial distribution of resources among the members of the society. Different initial distributions lead to different Pareto optimal outcomes.
2.20. Although votes cannot be bought and sold in the marketplace, a market for votes
does exist in the form of campaign contributions and logrolling (legislators trading
votes). What benefits would follow from allowing legal and open market for votes rather
than the current “hidden” market? More troubling, how would allowing an open market
change the balance of power between the haves (who can supply money and votes) and
the have-not’s (who can only supply votes)? Would allowing this market to exist fundamentally change our concept of government?
2.21. A Pareto improvement is a change in which at least one individual is made better
off, while no one is made worse off. The Kaldor-Hicks requirement recognizes that
some changes will be very beneficial to one subset of society, while harming another
subset. As long as the benefits outweigh the costs, Kaldor-Hicks views the change as a
superior out-come. A Pareto improvement requires those who benefit to compensate (or
to purchase the consent) of those who lose. A Kaldor-Hicks improvement does not require explicit consent by the losers, only that someone objectively verify that the benefits of the change exceed the costs.
2.22. A dominant strategy is a strategy that is optimal regardless of what the other player
does. If both players have a dominant strategy, then there is a Nash equilibrium. A Nash
equilibrium is a strategy where an individual player cannot do better, so long as the other
players do not change their strategies. Some games have multiple Nash equilibria, and
many games (the most common of which are the prisoner’s dilemma games) have a
Nash equilibrium that is not the Pareto efficient.
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Chapter 3
3.1. (p. 65) Butterfield, the plaintiff, asked to be compensated for injuries he incurred
when he rode his horse into a pole put across the street by Forrester, the defendant. Butterfield claimed that Forrester was negligent in leaving the pole across the street. The
judge stated the law and the jury determined the facts. The law was that a person who
exercised reasonable care could collect damages caused by the negligent behavior of
others. The jury determined that the plaintiff did not exhibit reasonable care and found
in favor of the defendant.
3.2. (p. 65) The plaintiff appealed the case and lost. The judge ruled that any negligence
on the part of the plaintiff (contributory negligence) was a complete bar to recovery.
3.3. (p. 67) The defendant, Mann, appealed the judgment on the ground that the judge
had misinterpreted the common law. He lost the case again. The court ruled that the defendant could have avoided the donkey had he been driving his wagon in a less reckless
manner. The defendant acted last and could have avoided the outcome had he been acting responsibly.
Chapter 4
In-Chapter Questions
4.1. (p. 76) After receiving the bid from Clair, Adam values the car at $3200, which is
the opportunity cost of selling it to Blair. (Recall that opportunity cost is defined as the
value of the next best use, which is, in this case, selling the car to Clair.) Adam’s threat
value vis-à-vis Blair is now $3200. The surplus from cooperating with Blair falls to
$800. A reasonable solution is for Blair to buy the car for $3,600, leaving Adam with
$3,600 and no car and Blair with a car worth $4,000 to her and $1,400 in cash. [p.76]
These questions are from the box “A Civil Dispute as a Bargaining Game” on p. 77.
a. Arthur’s threat value is his expected net gain from trial. Because the value of
the kettle is $300, because he has a 50 percent probability of winning, and because the trial will cost him $50, the expected net value of a trial is $300(0.5) $50 = $100.
b. Betty’s threat value is her expected loss from trial. Because the value of the
kettle is $300, because she has a 50 percent probability of losing, and because the
trial will cost her $50, the value to her of a trial is -$300(0.5) - $50 = -$150 - $50
= -$200.
c. The cost to Arthur and Betty of cooperatively resolving their dispute without
trial is $0 because the transaction costs of settling are, by assumption, zero.
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d. The surplus from cooperating (i.e., from settling the dispute rather than litigating) is $100, which is the sum of the two parties’ costs of litigating.
e. A reasonable settlement would be for Betty to pay Arthur $150. Thus, Arthur
gets his threat value ($100) plus half the surplus ($50). And so does Betty: -$200
(her threat value) + $50 (the saving in litigation costs) = -$150.
f.1. Assuming that the cost of litigating is still $50, Arthur’s net expected gain
from litigating is $300(2/3)-$50 = $150.
f2. Betty believes that the probability of her losing the case and having to pay for
the kettle is 1/3. Her probability of winning the case and not having to pay for
the kettle is 2y3. Thus, Betty’s threat value is (-$300)(1/3) - $50 = -$150.
f3. Now the actual cooperative surplus from settling rather than litigating is still
$100. But because of their optimism, the parties both anticipate doing better from
litigating than from cooperating. If the actual cooperative surplus is $100 and
each party anticipates a reasonable split of that surplus, then Arthur anticipates
receiving $200 from cooperating with Betty in settling the dispute: $150 (his
threat value) + $50 (his share of the cooperative surplus) = $200. Betty expects
to lose $150 from going to trial; with her share of the cooperative surplus, she
would be willing to offer Arthur $100 to settle: -$150 (her threat value) + $50
(her share of the cooperative surplus) = -$100. What Arthur expects from cooperation ($200) is much greater than what Betty is prepared to offer for cooperating ($100). Thus, neither party prefers cooperating to litigation. The putative cooperative surplus is 0.
f4. Neither party anticipates a surplus from cooperating because each party is optimistic about winning the trial.
4.2. (p. 81) The answer in part a will depend on social understandings and precedents
that may differ from time to time and place to place. The answer to part b is that disallowing destructive threats will affect the bargaining process. Presumably, if it is illegitimate to threaten to harm another person, for example, then people will channel their solutions into cooperative efforts. As to part c, we leave this to you to develop an answer
in class discussion or in discussion with your study-mates.
4.3. (p. 86) If transaction costs are zero, then the initial distribution of property rights
over land will not bar the efficient outcome. The efficient solution will be reached
whether the law protects the farmer or allows the railroad to emit sparks. However, if the
costs of bargaining are high, then the efficient solution may not necessarily be reached.
One scenario under which high bargaining costs may exist is when there are a multitude
of actors on either side of the conflict.
4.4. (p. 86) Think about how short-run contracting differs from long-run contracting. Do
the higher costs in the long-run involve anything other than higher transaction costs?
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That is, if the costs of searching, bargaining, and enforcing contracts was zero in the
long-run, then the Coase theorem should still hold.
4.5. (p. 86-87) The invariance principle is a strong version of the Coase theorem and
states that not only does any initial endowment lead to an efficient outcome, but that the
same outcome will be reached no matter what the initial endowment. The” income effect” is the change in the quantity demanded for a good whose price has fallen attributable to a rise in real income due to the price change. The “price effect” is the increase in
quantity demanded directly attributable to the fall in price.
4.6. (p. 87) One way to approach this problem is to consider the increase in wealth associated with an increase in the initial endowment. For instance, suppose the farmers were
granted the right to be free from cattle and all the ranchers’ land. The farmers may decide to build a house on the rancher’s land rather than allowing cattle to graze. While
this is the efficient outcome, it is a very different result from a situation where land is
split evenly.
4.7. (p. 87) The formal, legal rules of society are most effective when they are compatible with the informal social norms of everyday life. Informal norms often arise in situations where high transaction costs of contracting exist. Instead of relying on government
to lay the ground-rules of economic interaction, people in long-term stable relationships
form “rules of the game” that are specific to their situation. The loss of reputation of actors that cheat in a game with repeated play is often a sufficient enforcement mechanism
in long term contracts.
4.8. (p. 88)
a. bargaining.
b. enforcement.
c. search.
d. search.
e. search.
f. search.
Arguments can be made, however, for many of these to be considered in a different category.
4.9. (p. 90) In terms of the transaction costs of search, bargaining and enforcement, buying an artichoke would seem to be the easiest, and perhaps getting married the most difficult. But the level of transaction costs involved in the other situations would vary
greatly depending on the situation. For instance, selling a Burger King franchise may
have very low costs if standard forms and a clear legal framework exist. However, if a
unique contract is written for each franchise and if there is uncertainty in the legal system as to how franchising law operates, then the transaction costs could be very high. [p.
90]
4.10. (p. 91) Place each contract along the spectrum of transaction costs. In which situations are the costs of contracting a market-based solution “too high”? Here’s one sug11
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gested ranking of these various circumstances, ranking from lowest to highest transaction costs:
1. smoking in a private residence.
2. smoking in hotel rooms.
3. smoking on commercial airline flights.
4. smoking in a public area.
The factors that seem to differentiate these situations are the number of parties involved in a particular transaction and whether there might be a competitive market that
would compel a profit-maximizing private provider to take the desires of consumers into
account. Why would we rank “smoking in hotel rooms” as having lower transaction
costs than “smoking on commercial airline flights”? Perhaps because hotel owners are
generally subject only to local or state regulation in the United States, and the regulation
is relatively light-handed. So, hotel proprietors can be relatively quick and flexible in
their responses to changing consumer tastes. Airlines, in contrast, are relatively heavily
regulated and, more importantly, their normal business has them crossing state lines so
that the ability of local regulators to reach them is attenuated. Realistically speaking, only federal regulators or the national legislature could have caused the airlines to make
their flights smoke-free (unless, that is, the airlines decided on their own to make that
decision).
Another difference between hotel rooms and airplane flights is that the external cost
of smoking is more immediate and less avoidable on an airplane flight than in a hotel
room. Presumably, those who are occupying the hotel room can decide among themselves whether to smoke. And, very importantly, the hotel can accommodate both smokers and nonsmokers by simply designating some rooms or floors as nonsmoking. It’s
difficult to do that in an airplane (although airlines used to do just that years ago: some
rows were for smokers, and all others were for nonsmokers).
But these arguments may be thin. Maybe “smoking in hotel rooms” and “smoking on
commercial airline flights” are really pretty closely related.
4.11. (p. 94)
a. An example of a low-transaction cost setting might be one in which the issue is
the assignment of a legal entitlement to place a poster on a wall in a rental apartment.
Should the landlord or the tenant have the entitlement to decide whether and how to
place a poster on an interior wall? In some senses it doesn’t matter: the cost of negotiating between the parties are so small that whoever values the entitlement more is likely to
possess it.
An example of a high-transaction cost situation might be the entitlement to hold a
parade on public streets.
b. Should the bargaining process between employers and employees be regulated or
left entirely to the parties to resolve? Recall that the Normative Hobbes Theorem says,
“Structure the law so as to minimize the harm caused by failures in private agreements.”
It is certainly possible that employers and employees can bargain to a mutually satisfactory conclusion in their collective bargaining agreement, but there is a significant chance
that they may not. And if they do not, the costs to the parties and to society can be substantial. There used to be significant labor disputes in which strikers would be without
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pay and other benefits for months and employers were unable to hire replacement workers (because of menacing action by the current striking employees) and, therefore, to
produce anything for months at a time. Those costs can be significantly high and can
ripple through the community. Law might limit the damages that failures to reach an
agreement might cause by giving the government to power to order strikers back to work
or imposing a “cooling off” period. Additionally, competent mediators can help to bring
deadlocked negotiators together. And skilled personnel management can seek to head
off these disputes.
Such crippling industrial disputes between employers and employees have become
far less common than they used to be, as can be seen by looking at the number of work
days lost to labor disputes at the Department of Labor website.
c. What should the law do about the possibility that parties might (physically) harm
each other because of their inability to agree on a private bargain? What should it do
about the fact that parties may walk away in disgust from what would have been a potentially profitable exchange? Clearly, the law ought to take significant steps to prevent
violence from any source. There are direct and indirect methods of doing so. Directly,
the government might announce (as it does) that it will punish violence severely. Indirectly, the government can seek to educate citizens about techniques of bargaining and
communication so that they can be more effective bargainers. As to walking away from
otherwise profitable bargains, this is an example of the Hobbes Theorem. Since Cooter’s
original insight in “The Cost of Coase” that there were significant social costs to bargains not completed that would have been mutually beneficial, we have known that parties sometimes “overreach” – they bargain so hard for a large portion of the cooperative
surplus or so misjudge the amount that the other party was willing to pay or accept that
the bargain does not take place.
One might say that this is rare—that the parties can always resume their bargain later
if they have misjudged things in the prior bargaining sessions. Perhaps. But there are
often hard feelings and misunderstandings that prevent a return to the bargaining table.
Collective bargaining used to provide pointed examples of intransigence in bargaining. A large employer and the union representing the large work force of employees
would sometimes bargain to no avail. Then the union would go on strike, sometimes for
weeks and months at a time, to the distress and discomfort of the workers and the employers, their families, the viability of the employer, and, in some instances, the peace of
the community. The series of collective bargaining statutes – the National Labor Relations Act of 1935 (known familiarly as the “Wagner Act” after its sponsor) and the Labor-Management Relations Act of 1947 (familiarly known as the “Taft-Hartley Act” after its Senate and House sponsors)—were meant to create constraints within which these
potentially devastating failures to bargain would be kept to a minimum.
One of the heartening developments of the last 50 years is the general improvement
in the labor-management climate: the number of days lost to labor strikes has been declining almost continuously for this period. How have labor unions and management
avoided the costs of failing to bargain? How have they managed to take account of the
Hobbes Theorem? This would be a terrific question to investigate with your class.
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4.12. (p. 99) In the example given, an injunction to end future interference costs the defendant more than damages for future interference. We ask if this is general truth or a
special feature of this example.
This is a bit of a trick question. Presumably, the argument in favor of an injunction,
following Calabresi and Melamed, is that the transaction costs are low of the parties’
bargaining to discover if there is a cooperative surplus to be split from allowing the defendant to invade the plaintiff’s property interest. We do not know, in the mill run of instances, whether there will be scope for a bargain or not—whether, that is, the benefit to
the defendant of being allowed to invade the property is greater than the benefit to the
property-owner of not being invaded. But if it is the case that complying with the injunction costs the defendant more than it benefits the plaintiff, and if the transaction costs
between the parties are low, then they ought to be able to find some mutually satisfactory position that would cut the defendant’s costs of complying with the injunction and the
plaintiff’s benefit from not having the injunction complied with.
4.13. (p. 102)
Should we protection the following interests by an injunction or damages?:
a. a land owner’s right to exclude from his property a neighbor’s gas line.
An injunction. There are two parties involved, so, presumably, the transaction costs
between them to negotiate an easement for the neighbor’s gas line should be small.
b. a new car owner’s right to have her car’s defective transmission replaced by the
seller.
This is actually a subtle question. Normally, one would say that the car owner ought
to have the right to have his defective transmission replaced—that is, he or she ought to
have the equivalent of a property rule running in his favor. If, then, the seller wanted to
try to bargain ought of this obligation, that would be fine because the seller would have
to offer the car owner enough compensation to make him or her indifferent between having the transmission replaced or not. But it is possible that the seller, if required to replace the transmission, might misbehave in some way that would require someone –
perhaps a court – to supervise what he or she was doing to the car. If those supervisory
costs are sufficiently high, then it might be better to have the seller pay the buyer compensatory money damages.
c. a homeowner’s right to be free from air pollution by a nearby factory.
The transaction costs between a single homeowner and the factory might be low, but
there may be lots of homeowners who are affected by the pollution. If so, then the total
transaction costs of internalizing the external costs that the pollution imposes may be so
high as to argue in favor of compensatory money damages instead of an injunction. You
might also talk about the possibility that a regulatory solution—having an administrative
agency set pollution limits on the factory and then monitor compliance—might be superior to a private law solution (in which the homeowners bring a nuisance action against
the factory.).
d. a spouse’s right to half the house on divorce.
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This situation illustrates a situation first articulated in Ian Ayres & Eric Talley, “Solomonic Bargaining: Dividing an Entitlement to Facilitate Coasean Bargaining,” 104
Yale L.J. 1027 (1995). The title comes, of course, from the famous story in the Bible of
King Solomon’s sitting in judgment of two prostitutes, who came before him to ask him
to determine which of them was the mother of a baby. The evidence was ambiguous as
to which of the women was the true mother. Solomon, renowned for his wisdom, suggested taking his sword and dividing the baby in half. That suggestion induced the true
mother to give up her claim to the lying mother so as to assure her baby’s survival. The
true mother so revealed, Solomon awarded the baby to her.
The proposal to divide the house in two should induce the spouses to negotiate about
its value. Half a house is, typically, a useless commodity and, therefore, has no particular value, while the whole house may have a significant market value. Unless the two
parties can agree on a means of dividing up the asset’s value, they will each get nothing
(or close to it). This illustrates Ayres’ and Talley’s proposition that sometimes the best
way to induce bargaining is to compel the parties to do so by making the ownership of
the entitlement unclear or divided between them.
4.14. (p. 102) If two parties choose to litigate rather than settle, should the law presume
that the transaction costs between them are high and, therefore, award legal relief (compensatory money damages)?
This is a question that Ulen has used on his final examination several times. It is a
very difficult issue. There are several issues to think about here. If the transaction costs
between the parties were low, then they would have settled their dispute. And, as we
shall see in Chapter 10, the vast majority of disputes do settle. The best estimate is that
less than 5 percent of all disputes result in a trial. So, it does seem to be the case that if
they are willing to litigate, then perhaps the bargaining costs are high. But are there other reasons that people litigate—that is, other reasons besides the level of bargaining
costs? Sure. They might litigate because they are not communicating very well—an example of the Hobbes Theorem. They each might be overoptimistic about their chances
of prevailing at trial. The underlying legal issue at the heart of their dispute might be a
new issue about which the law is unclear, and so it is unclear what will happen. Also,
one of the parties may have a strong interest in having this matter of law cleared up or
changed in his favor because he has an on-going interest in this type of litigation.
4.15. (p. 106) If everyone has free access to a beach, there is a real danger that there will
be very little discretion in the use of this resource. The result may be that there are too
many people, too many cars, and too many conflicting activities (such as fishing and
swimming or free access and the building of beach homes). A rationing device is called
for to minimize these and other problems. One such rationing device is assigning private
property rights to the beach; another is governmental ownership of the beach but establishing rules of use of the beach and charging a user fee to those who make use of the
beach.
4.16. (p. 105) “Ecotourism” – short for “ecological tourism” – is a new phenomenon in
which people, usually those from developed countries with a deep interest in nature, the
environment, and ecological issues, travel to remote and distinctive parts of the world to
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see habitats and animals that are uncommon. For example, there are ecotours to the Arctic Circle, the Amazon, parts of Southern Africa, and like places. There is even an organization called The International Ecotourism Society (www.ecotourism.org).
To preserve the habitats that are of interest to ecotourists may require public ownership. While one might argue that a private owner might have a strong incentive to maintain the habitats if there were profits to be had from accommodating ecotourists, there is
the danger, with private ownership, that other uses, such as commercial uses, will also
be attractive. As a result, private owners might not preserve the habitats. Public ownership – or private ownership in a trust – will preserve the ecological character of these
rare habitats. The Nature Conservancy (see their website at www.nature.org) is an organization that uses privately donated funds to purchase property that has some ecological value and to put that land in a trust that will preserve it in an undeveloped state.
Chapter 5
In-Chapter Questions
5.1. (p. 122) The government-granted monopoly to the maker and inventor of Librium
ended when the patent expired. Prior to the patent expiration, the drug-maker earned
monopoly profits to reward them for their development of the drug. But after the patent’s expiration competition (or the threat of competition) caused the price to fall. (Why
shouldn’t a rational patent-holder charge less than the full monopoly price during the life
of the patent so as to discourage competitive entrants when the patent expires?)
5.2 and 5.3. (p. 122) If transaction costs are zero, one would predict that the two companies would contract around the problem surrounding a narrow patent. If Firm A never
made the initial discovery, Firm B would not be able to invest in its subsequent developments. Some cooperative solution should be reached where Firm B pays Firm A for
its research efforts. This is not necessarily the case where transaction costs are high.
Why not? If dominant and subservient patents are issued, then the gains from invention
may depend on the timing of the contract. Will the solution be closer to that reached under a broad or under a narrow patent law?
The “prospect” theory of patents, developed by Professor Edmund Kitch, views patents as a broad grant to explore around the area of the specific patent. (Kitch drew an
analogy to a mining prospector, whose claim was not narrowly defined but, rather,
broadly defined so as to create an incentive to find more valuable ore in the neighborhood of his precise claim and to keep others from crowding into his area.) There is
some interesting literature that now criticizes this theory of patents. See John E. Duffy,
“Rethinking the Prospect Theory of Patents,” 71 U. Chi. L. Rev. 439 (2004).
5.4. (p. 125) This is a delicate matter. We want the patent life (the exclusive right of the
patent-holder) to extend another term if the social benefits of so doing exceed the social
costs. Consider how private benefits are related to social benefits. Generally speaking, if
there are external benefits to an activity, then social benefits (which include the external
benefits) are higher than the private benefits. If the only thing that private entrepreneurs
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pay attention to is private benefits, then they do too little of the external-benefitgenerating activity. So, if an invention has social benefits, inventors may undervalue the
patent or invention. If the renewal fee is set too high (without taking into account the
social benefit of the invention), then the patent-holder might not renew when the time
comes to pay the renewal fee. A central point to see is that the renewal fee should be set
so that the patent-holder is comparing the social costs and benefits of continuing his or
her patent, not the private costs.
5.5. (p. 125) If the courts interfere with the patent process by ordering compulsory licensing, firms that were previously following a profit-maximizing strategy in marketing
the invention would experience a decline in profits. On the one hand, these monopoly
profits that the patent-holder is enjoying are precisely the reason that we grant (for a limited period) exclusive rights as an inducement to invest in inventions, innovations, and
improvements. On the other hand, if the patent-holder is behaving too egregiously
(whatever that means), then compelling the patent-holder to license his invention to others (presumably at a reasonable price) may mitigate the most extreme social costs of
monopoly. But clearly the greater the resort to compulsory licensing, the more this eats
into the incentive effect that the promise of time-limited monopoly profits has on future
inventors.
5.6. (p. 128) We assume that the invention allows the inventor to accurately predict the
weather during the growing season. Suppose that his invention allows him to determine
that the weather will be beautiful, and he concludes that there will be a bountiful crop at
harvest time. He further knows that a large crop means a large supply – that is, that the
supply curve of the crop shifts to the right. This will cause the market price of the crop
to fall after the harvest. Knowing this, the inventor may enter into contracts to sell quantities of the crop at a price slightly below that expected by others. (His invention is what
gives him alone accurate information about the post-harvest price.) When delivery time
comes, the inventor will be able to purchase the crop on the spot market at the depressed
price and deliver it to his customers for the higher price agreed upon earlier. The difference between what the inventor paid for the crop in the spot market and the price he receives from his promises to sell at the higher price contribute to his profit on the invention.
The point of the question is that sometimes one does not have to disclose one’s invention (and thereby receive a patent) in order to profit from an investment in innovation, invention, and improvement.
5.7. (p. 128) There is an extensive law-and-economics literature on this topic. See, for
example, the symposium issue of the Columbia Law Review (November, 1989) on corporate law issues and the chapter on insider trading in FRANK EASTERBROOK & DANIEL
FISCHEL, THE ECONOMIC STRUCTURE OF CORPORATION LAW (1989). See also REINIER
KRAAKMAN, PAUL DAVIES, HENRY HANSMANN, GERARD HERTIG, KLAUS HOPT, HIDEKI
KANDA, & ED ROCK, THE ANATOMY OF CORPORATE LAW (2004).
The gist of the literature is that insider trading may cause a rapid dissemination of information from insiders to market traders generally and that this may be an efficient
method of getting important information out. So, for example, if insiders learn that the
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forthcoming profit announcement will show great losses, they may attempt to sell their
shares quickly, before the price drops in response to the adverse report. But the very act
of flooding the market with sell orders will alert those watching the market that someone
somewhere has got some adverse information and will cause them either not to buy the
shares or to unload theirs, too. However, this may be a rough-and-ready way of getting
information disseminated and may, furthermore, unfairly advantage some groups of
traders over others, thereby damaging the general attraction of investing in the market.
5.8. (p. 134) At the margin, an additional year of copyright protection would have very
little influence on the production of copyrighted materials. This is because the present
discounted value of that benefit (that is, the value today of a benefit conferred many
years in the future) is likely to be very small.
5.9 (p. 134) This is a question about “derivative works.” The question is whether a copyright-holder is entitled not just to his or her creation but to the normal follow-on products, such as the production of a VHS tape or DVD disk of one’s theater movie. The
general proposition in copyright (but not in patent) is that the original creator is entitled
to some share – perhaps all – of the proceeds from derivate works.
5.10. (p. 135) One facet of “fair use” is that it does not detract from the economic value
of the copyrighted material. How might courts decide on what is fair or unfair? One
manner in which they do so is to create relatively bright-line rules for the circumstances
in which categorize the circumstances in which the user of copyrighted material may be
used without the copyright-holder’s permission—for instance, in the production of a
journalist’s article, in a book review, or as part of an educational enterprise.
The general argument in favor of a “fair use” exception to the general requirement
that a user must get the explicit permission of the copyright-holder is that it saves transaction costs and generates social benefits greater than its social costs. There are two distinct senses in which this is true. First, in the instance of educational use of copyrighted
material, the author or other creator would probably have consented to the use of his or
her copyrighted material for a very modest or even no fee. Simply hypothecating that
this deal has implicitly been made (as the vast majority of copyright holders would
probably do) saves everyone the transaction costs of explicitly agreeing to the deal.
Second, we all benefit from allowing journalists and reviewers to make limited use
of copyrighted material without the copyright holder’s permission in giving us an honest
review or story. The copyright-holder might have insisted on a favorable story or review
as a condition of licensing the use of his or her property. We don’t want that. We would
rather rely on the journalist’s or reviewer’s honest opinion. Allowing them to make “fair
use” of the material gets us closer to that goal.
See our Web Note about the Creative Commons.
5.11. (p. 135) Consider the problems that might arise if copyrights carried an indefinite
duration. Would it be possible to keep track of all the copyrights ever issued? Recently,
as one of the Web Notes indicates, Landes and Posner have proposed an indefinitely renewable copyright.
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The whole section on patents explains why patents are time-limited, and our discussion of the Orphan Drug Act in the Web Notes explains both why different patent lives
might be a good idea and how the Congress undertook to craft a longer patent life for
those drugs that affect a small patient population.
5.12. (p. 135) Consider the effect on the value of a trademark. If Coca-Cola licensed its
name to an inferior Cola producer, the value of the Coca-Cola trademark would fall. It
may be the case that the value of the Pepsi-Cola trademark also falls. Why? What about
the value of trademarks generally to consumers under this alternative? [p. 135]
5.13. (p. 138)
a. An example of the difference between ownership and governance in an organization is
the modern corporation. The owners are the shareholders, whose goal is, presumably, to
maximize the return on their investment. The managers are the corporation’s officers –
the Chief Executive Officer, the Chief Financial Officers, and so on. The fact that there
is separation of owners and governance (through the managers) means that there is a
“principal-agent” problem. The owners are the principals, and the managers are the
agents, whose task is to implement the goals of the principals.
A single-owner or family-owned enterprise is, typically, one in which ownership and
control are united.
b. The business section of a national or local newspaper will provide you with almost
weekly examples. The usual pattern is this. A corporation is not doing as well (financially) as some analysts think that it should, given its market position, its products, its customer base, and the like. This presents an opportunity for someone to purchase the corporation (or merge their corporation with the underperforming corporation), fire the
managers who are not using the firm’s assets to their fullest potential, and reconfigure
the corporation. This “market for corporate control,” as it is called, can lead to the more
efficient use of resources. It is sometimes a messy process and one that imposes costs on
those who suffer in the reorganization, but it works to push resources to higher-valued
uses. Joseph Schumpeter memorably called this process one of “creative destruction.”
5.14. (p. 142) Some of these collective enterprises work well – surprisingly so, in light
of the fact that economic theory predicts that they are likely to have governance problems. The great virtue of the “shareholder wealth maximization” model of corporate
governance is that it provides a clear guiding light by which to steer the corporation’s
affairs. If, for instance, the corporation’s value is not being maximized – as reflected,
say, in its stock value, then the owners (shareholders) may sell shares and put the proceeds into alternative investments that promise a greater return. That may result in a
drop in the corporation’s share prices (if many owners are disappointed and sell their
shares, the supply of shares may exceed the demand for them at the prevailing price; the
market for those shares can only clear at a lower price).
With some collectively owned enterprises the goal at which the enterprise is shooting is sometimes not clear—such as the “greater glory of God.” At other times, the goal
may be clear to the owners, but it may be difficult to tell whether a particular policy is
advancing toward or retreating from that goal. Additionally, decisionmaking within the
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collective enterprise may be cumbersome. There may be, for example, a practice of
reaching decisions by consensus, rather than by, say, majority vote, and it may be possible to reach consensus only by talking and talking or by compromising so much as to
eviscerate the enterprise’s strategies.
There is a wonderful discussion of the shortcomings of a collective enterprise in Professor Robert Ellickson’s discussion of Hutterite land practices in his “Property in
Land,” 102 Yale L.J. 1315 (1992).
5.15 and 5.16. (p. 146) Post, the plaintiff, has sued Pierson, the defendant, for interfering
with his property. Post had been chasing a fox, apparently as part of the sport of foxhunting (or “riding to hounds”) when Pierson intervened and killed and carried off the
fox. The lower court found for Post, and Pierson appealed. The highest court in New
York State reversed that judgment. The issue is how to establish a property right to a
wild animal: must the pursuer have actual possession – “manucaption” – of the animal
(the majority’s view), or is it enough simply to exhibit the intent to catch or kill the animal by chasing it (Justice Livingston’s (minority) view)? One way to resolve the issue is
to ask if some legitimate social goal is more efficiently advanced by one rule rather than
another. There are really two closely-related legitimate social goals suggested. The first
is to minimize the considerable damage done to crops and barnyards by foxes by increasing the incentives of hunters to pursue foxes. The second is to maximize the enjoyment of those who are riding to hounds. (Today, depredations to farms by foxes and
the sport of fox hunting are not closely related, but in 1805 they were.)
One side (the minority) argues that the rule of giving the ownership claim to those
originally pursuing a fox will create a heightened incentive for the killing of foxes. Under the majority’s alternative rule of manucaption, a pursuer of these “wild and noxious
beasts” could pursue a fox all day only to see another person rightfully take the fox and
that that result could lessen the incentive to hunt foxes.
But this distinction between the rules isn’t entirely correct. The majority’s rule might
lessen the fun of riding to hounds, but it does not necessarily lessen the incentive to kill
foxes in less sporting ways. In fact, the rules seem equally efficient at contributing to the
objective of killing foxes in order to reduce the damage they do to farms. The choice
between the rules must be made on other grounds. What may be said in favor of the majority view is that the actual possession rule is clearer, less subject to misinterpretation,
and easier to enforce than the intent rule.
See Dhammika Dharmapala & Rohan Pitchford, “An Economic Analysis of ‘Riding
to Hounds’: Pierson v. Post Revisited,” 18 J. L., Econ., & Org, 30 (2002).
5.17. (p. 149) The continuing conflicts over fishing rights between countries and the increasing value of resources to be found in the open ocean have led to ever-broadening
claims to territorial waters. But this broadening of claimed national rights conflicts with
the open-access problem surrounding the sea. That is, it is costly to enforce these broader claims of national right.
5.18. (p. 149) In order to answer this question, one must consider why the rule concerning water took the shape that it did in each historical setting. Why might riparians have
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land? Why is the legal rule different in different parts of the United States? Is this a story
about political power, or is it about economic efficiency? What role do you think that
resource endowments might play in these legal differences? That is, will the quantity of
rivers in an area affect water law? How and why?
5.19. (p. 154) The “electromagnetic spectrum” is a term used to describe the entire range
of light radiation, from gamma rays to radio waves. When the spectrum first began to be
used commercially in the early 1920s, there was no system for allocating rights. In the
1930s Congress rejected a market-based method of allocating rights to the spectrum in
favor of allocating the frequencies through application to the Federal Communications
Commission (FCC). Applicants must demonstrate that their receiving the right to use a
portion of the spectrum serves the “public convenience and necessity.”
Over the years, new technologies have made additional frequencies of the spectrum
commercially useful. How should these new frequencies be allocated: by the rule of adverse possession, by a mandate from the FCC, or through the market? When would it
matter for efficiency reasons? Because of the advent of new technologies such as cellular phones and personal communications services, there is a great deal of interest in this
topic today. The FCC has used game theory to devise interesting new methods of auctioning off portions of the spectrum for these new uses.
5.20. (p. 155) Because the representatives of the white settlers made the legal rules and
because the Indians had little representation in the formation of those rules, the rules favored settler-acquisition of Indian land. Additionally, the high costs to the Indians of
monitoring white settler behavior and a court system that favored the settlers hastened
the transfer of land to the whites.
5.21. (p. 155) One consequence of this rule is that the original owner would have to
spend more time monitoring her property under the gradual depreciation rule than under
the sudden-dispossession-after-10-years rule. That might be a more efficient practice
than that of swooping in in the last week of the 10-year period, asserting one’s claim,
thereby disappointing the adverse possessor.
5.22. (p. 155) Compare the costs of searching for the owner and bargaining with her
with the value of the lost object. Will the efficient lower bound be the same in all circumstances?
5.23. (pp. 155-56) There are various social goals at issue with regard to property lost or
abandoned at sea. The rightful owners have an interest in recovering their property; society has interests in keeping the chain of title unbroken, in keeping shipping lanes clear,
and in minimizing debris that floats onto beaches. Salvors are typically awarded their
expenses plus a fraction of the value of property they recover. This is true whether the
salvor explicitly contracted with the rightful owner or came across it by chance. A rule
of granting complete ownership to a salvor without requiring an effort to identify the
rightful owner would create the sort of moral hazard problems and title controversies
that the text said the law of lost property seeks to avoid. (Notice that these problems may
not arise if the rule is that the abandoned property belongs to the state.) The rule of
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granting the salvor an award of his expenses plus a fraction of the value of the recovered
property creates an incentive for chance salvors, as well as professional salvors, to
search for lost property at sea and to return it to its rightful owners. (See the discussion
of whether and how to enforce a contract between a rescuer and the person rescued in
Chapter 7.)
5.24. (p. 159) There is no clear answer to this question, which is precisely the point of
asking it. The rule of thumb, envisioned by the Rule Against Perpetuities, is that a generation lasts about 20 years – presumably on the theory that that is how long it takes
someone to mature, get married, and start having children. But why should that be the
period of time for measuring lives for bequest purposes? And could one not argue that
the measure should alter to reflect changing social mores of what constitutes a reasonably foreseeable lifetime and who wants to leave an estate across generations? In 1900
the average American lived 45 years. Today the average lifespan is close to 80 years.
And it is widely said to be the case that a baby born today, in 2007, can expect to live
100 years. Looked at in historical perspective, at the time the Rule Against Perpetuities
became law, the only people who had estates to pass on were wealthy landowners, and
they lived a reasonably long (by modern standards) time. But the vast majority of people
led lives that were, in the words of Thomas Hobbes, “solitary, poor, nasty, brutish, and
short.” And they had nothing to pass on to their heirs and assigns. Today wealth is much
more widespread so that many more people have estates to dispose of at death. Ought
we not to rethink the Rule Against Perpetuities as lifespan and the number of people
who might want to impose generation-skipping practices change?
For an interesting and entertaining argument that these matters of providing for our
descendants and the future are a mistake, see Stephen Pollan, Die Broke: A Radical
Four-Part Financial Plan (1998).
5.25. (p. 159) Circumvention costs are the costs that the owner of the property incurs in
attempting to work around the law. Depletion costs are the losses due to the inefficient
use of the property.
5.26. (p. 159) Generally, even if, as part of a bequest, the testator set aside enough money to deal with any future legal controversies that might arise in complying with the bequest, that would not fully deal with the social inefficiency of a bequest’s stretching too
far into the future. This is because the testator’s concern would only be with the private
costs of compliance, not with the social costs. See if you can show this graphically –
namely, that the marginal social cost of complying with a bequest exceeds the marginal
private cost.
5.27. (pp. 160-61) Analyze the decision of the ship’s captain. One would suspect that he
possessed the best information concerning the expected damages to his ship had he left
the dock and the expected damages to the dock from staying moored. In light of this information, does it make sense for him to be absolved from paying for damages to the
dock?
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5.28. (p. 162) Consider the types of people society wants in juries and the types of people who offer their services as jurors. Do these necessarily coincide?
5.29. (p. 168) Consider the number of people involved in each situation in order to determine whether the externality is private or public. A market can exist in many of these
situations. For instance, an apple grower may allow free access to his apple groves in
order to encourage people to raise bees. Ships using a certain port may have to pay a fee
to maintain the lighthouse.
5.30. (p. 168) Since the third good is consumed by all persons in the economy, the utility
of person j is: uj 5 uj(x1j, x2j, x31, x32, x33 ..., x3n).
5.31 and 5.32. (p. 172) There are a large number of actors involved on the plaintiffs’
side. This can create high transaction costs. On the other hand, the people who are adversely affected by the cement plant are a limited group, seeming to make this a private
nuisance or bad. Even though the bad may be private, there may still be high transaction
costs among the limited number of victims involved.
5.33. (p. 172) If the cement company tried to bargain with its neighbors, one possible
problem might be a hold-out problem. One neighbor or a group of neighbors may try to
extract a large payment in order to get their approval.
Another issue with which the cement company must deal is subsequent owners of
the neighboring properties. The company certainly does not want each successive owner
to complain of the dirt, smoke, noise, and vibration. So, if the company settles with the
current owners, it would also insist that this settlement be binding on all subsequent
property-owners. In the words of the law, this settlement would “run with the land” and
not be specific just to the current owners.
As a result of such an agreement running with the land, the externality of the cement
company’s production has been internalized to the prices of housing in the neighborhood. That is, the prices of the homes near the cement company will be lower to reflect
the disamenity of their situation. Potential owners who are not so sensitive to their surroundings will find these now lower-priced homes more attractive. Homes that are further away from the cement company will presumably be higher-priced to reflect their
relative amenity.
Consider Question 5.35 in light of this discussion.
5.34. (p. 172) The court granted the plaintiffs a “once and for all” settlement by awarding permanent damages. This is accompanied by a servitude on the land, which transfers
the court’s decision onto all subsequent owners of the property.
5.35. (p. 172) Notice that temporary damages create no efficiency problem: if money
damages are compensation for a fixed amount of harm inflicted in a past time period,
then if, in the future, the amount of harm increases, then so will the subsequent amount
of damages. Are permanent damages amenable to this adjustment? Certainly. They may
be considered as the present discounted value of the amount necessary to compensate
the neighbors for a given level of harm for a specified number of future time periods. If
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the level of harm rises or if the number of future periods during which harm is inflicted
rises, the permanent damages previously awarded become under-compensatory. The
neighbors should have a new cause of action to have the level of permanent damages
increased.
5.36. (p. 172) If all property rights (rights to air, water, etc.) were explicitly assigned and
the transaction costs of bargaining were zero, then an efficient outcome would en-sue.
For instance, if the cement company owned the right to pollute, then the plaintiffs could
approach them with a contract to reduce emissions. However, because all rights are not
assigned, and transaction costs are high, considerable effort is spent on litigating these
decisions.
5.37. (p. 174) A flat price line indicates that the market is perfectly competitive. An infinite amount of the good will be provided at price P0.
5.38. (p. 174) A new health hazard would raise the marginal social cost of cement production and decrease the efficient level of production. Presumably this means that a new
or a greater injury is being inflicted on the neighbors. If the company has purchased –
through permanent damages – the “right to pollute,” the neighbors could claim that the
deal needs to be renegotiated: the harm is greater than the earlier deal imagined.
5.39. (p. 177) The question has been phrased so that there is no doubt of the legitimacy
of the government’s taking: it is truly for a public purpose—the provision of a public
good. What is at issue here is the computation of “just compensation.” The situation in
which a monopolist (one seller) faces a monopsonist (one buyer) is known as a “bilateral
monopoly.” In the absence of governmental intervention, the price and quantity at which
an exchange takes place in a bilateral monopoly are indeterminate. In our example of the
governmental purchase of a parcel of land for use as a satellite tracking station, there is
no controversy about the quantity of land to be purchased. The dispute is about the price.
The monopolist landowner hopes to maximize his profits by charging a price that is consistent with marginal cost being equal to marginal revenue. The monopsonist (the government) wishes to pay as little for this parcel as possible. If there were bargaining between the government and the parcel owner, the price would be somewhere between the
monopoly and monopsony price depending on the relative bargaining skills of the parties. If there were no constraint on the government, then it is likely that the price paid for
the parcel would be close to the monopsony price. But the existence of the just compensation requirement for compulsory sales to the government should compel the government to take the parcel at a price closer to the perfectly competitive price.
5.40. (p. 178) The Kelo case was greeted with a great outburst of outrage. To some, it
looked as if the government of New London, CT, had taken private property and handed
it over, at a greatly reduced price, to a private pharmaceutical company. The city’s theory was that if the company would remain in downtown New London (a blighted area),
the city might be able to become a more attractive economic entity for all of its citizens
and that if Pfizer left New London, then the entire economic future of the city was in
jeopardy.
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Of course, the question is whether the government has the right to take private property in this fashion as part of a plan (deeply involving private profit-maximizing companies) to restore community economic health. There is no obviously correct answer to this
question. Whatever theoretical arguments we might debate, the fact of the matter is that
the U.S. Supreme Court (not enthusiastically) said that this use of the power to take private property was consistent with the Constitution.
It is interesting to note that since the holding in Kelo local and state governments
seem not to have taken the ruling to have given them a broad license to take private
property as part of novel and expansive urban redevelopment plans. It is possible that
the uproar with which the decision was greeted sent a strong signal to governments to be
cautious in using taking as part of an expansive urban redevelopment plan.
5.41.
(p. 178)
a. Suppose that the law defined “just compensation” to be “fair market value” of
the property taken plus 20 percent. How might that influence both the government in its decisions to take land and private property owners in their decisions
to plan for or resist taking? As to the government, the 20 percent add-on clearly
raises the cost of taking and might, therefore, make the government less likely to
take private property (as opposed, say, to regulating property). But because the
20 percent applies to all property taken, then the add-on would not bias the government in its decisions as to which property to take. So, the only effect would
be the possible one to discourage taking. But our intuition is that this discouragement would be minimal.
As to private property owners, the 20 percent add-on might make them less
likely to resist taking than they would be if they could only expect to receive fair
market value.
b. This alternative method – having the property owner declare a value of the
property, pay property (and other) taxes on that declared value, and then have the
government compensate the owner at that level in the event of taking – has much
to be said for it. The principal argument in its favor is that it presents a tractable
way for property owners to declare any subjective value they attach to their
property. But because they will be obliged to pay property taxes on that declared
(subjective) value, it is costly to declare a value in excess of the fair market value. Of course, some people may declare a higher value on speculative or strategic grounds—they may anticipate their property’s being taken and see this as a
way to get more for the property (even though they may not truly attach any subjective value above the fair market value to continued ownership of the property).
The only clear argument against the plan might be its administrability. How
often, for example, might someone be allowed to alter the declared value?
Clearly they cannot do so in the months or weeks before their property tax bill is
due. But with that exception can they do so once per year? Once every five
years? And what about absentee owners? Will they be allowed to participate in
this scheme or must one actually inhabit the property? What if you do inhabit the
property but you also rent out some of it? Can you still participate? And is com25
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mercial property excluded? Why should it be? Can’t one have a subjective attachment to commercial property, such as a family farm? Or does this procedure
apply only to single-family residential property?
5.42. (p. 184) The homeowner might believe that the terms offered by the Commission
do not at all mimic what he would have been willing to pay to receive a building permit.
He may well believe that he is either entitled to the building permit or he is not—that the
government should not use its strong position to exact a higher price for a permit than he
should have to pay. As we indicate in our answer to the next question, the homeowner
might recognize that exchanging the building permit for a path to the beach (but not
along it) may make some sense. But that the exchange of the permit for a path along the
beach goes too far in the sense that it overcompensates the public for the social harm
that may be done by the building of a second story on the Nollan home.
5.43. (p. 184) Presumably, the harm that the addition to the Nollan house did was to
block the view of the ocean from the roadway. If that is the harm, then a corrective
would be to give those who want to view the ocean or beach an alternative method of
viewing the ocean or beach. A path to the beach, rather than along the beach would
seem to accomplish that end and mitigate the harm.
5.44. (p. 184) Suppose that the government wants to protect the environment and takes
property, such as vacation homes, on sand dunes. Because that property is subject to
damage through flooding and other natural disasters, homeowners have typically been
offered disaster insurance by the federal government to compensate them when their
homes are damaged by those occurrences. In taking the private property thus protected
by disaster insurance, should the government include in its compensation amounts, the
increase in the value of the property owing to its being insured? This is a difficult question. The availability of the federally subsidized insurance induced the people to stay on
the dunes and to rebuild when there had been disasters before. If the owners had not had
the insurance, then the value of their property would have been less and they might have
been induced not to rebuild. Or they might have bought vacation homes in different locales. The insurance may have been, from a social point of view, a mistake. It may have
encouraged people to locate there when social values would have been enhanced by their
not being there. If you believe that the government insurance unfairly induced families
to remain on the dunes in their homes, then you may argue that the families are entitled
to the full value of their homes (that is, including the increase in value due to the availability of federal insurance) if they are taken.
On the other hand, you may believe that the homeowners should never have had that
insurance in the first place. And if you believe this strongly enough, you may be in favor
of compensating them, if their homes are taken, only up to the extent of the homes’ values if there had been no insurance.
Chapter 6
In-Chapter Questions
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6.1 (p. 190) Regulations typically correct for market failures, while efficient default
rules reduce the transaction costs of bargaining. How do the concepts of “transaction
cost reduction” and “market failure” apply to tort law? Bargaining is not really possible
between the vast majority of people who will meet in an accident. So, the transaction
costs that are to be reduced certainly are not those that are involved in pre-accident bargaining. The market failure in most accidents is an externality. By taking precaution
someone can confer a benefit on another – an external benefit – by making accidental
injury less likely and less severe.
6.2. (p. 192) The court would need to decide what amount of money would perfectly
compensate the burn victim for her one week of pain. This is extremely difficult to calculate, thus illustrating the problem. Do you have any idea how much money you would
accept in exchange for suffering one week of intense pain? We doubt it.
6.3. (p. 192) The uniqueness of the estate and the subjective valuation of the estate by
the family makes perfect compensation difficult.
6.4. (p. 196) This is a fact pattern based on the case British Columbia Electric Railway
Co. v. Loach, which we discussed in some earlier editions of the book and that we’ve
placed on our website. Causation is a notoriously difficult issue in the law, and here there
is fault on both sides of the accident – the car driver in not maintaining her car properly
and the train operator in not maintaining its brakes the proximate cause Notice that once the
car had stalled, the train had the last clear chance to avoid the accident. Presumably, if the
train’s brakes had been in working order, then the train would not have smashed into the
stalled car on the tracks.
6.5. (p. 198) At what speed does the driver enter the forbidden zone?
6.6. (p. 198) Part of the answer has to do with the commonness of dogs as pets and the
unusualness of keeping a pet tiger, and the domestication of dogs and the basically wild
nature of tigers. An old legal adage says that every dog is allowed one bite. What does
that mean?
6.7. (p. 199) The three elements of a tort are: harm, cause, and breach of a duty of care.
We’ll do one and leave you to do the others. In situation (a), each motorist has a duty of
care to drive within the rules of the road and the prevailing conditions. If one of them
fails to stop at a stop sign and an accident results, then that failure to stop is a (if not
“the”) cause of the accident. And whatever injuries the victim suffers constitute the
harm.
6.8. (p. 205) The rule of strict liability with perfectly compensatory damages gives the
victim no incentive to avoid the harm. On the other hand, the rule of no liability gives
the injurer no incentive to avoid the harm.
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6.9. (p. 205) The injurer has no incentive to take all accident-avoiding precautions because he is liable for only half of the damages. And the victim has no incentive to take
care to avoid all harm because he is liable for only half of his own injuries.
6.10. (p. 208) Once each party is taking efficient care, there is no incentive for either
party to change the amount of care he is taking.
6.11. (pp. 210-11) Regardless of the form of the negligence rule, the victim has an incentive to take precaution (such as wearing her seat belt) to minimize her residual liability.
6.12. (p. 211) No. Whatever the form of the negligence rule, the victim has an incentive
to take any care that can minimize her residual liability. But also remember that in the
typical circumstance, one doesn’t know ex ante whether one is going to be a victim or an
injurer in the next accident.
6.13. (p. 213) Both parties are the bearers of residual liability.
6.14. (p. 213) See Table 6.1. The argument in favor of strict liability when there are activity-level effects is that the potential injurer has an incentive to discover every action
or precaution that reduces his or her expected liability. If there is increased expected liability from engaging in more of the activity, the person subject to strict liability has an
incentive to discover that and to limit their activity to the expected-liability minimizing
level.
6.15. (p. 213) The level of activity of airlines and railroads can be objectively measured
in several ways – the number of passengers or freight carried, the number of miles traveled, etc. However, some activities are difficult to measure. For instance, the front step
of a home could be perfectly maintained even though the homeowner has not engaged in
any maintenance activities. Could the activity level at the home be the number of guests
who approach the front door?
6.16. (p. 217) To determine whether to incur the $25 expense of keeping the bargee present, we must compare the marginal cost of precaution ($25) with the marginal benefit
(the reduction in the expected accident costs from taking the precaution). The rule for
determining x• is to choose the x for which w • p•( x) A . If w • p•( x) A , then x • x• , and
the injurer is negligent. If w • p•( x) A , then x • x• , and the injurer is not liable. Here, w =
$25, A = $100,000, and p•( x) = 0.0005. Thus, p•( x) A = 0.0005($100,000) = $50. Because w • p•( x) A , the barge owner would be negligent if he did not pay the bargee to be
present. [p. 217]
6.17. (p. 217) Apply the logic of Figure 6.6 to this question. Will “too few” or “too
many” accidents occur?
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6.18. (p. 220) Use the standard graph for showing the social-cost minimizing level of
care and then use that graph to show what the effect would be of defining a standard of
care that is greater than that social-cost minimizing level of care. Will a rational potential injurer comply with the legal duty of care or with the social-cost-minimizing level of
care?
6.19. (p. 220) This is an extremely complicated question. Under all forms of negligence,
the rational potential victim should presume that the rational person who injures him
was complying with the legal duty of care and will not, therefore, be liable for his accident losses. So, the potential victim should always take all cost-justified precaution. What
complicates this scenario is two things. First, people do not know whether they will be victim or
injurer in their next accident. Second, if the legal duty of care is set at a level different from the social-cost-minimizing level of care, then there could be problems. It still makes sense for the potential victim (if he knows he’ll have that role) to assume that the other party will comply with the
legal duty of care and, therefore, not be held liable. But suppose that that level is below the socialcost-minimizing level of care so that accidents are more frequent and severe than they should be.
Would that change the way in which the potential victim should behave? Should he or she take
more precaution than he otherwise would? Perhaps so. But all this presumes a great deal of
knowledge about where the legal duty of care lies, where the social-cost-minimizing level of care
is, what role one is going to have, and so on. The simplest thing to do is simply to take all costjustified precaution, regardless of whatever else is going on.
6.20. (p. 222) Excessive damages awarded by the court will increase the expected liability of the injurer, but will not influence her level of precaution. The excess damages will
simply shift the expected accident cost curve up. But that will not shift the level of due
care to which the injurer is to be held.
6.21. (p. 222) This is related to the fact that small random errors in the legal standard
will probably cause the injurer to increase precaution. The simple reason is that when
faced with uncertainty about liability, it is cheaper to take extra precaution than to
chance an accident’s occurring, a trial’s taking place, and being held liable.
6.22. (p. 225) Strict liability excuses the plaintiff from proving fault by the injurer. This
lowers her cost of suing the doctor. But that might lead to more malpractice actions so
that even though the administrative costs of each action was less, there might be more
total actions and, therefore, greater total administrative costs.
6.23. (p. 225) Begin by asking what the best way for a manufacturer to protect the users
of his or her ladder from injury from ill-designed rungs and then see the extent to which
regulation or case-by-case adjudication is better able to reach that optimum. Presumably,
manufacturers should build ladder rungs so as to include all cost-justified safety
measures. So, let us assume that there is a rising cost of building ever more secure ladder
rungs. The manufacturer’s problem is to determine where on that rising line to settle.
Guidance can come either from a compulsory standard imposed by regulator or a duty of
care imposed by a court in resolving an actual case or controversy.
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How would a court resolve this matter on a case-by-case basis? They would probably apply the Hand Rule, determining what the expected accident losses from rung collapses are (the probability of an accident’s occurring, which, in this instance, would certainly be influenced by the distribution by weight of ladder-users, times the likely accident losses). Recognize that the manufacturer would probably be making exactly this
calculation in an effort to avoid liability. In addition, the manufacturer should warn his
or her customers about weight limits on the rungs of the ladder. Failure to do so would
certainly constitute negligence.
How would a regulator decide where to set the mandatory weight capabilities of ladder rungs? We’re not sure. But if they are behaving rationally, they should more or less
duplicate the process we have just described—determining the cost-justified level of
precaution supplemented with warnings.
One of the fears with respect to regulation is that there will political pressures to do
more or less than this optimum. Moreover, the regulatory system may not be as flexible
as the case-by-case adjudication system. If, for example, there is a change in technology
that makes the precaution for stronger ladder rungs cheaper and more effective, the caseby-case adjudication method would have an incentive to alter the standard of care to take
account of that (even without a court case being brought). Would the regulator’s have
the same flexibility?
6.24. (p. 226) One inefficiency might result if the seller is an inefficient producer of one
of the joint products. Or the purchaser might be able to produce or to buy one of the tied
products more cheaply elsewhere.
6.25. (p. 229) The contributory negligence defense in strict liability (something that does
not really exist) exonerates the injurer from liability if the victim is negligent. In Quadrant IV the victim is negligent.
6.26. (p. 229) In Quadrant II, the victim is not negligent and, and therefore, the injurer is
liable under strict liability.
Chapter 7
7.1. (pp. 234-35) Three hypotheses might explain the limited use of seat belts. First, the
decision to wear a seat belt is a utility-maximizing decisions made by fully informed,
rationally self-interested economic actors. They wear seat belts up to the point at which
the benefits exceed the costs but not beyond. So, whatever they do is optimal (assuming
there are no external effects from the decision about whether to wear seat belts).
A second hypothesis is that people fail to wear belts because they have made an inaccurate estimate of the benefits of doing so. If so, then the public policy corrective is to
get them the correct information. That might be done through public service ads on TV
or in newspapers and magazines.
A third hypothesis holds that people misestimate the benefits from wearing seat belts
because of an inability to make the relevant calculations, not because of a lack of information. People might be over-optimistic about their driving abilities and believe, as a
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result, that they do not need protection from automobile accident injuries. If so, then the
solution might be mandatory safety measures, such as mandatory air bags. The alternative of allowing people to purchase seat belts or airbags only if their own private calculations indicate that they are cost-justified is not to be trusted to minimize the social
costs of accidents.
7.2. (p. 240) Subrogation clauses are almost certainly efficient. We have just explored,
in this section, the possibility that costly litigation might deter victims from bringing an
action for compensation against the person who injured them and the further possibility
that this might muddy the signal about the appropriate amount of precaution that a potential injurer should take. But the fact that the victim’s insurer may have, through the
subrogation clause, an interest in proceeding against the injurer or the injurer’s insurer
for indemnification of the amount that the insurer paid to the victim diminishes the adverse effect of the victim’s not bringing an action against the injurer. [p. 240]
7.3. (p. 243) Recall our discussion in Chapter 4 of the distinction between a private bad
(an external cost imposed only on one person or a very few people) and a public bad (an
external cost imposed on many parties). We argued there that the appropriate remedy for
a private bad was an injunction because that remedy clearly delineates rights and induces the parties to solve their disagreement through negotiation. For a public bad the costs
of achieving a bargaining solution are too high so that the court must undertake a hypothetical market transaction and determine, through the levying of compensatory damages, the appropriate price to impose on the wrongdoer. The same factors apply to the issue of settling disputes when litigation is costly. If only a few parties are involved, bargaining costs are low and a settlement is likely. If many parties are involved, bargaining
costs are high. It is possible that if the bargaining costs exceed litigation costs, a trial
will result. We will return to the important issue of litigation versus settlement in the next
chapter.
7.4. (p. 243) Under any form of the negligence standard, the plaintiff needs to prove
harm, cause, and breach of a duty of care. Unless the compliance with the duty of care is
straightforward—as would be the case if the negligence was per se—that is, so obvious
as to be self-explanatory, such as chucking a box out of a window—or compliance with
a bright-line rule, demonstrating that the defendant-injurer took all cost-justified precaution may be costly. Additionally, if there is a defense of contributory negligence or the
standard is comparative negligence, the defendant-injurer might examine the victim’s
behavior for cost-justification. That could add substantial administrative costs to the litigation.
In contrast, under strict liability the victim need only show harm and cause.
So, the per-litigation cost under strict liability is less than under negligence. But it is
possible that the lower cost for each harm litigated under a strict liability standard will
induce more litigation and the higher cost of establishing liability under negligence leads
to fewer trials and fewer accidents. In short, we are not sure whether the total administrative costs of a strict liability system would be less or more than those of a negligence
system.
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7.5. (p. 245) Clearly, the employer has a duty to do a reasonable check on the qualifications of an employee and to continue to monitor the employee’s performance to make
sure that the employee does, in fact, have the qualifications necessary to do the job. If
the employer fails to perform due diligence before hiring the employee or fails to monitor that employee’s performance, then the employer ought to be liable for the employee’s torts done in pursuance of that employee’s regular assignments. This possibility of
liability will create a strong incentive for the employer to take due care.
But if the employer has done all that it might reasonably do to check the employee’s
qualifications and performance, then it is the employee who ought to be held liable
(even if he or she does not have the resources to compensate the victim). To relieve the
employee of all liability would create an unfortunate incentive for prospective employees to lie about their abilities.
7.6. (p. 245) The justification for the distinction was apparently that although parents
could not, at reasonable cost. control their children’s actions, husbands could at reasonable cost control their adult wives. We wonder whether that is still true.
7.7. (p. 245) We will see in Chapter 8 that contract law treats a person who is drunk as
incapacitated, so that a promise that a drunk makes is unenforceable. Similarly, tort law
recognizes that a drunk is no longer capable of making reasonable decisions about precaution although his condition creates a high probability of causing harm. One way to
reduce this probability or to make accidents involving drunks less severe is to make sober people responsible for the drunk’s actions. As between the drunk and the bartender
or social host, there is now a situation of what we have called “unilateral precaution”:
only the sober bartender can guide the drunk into taking adequate precaution. It is worth
thinking about whether the bartender or social host should bear complete or only partial
liability for the drunk’s action. Are social hosts more likely to help if liability is shared
with the drunk? Will helpers avoid drunks if they realize they become fully responsible
for the drunks’ actions? If so, can this effect be reduced by applying comparative fault
principles to the helper?
7.8. (p. 250) The 50-50 rule from admiralty law is a rough-and-ready method of inducing care where both parties are at fault. The value of this device is that it saves the potentially large administrative costs of making a finely tuned or more accurate assessment
of the fault on both sides. The key issue is whether that rough-and-ready apportionment
induces optimal precaution. And to our knowledge no one has investigated whether that
is the case.
Please note that the next two questions are out of order in the text.
7.10. (p. 253) Reconsider Figure 6.7 in the Appendix of Chapter 6. Enterprise liability is
a situation where the victim bears the liability only in quadrant III, but the level of precaution legally required of the injured party is exceedingly low. Similarly, the precaution
legally required of the defendant is exceedingly high. As a result, potential injurers are
almost absolutely liable, and potential victims are almost completely exonerated. It is
not clear that this will change matters from a setting of strict liability.
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7.9. (p. 256) This is a complicated question, requiring some strong assumptions and
some fancy calculations. The strong assumptions are that V makes rational calculations
about costs and benefits, can accurately estimate and evaluate the risks that he or she
faces, and knows about discounting to present value. Also, we want to keep our focus on
the fact that we want to accomplish two things simultaneously—compensating V’s heirs
for the harm he suffered and deterring people like V’s employer from negligently exposing people to this risk.
We begin by noting that V’s willingness to accept $15,000 for exposure to this risk
implies a valuation that he places on his life. So, if we assume that that amount compensates him for the marginal increase in the likelihood of death—the increase from 0.01 to
0.02 in the likelihood of death in 20 years—and that the accident losses 20 years from
now are A, then according to the Hand formula,
Solving for A,
And that gives A = $1.5 million.
There is a potential complication that arises from the fact that V spent $1,000 moving to another town shortly after being exposed but 20 years before becoming ill. This
action did not give him any relief, but it indicates that V valued not being injured. In a
way, he was willing to take $1,000 of precaution to avoid the loss of life. You might
compute the future value of $1,000 today and assume that the move gave him that much
pleasure over the ensuing 20 years and subtract that amount from the $1.5 million.
7.11. (p. 268) Remember that in the rent control example in Chapter 2, a cap was placed
on the amount of rent that landlords could charge, on the assumption that that maximum
price was below the market-clearing price. The result was a shortage of housing—that
is, the demand at that price exceeded the supply. More people wanted apartments at the
capped price than were being supplied by the market. This created a housing shortage
and problems such as fewer improvements in existing structures and black markets for
apartments.
Suppose that states place a monetary cap on damages in tort. What are the predictable effects? Presumably, there will be no effect on those accidents that have relatively
minor injuries because the compensable amount will be below the cap. But for major
incidents that have losses above the cap, there may be adverse consequences. First, potential injurers may not take adequate precaution against these major incidents. As a result, those incidents may be more frequent or more severe. Second, if potential victims
figure out that they are not going to be fully compensated for major injuries, they may
respond in various ways, most of which involve inefficiencies. For example, they may
take out more insurance; they may take much more precaution than they otherwise
would, including avoiding activities, routes of travel, and places where there might be
high-loss accidents.
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7.12. (p. 268) Be sure that you understand why your answer will differ if the legal standard is negligence or strict liability.
7.13. (p. 268) Plaintiffs’ incentive to ask for punitives might be diminished by the proposed scheme. If the plaintiff can recover none of the punitives, then he has no incentive
to ask for them. But he might get some utility from having his favorite charity enriched.
This may mitigate the disincentive to ask for punitives, but it is unlikely to remove it
entirely.
This is the opposite extreme from the current case in which plaintiffs have a strong
(and probably inefficient) incentive to ask for punitives in a wide range of torts, even
where punitive damages are unwarranted. Neither extreme is efficient. Some compromise is necessary: perhaps the appropriate public policy is to allow successful plaintiffs
to receive a fraction of the punitive award with the bulk going to the state or to an umbrella charitable organization.
The jury might be more willing to award punitives if they knew that the award
would not necessarily enrich the plaintiff.
7.14. (p. 270) If an employee waives the right to seek compensation if he is injured on the
job, he transfers the liability from himself to the firm. Why would he agree to such an action? Presumably he believes that that waiver makes his continued employment more likely or
more rewarding. It is also possible that the employer will be more willing to assign risky tasks to
the employer who waives a claim to compensation. All of this assigns, as does a UTC, compensation to a different party from the person injured.
7.15. (p. 273) In the first contracts chapter, Chapter 8, we will consider what are called
“standard form” contracts. Those are The elective no-fault proposal, like the UTC, imports contract principles into tort law where (contrary to our general assumption about
tortious situations) the costs of bargaining between injurer and victim are low. And presumably this contract-like solution will allow the parties to allocate risk more efficiently.
Chapter 8
8.1. (p. 280) When the nephew gives the uncle the peppercorn, he seeks to make the
promise enforceable by the presence of consideration. If courts only require that there be
consideration in order for a promise to be enforceable (and do not inquire into the adequacy of the consideration), then the bargain is likely to be enforceable. But modern
courts are not so formalistic that they would not see this subterfuge. Rather, modern
courts will see to determine if the consideration was roughly adequate (and we really
mean “roughly”) if they think that this was a genuine bargain. Or if they believe that this
was a gift promise, then under modern understanding they will inquire whether the
promise (regardless of the handing over of a peppercorn) would have induced reasonable
reliance by the promisee (the nephew) on the enforceability of the promisor’s intention
to convey the gift.
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8.2. (p. 286) When the offers were made and accepted, the parties to the contract wanted
enforceability and in both instances, a reasonable donee or promisee would have expected that the donor or promisor intended to go through with the deal.
There is much more about donative promises in the Web Notes.
8.3. (p. 286) If the second player performs the contract, the first player can expect to receive a profit of 0.5. Therefore, the second player must compensate the first player for
the value of the investment and the services she would have provided.
8.4. (p. 286-87) Consider again the car dealer promising to hold the new Chevrolet for a
period of time. At the time the bargain was made, the car dealer calculated the probability of selling the car to the current party—that is, of this buyer’s not going through with
the deal at the later date—and the probability of somebody else’s walking in and offering to buy the car before that first buyer returns. (A related point is whether, if the first
buyer does not return, there will be a lost sale. That would certainly be the case if the
seller had customized the car to the buyer’s specifications.) Given this information, the
seller may choose to hold the car for the first buyer. If someone else in fact does show
an interest in buying the car, the dealer may regret promising to hold it. If he were to incur no penalties for failing to keep the offer open for the first buyer, then he would be
better off to breach the offer to the first buyer and sell to the second. But recall that part
of the purpose of making promises enforceable is to allow the first player to rely upon
the commitment made by the second player. Part of this commitment is the willingness
to forego alternatives that may arise between the time that the contract is formed and it is
performed.
8.5. (p. 287) This is like being in law school. Consideration is something of value that
the promisee gives to the promisor. What did the second player give to the first player in
exchange for his promise to invest? In most instances, the simple promise to cooperate
is not enough to serve as consideration. The law typically requires something tangible—
and, therefore, verifiable by the court—to count as consideration. Actions (a nod of the
head, a shake of the hand) and mere words (“I promise to cooperate”; “You can count on
me”) are not enough. The sense is that consideration, being something of independent
value to both parties, signals seriousness and eases evidentiary problems.
8.6. (p. 287) Recall that a “firm offer” is an offer to keep an offer open and that under
the traditional bargain theory this was not an enforceable promise. Under the economic
theory the firm offer might be enforceable. In your answer to this question, bear in mind
that you must show what difference the enforceability of the firm offer would make.
8.7. (p. 289) If the expectation damages are perfectly compensatory, then the promisee is
indifferent between performance and breach.
8.8. (p. 289) In Figure 6.4, performing is efficient when performance is costless. If the
promisor still decides to breach, total payoffs fall from 1 to 0.
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8.9. (p. 291) There are many facets to the answer. Consider one: if the breachee receives
compensation for excessive reliance, then breachees have an incentive to overrely,
which is inefficient. From the point of view of the breacher, the liability for excessive
reliance by the breachee may induce performance when breach is more efficient.
We have already explained that if the breachee receives the “benefit of the bargain”
– expectation damages, then he is indifferent between performance and breach. And so
the breach is Pareto efficient.
8.10. (p. 294) That is, the more efficient a default rule is, the greater the savings in transaction costs. By supplying routine contract terms, default rules allow parties to save on
the costs of crafting their own contract terms. One of the principal ways to choose default rules is to choose those rules that the vast majority of contracting parties would
have chosen, if they had thought of those terms. This is called the “majoritarian” basis of
default rules. (See the Ayres and Gertner piece mentioned in n. 16 for an alternative
method for choosing a default rule – “punitive” default rules.) The more uniform the
preferences of the majority are, then the greater are the savings from adopting a default
rule on the “majoritarian” ground.
8.11. (p. 294) Assume that the homeowner is entitled to damages. That is, assume that
the contract clearly specified that the contractor (the construction company) was to bear
the risk of nonperformance. What damages has the homeowner suffered? Presumably,
he or she has had to find alternative lodging for the month, and the fair market value of
that lodging should be a portion of the damages. Additionally, there may have been
some events, such as a wedding reception, that the homeowner planned to hold at his or
her home during the month that the delay occurred. Expenses of finding an alternative
venue for the reception ought to form part of the recovery, too. Finally, the homeowner
may have arranged for furnishings to be delivered or indoor alterations to be made during the month of the delay. The costs of adjusting these arrangements, such as taking
delivery of the furnishings and storing them, also would be a portion of the damages.
8.12. (p. 294) Consider a situation where the cost of allocating risk is less than the benefit of allocating the risk. The benefit – or “expected” benefit – of allocating the risk is
the costs of the risk if it materializes time the probability of the risk materializing. So,
suppose that if the risk materializes, it will impose losses of $1,000 and the probability
of the risk’s materializing is 0.05. The expected benefit is, therefore, $1,000 x 0.05 =
$50. So, if the cost of allocating this particular risk is less than $50, then the parties out
to allocate it.
In the case of marriage, to take another example, the costs of allocating risk for losses if there is a divorce may be (depending on at what point in the marriage this negotiation takes place) may be extremely high. For instance, imagine two people on their way
to the courthouse to get a marriage license. Suppose that one of them says, “You know,
there is a probability of 0.45 that this marriage is not going to work out and if it does
not, things could get messy. Maybe we ought to take a few moments to allocate the risk
of loss if this marriage contract doesn’t work out.” Wouldn’t your first reaction be to call
the whole thing off? Why marry someone who’s thinking about the worst that could
happen instead of the best that could happen?
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Would business mergers have the same problems?
8.13. (p. 305) Corporations might promise to transfer valuable assets, such as plants,
marketing territories, or patents. to a partner as a method of inducing reliance on the
long-term relationship.
The short-term and long-term relationships might be different in several important
ways. Short-term relationships usually have as their goal the accomplishment of a single
or relatively simple task. But in the long-term the principal goal is the establishing of a
relationship, rather than the accomplishing of a specific goal or set of tasks. One way to
look at this is to suggest that in the short-term one partner doesn’t necessarily need to
trust the other – just to have some assurance that they will do what they said they will
do. In the long-term, however, a significant aspect is to establish trust, a belief that one
can rely on the other person.
These differences are not hard and fast. For example, there may be a relatively simple one-off, short-term deal that is so valuable to one of the parties that he wants a hostage to guarantee performance. And in some long-term relationships (such as marriage)
one of the keys to success may be the engendering of trust without a hostage’s being involved. Consider the fact that in some relationships one wants to know the partner’s
character so that it is important to believe that the person complied with the implicit
terms of the relationship because his character led him to do so, not because he contemplated the loss of a hostage if he failed to comply.
Chapter 9
9.1. (p. 317) Expectation damages would compensate B fully for the amount of B’s expected profits. What was B’s expected profit from this series of transactions? B paid
$10,000 for the grain and anticipated selling it in London for $11,000 after paying a
$100 docking fee. It looks as if B’s anticipated profits are $900. Reliance damages
would compensate B to the point where he was just as well off as he was prior to making
the contract. What costs did B incur that would be compensated under reliance damages? The $100 non-refundable deposit. Opportunity-cost damages would pay B the profits
from his next best alternative. How much would B have earned had he contracted with
the other dealer for a price of $10,500? B’s profits would have been $500 less or $400 in
that instance.
9.2. (p. 317) For the first question, consider situations where the payoff from a certain
action is unknown, but the payoff from the next-best-alternative is known. This might be
a nonmarket traded good or service. For the second question, consider situations where
the amount invested in reliance of a contract is easily observed, but the opportunity cost
is difficult to measure (perhaps, again, because there is no market for the traded good or
service).
9.3. (p. 318) If the opportunity cost is the same as the expected payoff, then the expectation damages should equal the opportunity-cost damages. This is likely to be true only in
a perfectly competitive market.
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9.4. (p. 318) One simple way to think about this issue is to imagine yourself canceling
an airline ticket versus canceling a purchase of a hearing aid. Who is hurt more by your
decisions? Has the seller lost a profitable sale in one case and not lost a profitable sale in
the other? Which is which? The airline typically has other customers willing to take the
seat you did not occupy. But can the hearing aid manufacturer easily find someone to
purchase the aid that you did not buy?
9.5. (p. 318) Think about the ease of finding substitute performance in each situation.
Clearly, the law ought to encourage B to purchase the substitute widget after A repudiates at the lowest alternative price. (This is called “mitigating damages.”)
9.6. (p. 323) The contract with the portrait painter is a contract for specific services, as
would be the case with a specific actor to perform a specific role. Courts are reluctant to
enforce these contracts through specific performance because they fear high enforcement costs. But with the housepainter, there are plenty of substitute performers, and
there are no particular monitoring or enforcement costs (none, that is, above and beyond
the normal such costs).
9.7. (p. 323) Restitution is very easy to measure. The court simply orders the breacher to
return any benefits that the innocent party conferred on him or her. [p. 323]
9.8. (p. 323) As long as there is a positive probability of not getting caught, the swindler’s profits are positive. That is, the probability of getting caught must be 1. If that
probability is 0.5, then the amount that the swindler should return is twice the actual
loss. (We are going to meet this principle again when we discuss crimes in Chapter 12.)
9.9. (p. 323) Specific performance may simply be impossible: the travel agency promised you no rain on your trip to Cancun, but there was rain. The agency cannot specifically
perform something that has already been performed. Or consider the example discussed
above in which the portrait painter died. He simply cannot specifically perform. Under
what legal rule would specific performance be “unfair” in the example given in the hint?
Would paying the third party her cost of the manuscript compensate her for her loss?
9.10. (pp. 323-24) Because L can, contractually, receive $1500 for each day of the
breach of contract but will only suffer $1000 in losses, there is $500 in a cooperative
surplus that the parties can split through renegotiation. So, you, as the lawyer, might
propose reducing the contract price by something between $1 and $499 (depending on
how confident you are in your bargaining skills) in exchange for accepting only $1000
per day that the contractor is late (rather than insisting on the $1500 to which you are,
contractually, entitled).
9.11. (p. 330-31) After the employer announces the move, the house is more valuable to
A than to B. It therefore should never be the case that B moves into the house. Should B
(who knew his own employment situation better than A did) be responsible for taking
the hit—that is, the loss from having to complete the contract and resell the house?
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Probably so. Alternatively, B could try to renegotiate the contract, paying A to release
him from the contract and paying for the costs of re-advertising the house for sale?
9.12. (p. 331) One situation might be a contract to ship goods overseas. What fortunate
or unfortunate contingencies might appear? A war might begin, making the usual shipping routes impossible and thus necessitating a longer and more expensive delivery
route. Or a war that was in progress might end, making a more direct and cheaper shipping route possible. Think of some other contracting situations. Would parties insert
clauses to cover these contingencies if to do so would reveal a special subjective value
on performance? What if the costs of identifying and then allocating the risk of some
losses was higher than the expected benefit? What then?
9.13. (p. 331) The Coase Theorem states that given zero transaction costs, private bargaining always succeeds in allocating resources efficiently, no matter what the initial
endowments. In the contract setting, when transaction costs are zero, the parties will always bargain to an efficient agreement, including efficient performance and efficient
breach, regardless of what the law says.
9.14. (p. 331) For the first question, consider the example given in the text. For the second question, think about the court’s problem of measuring subjective valuation. If the
court awards specific performance, who or what process determines the subjective value
that the breachee attaches to performance? Renegotiation between the parties.
9.15. (p. 337) This is fairly straightforward. A “foreseeable event” is one that a person
possessed could foresee at reasonable cost. A “foreseen event” is a subset of the group
of foreseeable events: those foreseeable events that a person actually foresaw.
9.16. (p. 337) This sounds harsh: you ought to expect receiving damages at the ordinary
level, which would probably be the replacement cost of the film that was undeveloped or
lost. Clearly, the developer’s desire to shift the risk to you by insisting on your signing
the waiver was meant to absolve him of any liability. But shame on you for signing the
waiver! You’ve just removed any incentive for the developer to take care in handling
your photos.
9.17. (p. 337) The mitigation requirement alerts the breachee to the fact that he or she is
only going to receive in contract damages the amount that he or she would have received
if they had taken reasonable steps to limit the amount of harm they suffered. That creates
an incentive to take steps to resell the goods, find a substitute renter, etc. so as to minimize the harm suffered.
There is a reasonable case to be made for the proposition that mitigation will occur
whether the law requires it. (This is an example of the Coase Theorem as applied to contract law.) You ought to explain why. If there is no duty to mitigate, then the breacher
will have to initiate the steps to minimize damages. If there is such a duty, then the duty
to mitigate shifts to the breachee, who much initiate the steps to reduce damages.
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You might also note that in specific performance, there is no duty on the breachee to
mitigate, and yet, as one of us argued 23 years ago, there will, nonetheless, be mitigation.
9.18. (p. 340) This is a variation on the problem we asked earlier. You might think that
the law would be more efficient if it put the burden on the breachee to take steps to
“cover” the breach at the lower cost at time 1. But this may be yet another example of
the Coase Theorem in contract law: it doesn’t matter whether there is a duty to mitigate
because the parties will have an incentive to renegotiate at the appropriate time to get the
less expensive form of damages.
9.19. (p. 340-41) The crucial difference here is that the good g does not have a close
substitute. So, although there is an incentive to renegotiate, there is not much to be
gained from renegotiation. If the courts typically award expectation damages, then the
seller might be fearful that there will be subjective damages. And those could be very
high. Reliance damages are likely to be easier to measure and more modest, particularly
because the buyer might limit those reliance expenditures because it is necessary to receive the good in order to realize the benefit of the bargain.
9.20. (p. 343) In this case, we cannot presume competency on the part of the young girl.
The law assigns responsibility for protecting the incompetent to the competent people
with whom they deal. Here, that would be the dealer.
9.21. (p. 343) One issue to think about is how different legal rules might influence the
decision of a competent (sober) person to make herself incompetent (drink heavily).
What about the behavior of those who deal with the temporarily-incompetent person?
Do they have any special duties?
9.22. (p. 347) This is a fundamental question that has different but mutually reinforcing
answers. A’s threat to harm B unless she engages in a transaction destroys B’s security
in her person. This destruction can be faulted on both moral and efficiency grounds. For
example, one might argue that everyone is entitled by reason of morality to liberty over
his or her person. That freedom may be surrendered only voluntarily. (And only perhaps
temporarily; an argument may be made that no one should be allowed even voluntarily
to become a slave.) Threatening someone’s freedom over her person is, therefore, immoral. Not allowing a destructive threat to B’s person also promotes efficiency. If such
threats were allowed, people would incur costs to avoid being so threatened; they might
carry weapons, avoid being alone, or surround themselves with hired toughs. These
costs of avoiding being coerced would be reduced (but not eliminated) by adopting a
legal rule of not enforcing promises elicited by coercive, destructive threats.
9.23. (p. 347) Is the baseball star demanding renegotiation under the condition of coercion? Think about the issue in these terms: is the baseball player “creating value” or
“threatening to destroy”? If the club refuses to negotiate, what incentives does that create for the player in the remaining years of his contract? Would it have an effect on other players? Incidentally, the labor agreement between the owners of the Major League
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Baseball teams and the Players Association forbid contract bonuses to players for individual performances, such as leading the league in home runs. Why?
9.24. (p. 348) The professional rescuer is entitled to receive a normal return on his investment. The rescuer who anticipates having to rescue has also made an investment, but
not as extensive an investment the professional. The fortuitous rescuer has, presumably,
made no dedicated investment and so has no capital on which to need a normal return.
9.25. (p. 348) Apply your answer from the previous question.
9.26. (p. 349) Sea captains have a legal duty to rescue ships and cargo in distress. The
captains in this case threatened not to do their legal duty, which would have resulted in
the destruction of valuable cargo. Thus, their threat involved destruction of value, not
merely the refusal to participate in its creation. And as we have seen, promises extracted
under threats to destroy existing values should not be enforced on both moral and efficiency grounds.
9.27. (p. 352) Think about how the threat of being struck by lightning might affect the
terms of a contract. What might be some situations in which this threat would have a
substantial impact on the contract? Would professional sporting events that have business invitees, as they are called, like to limit their liability for harms suffered because of
lightning strikes?
9.28. (p. 352) The relevant question is whether Taylor (the performer) or Caldwell (the
concert hall owner) could have prevented or insured against the unavailability of the hall
due to this contingency at a lower cost. The fact that it is physically impossible to perform in the hall is really beside the point. Caldwell probably has better information
about the fireworthiness of the hall and its risks of being destroyed by fire. Moreover,
being an impresario, he was better able to arrange an alternative venue for the concert
than was the performer. In short, Caldwell breached the contract and should be responsible to Taylor for damages. Such a holding, made on those grounds, is likely to induce
more efficient risk-allocation among future contracting parties.
9.29. (p. 353) There are many issues to consider in determining the validity of the contract. Did the rise in the price of uranium make fulfillment economically impossible?
How would your answer differ if the trade was merely a futures transaction on a commodity exchange? Was the rise in uranium prices foreseeable? Did the actions of Westinghouse in any way cause the increase in the price? See the marvelous discussion of
these issues in Professor Joskow’s classic piece cited in n. 37 of the text.
9.30. (p. 353) We leave this to you.
9.31. (p. 355) The opinion that this contract is void because there was “no true meeting
of the minds” is not particularly helpful. An economic analysis can provide clearer
guidelines. The problem that has arisen to frustrate the performance of the contract is the
unforeseen contingency that there were two ships named Peerless. If this contingency
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could have been foreseen by one of the contractual parties at a reasonable cost, then responsibility for nonperformance in the event of the contingency could have been and
should have been assigned in the contract. Presumably, the parties would have assigned
responsibility for nonperformance in the event of that contingency to the party who
could have more cheaply taken steps to prevent or insure against this contingency. For
example, if either of the parties had had extensive business dealings in the England-India
cotton trade, he could or should have known that there were two ships named Peerless.
Notice, however, that if neither party could have foreseen this contingency, then the
issue is no longer so much one of creating a rule to induce efficient risk allocation as it is
one of apportioning unavoidable losses between two innocent parties. If there is a content to the expression “no true meeting of the minds,” it is precisely to cover those circumstances in which a contingency that was not foreseeable at reasonable cost has arisen to frustrate contract performance. In those circumstances the task of the court becomes
one of equitably dividing the unavoidable loss.
9.32. (p. 359) In Laidlaw v. Organ, the court ruled the contract void because Organ had
discovered fortuitously that peace was concluded. The important issue is whether the
information was solely redistributive in nature or whether it had productive use. Which
do you think this is?
9.33.
(p. 359)
a. If the information is productive, it will change the economic incentives facing
the owner and may, therefore, cause him to change his behavior. (If the information is merely redistributive, then it is not likely to change incentives and
thereby behavior; redistributive information merely changes the identity of the
economic agent, the person who receives the economic reward.) Here, if the
owner knows the cow is fertile, he will breed her rather than butcher her.
b. Sherwood would have no incentive to invest time and effort in discovering
such facts if the payoff from such information goes to Walker.
c. Professionals assume the risk of mistaking the fertility of a cow as part of their
job.
9.34. (p. 360) No. The buyer should be suspicious of a conditional statement and should
push the seller further. Notice that there is a difference between the circumstance here
and an intentional falsehood.
9.35. (p. 361) The informational asymmetry in this case concerns productive facts, not
destructive facts, so the economic analysis suggests that the contract should be enforced.
Enforcing the contract will reward people like Schmidt for the cost of discovering minerals. If the buyer had acquired the information casually and fortuitously, as did Organ
in Laidlaw v. Organ, rather than by an investment, the economic case for compensating
him is weakened.
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9.36. (p. 361) This is a destructive fact by the buyer, an affirmative and intentional misrepresentation that may have caused the seller to sell to him when, if she had known the
truth, she would have sold to someone else. The court should rescind the contract.
9.37. (p. 363) The elasticity of demand measures the percentage change in the quantity
demanded in response to a percentage change in price. Consider the demand curve faced
by a particular firm. If the firm has many competitors, how will demand for its product
react to an increase in its price?
9.38. (p. 364) A “bilateral monopoly” situation arises where there is one seller and one
buyer. That seems to be the case here. The price that will prevail in a bilateral monopoly
is not clear: all we know are the limits – the maximum is the price that the monopolist
could exact; the minimum is the price that a monopsonist would pay. Where within that
range the actual price settles depends on the bargaining strength of the parties.
9.39. (p. 366) Uniformity of product or service makes it easier for the sellers to agree on
price and quantity. But uniformity also empowers consumers, who can shop among producers to find the cheapest price for the identical good.
9.40. (p. 366) If such lawsuits are possible and if, importantly, there is truly a reason for
the higher price, then the manufacturer or seller will have to incur the costs of demonstrating that reason. That may not be very expensive to do, but it might be. If competition is vigorous, then there’s no reason to require the manufacturer or seller to incur
those costs. It will only hurt their competitive situation.
9.41. (p. 366) Presumably, the monopolist will find any method at all for increasing his
or her profits. There is a limit, of course, to the price that a monopolist can charge. Once
the monopolist has reached that price, then it might be eager to find nonprice elements to
increase its profits. So, for example, if limiting the liability would allow the monopolist
to produce a lower-quality product (that is, one that would break down more easily or
might cause direct or consequential harm to users), he would do so because producing a
lower-quality good but selling it for the monopolistic price would increase his profits.
9.42. (p. 366) When a firm discriminates between consumers, it either offers the same
good at different prices to different consumers, or it offers different quality goods at different prices to different consumers. This helps the firm capture as much of the surplus as
possible. If the firm offers the three choices to each consumer (standard monopoly price
or the two differentiated products), we can assume that the consumer will choose the
option which maximizes her expected benefits.
There is an important difference in economics between a “separating equilibrium,”
in which it is possible to make the distinction between different consumers and a “pooling equilibrium,” in which the separations cannot be made at reasonable cost.
9.43. (p. 370) It could be that the terms are efficient in the sense that there are lots of
music publishing companies with whom the young songwriter might have signed and
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ers, will not be successful. Why do you think the plaintiff brought this action? The most
likely reason is that he has, contrary to the odds, been successful and finds the constraints imposed on him when he originally signed with the publisher to be confining.
The House of Lords voided the contract as being unconscionable. Assume that it is, in
fact, not unconscionable, but rather, an efficient allocation of risk. What effect might the
decision have on the fortunes of other young songwriters who do not yet have contracts
and on those who do have the standard form here held void? Music publishers and untried songwriters must find some alternative method of allocating between them the risks
that are inherent in the business. If the terms that were here held to be unconscionable
were the most efficient method of doing that, then this decision will impose unnecessary
costs on future contracting parties.
See Michael Trebilcock, “The Doctrine of Inequality of Bargaining Power: PostBenthamite Economics in the House of Lords,” 26 U. Toronto L. J. 359 (1976).
9.44. (p. 378) This is an important exercise. Spend some time trying to get this right. We
think that we’ve explained this adequately in the text.
9.45. (p. 378) Which curve depicts the cost of expectation damages? For part b think
about how you would redraw this curve if specific performance was higher than expectation damages. This should lead to a higher level of precaution.
9.46. (p. 378) Again, think about the shape and location of the disgorgement curve. Disgorgement, recall, requires the parties to give back any benefit that they have received.
9.47. (p. 381) Consider who bears the risk both when there are perfect damages and
when there are no damages.
9.48. (p. 381) At what level of y are Yvonne’s expected profits maximized when the
composite curve is used?
9.49. (p. 381) Think about how Yvonne would act if she knew absolutely that performance was forthcoming. Would she take the efficient amount of reliance or would she
over-rely? Why?
9.50. (p. 381) Disgorgement damages can be thought of as a transfer of unknown size to
Yvonne in case of breach. Will Yvonne’s optimal reliance curve still be concave? Consider the factors that give shape to the “no damages” curve.
Chapter 10
10.1. (p. 386) The court would award the farmer two times his expenditures in reliance
on the promise.
10.2. (p. 386) Because the costs of litigation are generally much greater than the costs of
settlement. Indeed, the cost of settlement have typically been incurred before a trial begins.
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10.3. (p. 391) Work your way backwards as in the example in the text. The only difference is that the expected value of the trial (EVT) is now $10 instead of $30.
10.4. (p. 391) This will change the EVT. Instead of subtracting the trial costs as a lump
sum, you must include them in the probability. That is EVT = -.5($100) + 0.5(-$40) =
$30.
10.5. (p. 398) These assumptions may result in the policy prescription that the courts
should set lower administrative fees for business decisions than for divorces. Why?
Generally speaking, at least for economic analysis, it is more important to encourage
litigation where there are efficiency consequences than were there are distributional consequences.
10.6. (p. 398) In economic jargon, this is called a “price floor.” This is the opposite of
the rent control example of Chapter 2, which was a “price ceiling.” The quantity demanded is q1 while the quantity supplied is q3. How does this excess supply influence the
market for lawyers? The price per unit of legal services cannot, by assumption, go down,
as it would in an unregulated market. As a result, people may economize on legal services, using whatever substitutes they can, such as more precaution.
10.7. (pp. 398-99) Consider the question in this way. There is only a 10 percent probability that the dispute will go to trial, and a 90 percent chance that it will settle. Suppose
that the cost of obtaining the information before trial is $100. We know that the cost of
obtaining that same information at trial is 100x, where x is some number greater than 1.
Presumably, we will be indifferent between trail and settlement when the expected value
(or cost) of this information is the same before and at trial. So, we need to solve the
equation: .1(100 x) • .9(100). And that gives x = 9. So, the implication is that if the expected cost of the trial information is less than 9 times that of the expected cost of the
discovery information, go to trial. Otherwise, settle.
10.8. (p. 399) One of the important elements of the trade-off will be time. According to
the example given in the question, allowing a witness more time to think may increase
his or her ability to concoct a plausible alternative to the truth. One way to impose time
pressure on witnesses is to depose them quickly, with the understanding that what they
say in the deposition may be used to impeach their testimony at a later trial.
10.9. (p. 403) Use the equation immediately preceding the question. SC = $0, and LC of
the two parties combine to equal $200. Therefore, how large can the value of the relative
optimism be where the parties still settle out of court?
10.22. (p. 408) In the text we claim that judges have the incentive to do what is easy and
lawyers have the incentive to do what is hard. Why? Judges are on a fixed salary – that
is, one that is not determined by the number of cases they handle or the quality of their
performance. So, all other things equal (and they are not), judges want to get through
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selves on dispensing justice and doing so in an even-handed and laudable manner. And
it is true that a judge’s prospects for advancement (to a higher court, for example) are in
part determined by how well he or she does his or her job. (That might be measure by
the number of citations to the judge’s opinions.)
Lawyers, by contrast, are generally paid by the hour. So, they are not at all averse to
having “hard” cases that take a great deal of effort on their part. This, too, is a caricature
of the lawyer’s incentives and life.
10.11. (p. 408) Clearly, it is far easier to bribe one person (a judge) than to bribe a majority of the jury. Put in the vernacular of this book, the transaction costs of bribing one
person are much less than those of bribing seven.
10.12. (p. 410) Here’s what Rule 68 of the FEDERAL RULES OF CIVIL PROCEDURE (the
“Offer of Judgment” rule) says: “An offer not accepted shall be deemed withdrawn and
evidence thereof is not admissible except in a proceeding to determine costs. 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.” So, if the court follows this
Rule, then the plaintiff will pay most of the defendant’s legal fees. (Presumably, the preoffer legal fees of the defendant will not be covered by this rule.)
10.13. (p. 410) The only difference here is that the defendant offered less than the court
ultimately awarded. Otherwise, this is exactly the same matter as in the previous question. The plaintiff will again pay the defendant’s legal fees after the extension of the offer.
10.14. (p. 410) The British rule will cause fewer nuisance suits because the threat position of an undeserving plaintiff is weakened by facing the prospect of paying the defendant’s trial costs.
10.15. (p. 410) The issue of liability is not amenable to compromise: one is either liable
or not. So, there is not much scope for bargaining on that matter. But once liability is
established, the matter of damages is amenable to compromise. The matter of legal fees
could be traded off against the value of a monetary judgment.
10.16. (p. 410) There’s a great deal of controversy about this matter. Our intuition is that
if both parties are risk-averse and if the case is closely contested (that is, both parties
have a roughly even chance of winning), then they are more likely to settle under the
English rule than under the American rule. The total amount that each party has at stake
is larger under the English rule.
10.17. (p. 410) The transaction costs for the parties of bargaining around the default rule
might inhibit this deal from occurring. Recognize that for most parties litigation is not so
common that they can develop boilerplate to deal with this situation. For most parties,
litigation is uncommon. (The average American consults a lawyer only three times during a lifetime.) And many people may well be overly optimistic about their abilities to
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prevail at trial, thus inclining them not to want to bargain away from the default of “loser pays.”
10.18. (p. 412) Many examples are possible where appeals with high probability of success are pursued, but appeals with low probability of success are not. As you will learn
later in the chapter, appeals are not that expensive but are not that common either.
10.19. (p 412) Appellate courts make law in the common-law system. Therefore, all of
us—not just the parties involved in the dispute—have an incentive to have cases with a
potential to make law heard by an appellate court. Ideally, the subsidy for appeals would
be confined just to those cases with a potential to make law. But making a determination
beforehand of which cases have that potential is difficult. Therefore, it makes sense
simply to subsidize all cases for appeal.
10.20. (p. 412) If the cost of delay is higher to the plaintiff than to the defendant, then
presumably that creates an incentive for settling sooner rather than later and on terms
that may favor the defendant.
10.21. (p. 414) Yes. If there is a potential social benefit to an appeal (which can make
law), then society has an interest in having the appeal go forward. To encourage the appellant to bring that appeal, the government should subsidize the costs of appeal. But not
fully. The appellant needs to bear some of the costs, too.
10.22. (p. 414) The inquisitorial system is common to most civil law countries. The
judge directs much of the questioning and determines the course of events in the courtroom. The goal of the inquisitorial system is to reach a correct or truthful account of
events. In the adversarial system the lawyers of the litigants direct questions and present
evidence. The goal is to foster fairness and a balance between the parties, but no one
would contend that the goal of the adversarial system is to find the truth.
These differences might mean that the inquisitorial system has fewer frivolous suits.
But if selective litigation means that 50-50 cases are the most likely to be litigated, that
seems to characterize both systems.
10.23. (p. 416) To do their job efficiently, the central planners in a communist society
need to know the preferences of all people in society. The great virtue of the market is
that it is decentralized and takes individual preferences fully into account. The creation
of laws in a centralized fashion suffers the same problem as central planning—it requires the central authority to know a great deal, more than most administrators can possibly know.
10.24. (p. 417) Remember that under the Hand Rule, the injurer is negligent when the
marginal cost of her precaution is less than the marginal benefit resulting from her precaution. So, yes, the injurer has got to give due regard to the health of those whom his or her
failure to take care might injure.
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Chapter 11
11.1. (p. 422) Where efficiency is at stake, there are arguments to be made in favor of
creating the right incentives for people to behave in a socially optimal fashion. So, for
disputes about business contracts, the filing fees need to take account of the fact that renegotiation between the parties may be more efficient than resolution by means of trial.
If filing fees are too low, then the parties may not negotiate hard enough to resolve their
dispute – perhaps leading to an expensive trial that affects not only their productive possibilities but also affects the production decisions of other similarly situated parties.
This last point can be construed in a different manner. If the matter between the parties has a potential external benefit in that it creates a rule or standard that is helpful to
other parties (and they are unlikely to discover that rule or standard in the absence of a
formal judgment), then the filing fees ought to be set low enough to give the courts a
chance to resolve the dispute and articulate some law.
The difficulty, of course, is that courts cannot set the fees after the parties file their
complaints and answers. They have to announce a fee schedule not knowing whether the
dispute is one that the parties can resolve through negotiation or is one that has wider
applicability. In the absence of that knowledge, the first point above – that, generally,
businesses are better placed than courts to resolve disputes through negotiation – ought
to guide the setting of filing fees.
Where, however, the dispute is about distributional matters, as in a divorce, the
courts may be better placed to make those allocations on general principles of justice.
Moreover, passions often rule much higher when there are distributional matters at issue
than they do when the core of the dispute is efficiency. As a result, where the central issue at stake is distributional, the filing fees ought to be low.
11.2 (p. 424) If regulation keeps the price of lawyers higher than its equilibrium price –
that is, if the price is held at p1 rather being allowed to fall to the market-clearing price
of p2, then there will be an excess supply for lawyers equal to the quantity (q3 – q1).
How do markets deal with excess supply? In unregulated markets, the price falls,
equilibrating supply and demand at a single quantity and price (q2 and p2 in Figure
11.3). If the regulation is effective (and it may not be), this equilibration cannot occur in
this fashion. But there is likely to be a reaction – just not an efficient reaction. If the
price is held at p1, then many people who would like a lawyer’s advice will not find it
economical to get that advice. They will find some other method of answering their legal
questions – self-help, talking with co-workers and neighbors, and so on. If the price of
legal services cannot be adequately policed so as to remain at the regulated level, then
some lawyers may start offering discounts or nonprice incentives to consumers. The
price per unit of lawyer (!) may be held at p1 but lawyers may start offering free movie
tickets or other inducements that amount to a price decrease.
Arguably, we are in a situation of adjustment at the moment (since the beginning of
the Great Recession) in which the price of legal services is deemed to be too high.
11.3. (p. 424-25) Consider the question in the framework of Figures 11.1 and 11.2. Do
each of these three propositions influence incentives in the same way? Clearly not.
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Among other considerations, there are efficiency consequences to some of these suggestions and, in others, the proposal represents a default rule around which interested parties can contract, if they feel the need to do so. Proposal (a) – low damages – is a very
poor idea. Certainly, it will induce victims not to bring actions against their injurers, but
think about the inefficiencies that this will entail in the market for precaution. Proposal
(b) – high filing fees – will discourage small claims. If this filters out trivial controversies, that may be a good thing. But it may filter out meritorious claims, which would be
a bad thing. Proposal (c)—high legal fees set by the state—is a poor idea, as we saw in
the previous question. High mandated legal fees will encourage an excess of lawyers on
the supply side, but economization on legal services on the demand side. The unregulated market is not ideal, but it does not have this problem of a persistent excess supply.
11.4. (p. 425) Figures 11.1 and 11.2 assume that the plaintiff is risk neutral. What if she
is risk averse? That is, what if she preferred a certain payoff of $50 rather than a 50 percent chance of earning $100? How might insurance then influence the number of suits?
In thinking about this, remember our discussion at the beginning of Chapter 9 about the
influence of insurance on precautionary decisions. Generally speaking, if plaintiffs and
defendants have litigation insurance, they will be less reluctant to proceed to trial than if
they had to pay for the litigation directly out of pocket. Indeed, there might be moral
hazard and adverse selection problems that arise from litigation insurance. (What would
those be?)
11.5. (p. 426) What will happen to the total number of law suits as a result of the wider
availability of class actions? That is unclear. It might rise if a number of potential litigants who previously would not have brought an action can now band together with others, who also would not have filed separate actions. It might fall if some litigants who
would have previously filed separately will not consolidate their claims with others.
The great virtue of class action litigation is that it encourages those with genuine but
small harms (those with low or negative expected value (NEV)) to seek redress. The
great possible cost, which Judge Posner emphasized in Rhone-Poulenc, is that even nonmeritorious NEV claims will succeed in class actions because of the fear by defendants
of losing vast sums.
11.6. (p. 429) We do not find the arguments against advertising by lawyers to have merit. The only argument that might be worth elaborating is that advertising by lawyers
gives potential clients the idea that one should choose lawyers according to the criteria
that lawyers choose to advertise, not according to merit and price. But even this strikes
us a weak argument. One could make the same argument about any sort of advertising:
it induces consumers to choose on the wrong criteria. So that, for example, consumers
choose cars not according to safety testing but according to the beauty of the models
who advertise them. These and similar criticisms of advertising have been made for
years. There is, of course, a germ of truth in the criticisms, but how are we to regulate
advertising so as to compel those who advertise only to advertise those qualities and
characteristics that they ought to? And who gets to decide what those qualities and
characteristics are? Better to allow lightly regulated advertising and hope that laws
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against fraud and legal malpractice and attorney discipline schemes minimize advantage-taking of clients by unscrupulous lawyers.
11.7. (p. 429) Contingent fees:
a. If the client is more risk-averse than the lawyer, the contract will almost certainly be a contingent-fee contract. That puts almost all of the risk on the lawyer and relieves the client of any risk.
b. The lawyer might benefit from this hard position because it makes his negotiations with the other side’s lawyer easier for him.
c. The incentive effects for the two kinds of contracts may be different. Note
that from the plaintiff’s view, the virtue of the contingent-fee arrangement is
that it aligns her interests in succeeding with the lawyer’s interest in getting
handsomely compensated (and shifts the risk of nonpayment to the lawyer).
Can a contingent fee accomplish the same thing for the defendant—namely,
provide him with a vigorous defense and shift the risk of loss to the lawyer?
If the defendant-client gives his lawyer a modest up-front payment and then
entitles the lawyer to a sizeable fraction of any monies that the client does not
have to pay the plaintiff, this should work. Alternatively—but unrealistically,
the lawyer could agree to take the defense on the ground that he will pay twothirds of the amount owed the plaintiff, if he should lose.
11.8. (p. 430) The expected value of the trial should be negative. In the law-andeconomics literature, a nuisance suit is sometimes referred to as a “negative expected
value” (NEV) claim.
11.9. (p. 431) What is half of the cooperative surplus?
11.10. (p. 431) Include the litigation costs as part of the value multiplied by the probability of winning. For instance, the plaintiff will win $40 with probability 0.5, and will lose
$80 with probability 0.5.
11.11. (p. 431) As we saw in the box on class actions and the discussion there of the
Rhone-Poulenc case, there is a deep concern that the prospect of losing a huge amount
of money, even with a modest or low probability, could be enough to frighten a company into settling a class action that had NEV.
11.12 and 11.13. (p. 435-36) Remember that the administrative costs are the costs of
passing through the stages of a legal dispute. These include the costs of filing a claim,
exchanging information, bargaining, litigating, and appealing. The social costs of an error depend on the distortions in incentives caused by it.
With respect to unitary and segmented trials, the social costs of unitary trials are
probably less than those of segmented trials.
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With respect to joint and several liability (with and without contribution), it is probably the case that joint and several liability with contribution has lower social costs than
the same standard without contribution.
11.14. (p. 441) In part the answer depends on how the judge is compensated. If the renta-judge is compensated by being given a percentage of the total amount in controversy,
then she has an incentive to take only valuable cases or to exaggerate the amount in controversy. If she is paid a flat fee, then she wants to deal with as many cases per time period as she can (so as to maximize her income). So, presumably she will decide cases
quickly. It is not clear that either of these compensation schemes will cause the rent-ajudge to reach different conclusions than a public judge would reach.
11.15. (p. 442) The law clearly gives eyewitness testimony greater weight than statistical
inference. Cases are almost never decided by what is called “naked statistical evidence.”
Why do you think that is the case? Should it be? It seems fairly obvious that if the Blue
Bus Company can be held liable solely because it has a greater probability (and greater
than 50 percent) of being the liable bus company, then the Red Bus Company will be
less interested in merging.
11.16. (p. 442) The rational gatecrasher should be more deterred if the court accepts
probabilistic reasoning because he or she is more likely to be found liable then. And if
the court accepts probabilistic reasoning, then it would make much more sense to go
with more people than with fewer.
11.17. (p. 442) Most courts do not take into account the joint probability of the two
events. They rule on each issue separately to determine whether there is a preponderance
of the evidence. In this sense, trials in the United States are segmented. Is this the right
way of deciding on the evidence when the plaintiff must prove “simultaneously” that the
defendant caused the injury and was negligent? We think so. To decide otherwise would
leave open the problematic possibility that in a multiple-issue trial a party could be much
more right than wrong on each individual issue but lose the entire case because the joint
probability of those events was less than 0.5.
Chapter 12
12.1. (p. 457) This would shift the line separating civil from criminal wrongs to the left,
but how far to the left would depend on a trade-off between deeply political values that
could differ among people and regimes.
12.2. (p. 458) We have suggested that the term “victimless crime” implies that society or
the social fabric, rather than a single individual, is the victim. Counterfeiting is a crime
in two senses: it imposes extraordinary costs on individuals and on society. For example,
counterfeiting causes losses to the individuals who accept the counterfeit currency. And
that may make them suspicious of accepting paper money. If that suspicion becomes
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merce generally could be adversely affected. The costs to everyone of engaging in mutually beneficial exchange are raised. Other aspects of counterfeiting that are important
in explaining why it is a crime are that it is an intentional wrong and that it is frequently
difficult to apprehend and convict counterfeiters. Why these are elements of a crime will
become evident shortly.
12.3. (p. 458) One might argue that speeding or running a stop light or stop sign when
no one was around or no one was injured are examples of inchoate crimes. But why can
one not alternatively argue that they are examples of “negligence in the air,” faulty actions that result in no harm? The reason for punishing speeding and running a stop sign
as inchoate crimes is twofold. First, the probability of harm from those actions is very
high; society does not want its members to be subjected to such large risks, nor do we
want people to take excessive precaution to prevent themselves from being injured. Second, there may be a large detrimental spillover effect from the failure to punish inchoate
crimes. Those who get away with such actions as speeding or running a stop sign may
deduce that it is acceptable to scoff at other laws as well, thus imposing even more risks
on other members of society.
By contrast, those who are merely negligent are not generally creating such a high
probability of harm as to rouse societal concern. They are generally going about lawful
activity but doing so in a less-than-acceptably careful manner.
12.4. (p. 460) In the United States, if the public has great confidence in the prosecutor,
then the jury, which is a random sample of the public, may be predisposed to believe the
prosecution’s case. They may resolve controversial evidence in favor of the state, thus
making conviction easier.
12.5. (p. 460) The distinguishing feature—at least in the U.S.—between guilt and innocence is whether the fact-finder believed that the evidence of guilt was persuasive “beyond a reasonable doubt.” No one is quite sure what that means, but in some surveys
judges and jurors have indicated that it means something in the neighborhood of 90 percent certainty. (In statistical work, scholars strive to have 95 percent confidence in their
results’ being true.) So, if we take that as a rough guide, then we could suppose that
“not guilty” means that judges and jurors do not have 90 percent confidence that the defendant is guilty. But what about “not proven”? Clearly, that lies below 90 percent
(again, taking that to be the definition of “beyond a reasonable doubt”) but not so far
below that there is not some residual suspicion that the defendant might be culpable. It
would be extremely interesting to have some evidence on what probability estimate corresponds to the upper and lower ranges of “not proven.”
12.6. (p. 460) There are two important differences between burglary and breach of contract for the purposes of computing damages. First, burglary is intentionally wrong and
unavoidably harms the victim; breach of contract may be intentional but it is not (if remedies are appropriate) done with the intention of harming the breachee. Second, we are
only probably likely to detect and identify the burglar (and the probability of doing so
may be well below 50 percent); we are almost certain to identify the breacher. These two
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cept of “damages” isn’t really appropriate for burglary; we do not want that activity
priced correctly. We want it stopped. With respect to breach, we do not want breach
stopped; we want it priced correctly.
12.7. (p. 463) The three reasons for having criminal instead of tort punishments are: limitations on compensation, protecting rights rather than interests, and deterrence. It is difficult to find an adequate amount of money to compensate for an intentional or reckless
loss of life. The previous answer’s discussion of discouraging burglary, rather than
simply pricing it correctly, is an example of “protecting rights rather than interests.”
And the need for supracompensatory damages (or punishment) in crime so as to discourage (strongly) the activity – rather than merely compensating the victim – is an example of deterrence.
12.8. (p. 464) A corporation has committed an act for which it is both criminally liable
and strictly liable in tort. How should the state decide whether to proceed against the
corporation for having committed a crime or for compensation for a private wrong? One
does not have to choose which of these actions to pursue. One can do both. And indeed,
there is a strong case to be made for doing both. The state can proceed against the corporation for a crime, and the private victims can proceed against the corporation or the civil wrongs. There may be an argument (based on economizing on transaction costs) for
consolidation these actions – for allowing, for example, the private victims to act as
“private attorneys-general” to seek to collect both in their status as victims and on behalf
of the state.
12.9. (p. 464) A corporation cannot, like a person, have a “guilty mind.” (There is a famous phrase from English common law: a corporation has “no soul to damn; no body to
kick.”) Nonetheless, the officers of a corporation can form an intention to commit a
crime. And that raises the possibility of punishing the officers of a corporation in addition to or in lieu of punishing the corporation itself. Notice that that has been done recently. When Enron and WorldCom were convicted of crimes, the corporations paid a
punishing price, but many of the officers were also independently convicted of crimes.
Indeed, in one instance Jeffrey Skilling, the CEO of Enron, was sentenced in 2006 to
serve 24 years in prison. And a corporation cannot be punished beyond the value of its
assets. Indeed, if shorn of its assets, a corporation has, in essence, been given capital
punishment.
12.10. (p. 467) This will shift the expected punishment curve closer to the certain punishment curve. That could indicate that either fewer crimes are being committed or that
they are less severe or both.
12.11 and 12.12. (p. 467) These questions are a bit advanced and require some familiarity with calculus.
Adding a constant k to the fine term makes the equation
y ( x) • p ( x)[ f ( x) • k ].
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We find the optimal amount of crime by differentiating this with respect to x, to get
y• • p•f • pf • • kp•.
Because the marginal probability of detection and punishment is negative in x, the final
term in that marginal values equation is negative. This indicates that the optimal amount
of crime will be less because of the addition of a fixed amount to the fine.
Adding a constant k to the payoff term on the left-hand side of the equation gives
y ( x) • k • p ( x) f ( x).
The solution of the optimal amount of crime, x, involves taking the derivative of that
equation with respect to x. In doing so, k drops out, not being a function of x. So, increasing the size of the benefit to the criminal of the crime by a constant amount does
not alter the optimal size of the crime, given the expected punishment. In essence, the
addition of k to the payoff curve shifts it up vertically, and should not, therefore, change
the optimal amount of crime.
12.13. (p. 470) We defined a lapse as an episode where an actor temporarily discounts
the future consequences of her actions at a very high level. This leads the actor to care
less than she normally would about the penalties associated with her crime. Therefore,
deterrence is much more difficult when the actor experiences a lapse. Lapses are difficult for the potential offender to anticipate. By contrast, a deliberate crime was not spontaneous or the result of a momentary lapse. All of us sense that deliberately doing wrong
is far worse than doing so spontaneously. There is an old expression in the law: “Even a
dog knows the difference between being stumbled over and kicked.” That captures, imperfectly, the difference between spontaneously committing a crime and deliberately doing so.
12.14. (p. 470) Can a rat have mens rea? Probably not. A rat, we think, simply responds
to incentives in its environment. It probably doesn’t form an intention to do something
evil or wrong (whatever that might mean to a rat).
12.15. (p. 475) Remember that the social cost of a crime is the sum of the cost of crime
prevention and the harm it causes, not just to the particular victim but to others, too. And
you should be certain to include direct and opportunity costs in your computation. The
crime of murder clearly has direct costs to the victim and his or her immediate family,
friends, acquaintances, and co-workers. (There are also direct costs to the family,
friends, and co-workers of the perpetrator.) But there are also indirect costs to others
who are frightened by the murder and take steps to avoid being victims themselves. For
instance, some people may spend resources arming themselves so as to fight back. Others may avoid certain areas or commercial entities where they anticipate being victimized.
12.16. (p. 475) The economic goal of criminal law is to minimize the social costs of
crime. The economic goal of tort law is to minimize the social costs of accidents. Do
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you think that one can say that, generally speaking, the social costs of crime are greater
than the social costs of accidents? Is that because criminal law is more effective than tort
law? Or is it because there are fewer crimes than torts? Aren’t we, as societies, generally
more concerned about the social costs of crime than about the social costs of torts? Is
that because there are generally no offsetting social benefits from crime but there are
from activities, such as driving a car or producing manufactured goods, that may have
tortious consequences?
12.17 and 12.18. (p. 477) When police acquire computers, the cost of deterrence decreases, all other things equal. When criminals acquire computers, the cost of deterrence
increases. In the first instance – that of police acquisition of computers – the marginal
social cost curve in Figure 12.11 should fall, leading to further reduction in the optimal
level of crime. In the second instance – that of criminal acquisition of computers – the
marginal social cost of deterring crime should rotate up, so that the optimal amount of
crime goes up.
12.19. (p. 479) Crimes that have very low probabilities of detection, arrest and conviction but have high social costs ought to be severely punished so that that the expected
cost clearly and certainly exceeds the expected benefits. In contrast, if the social costs of
a particular crime are modest but continuing (not episodic), then mild punishment with
high certainty ought to be optimally deterring.
12.20. Think about this question in the context of Figure 12.11. Full employment means
that the opportunity cost of committing crime has increased. So, we would expect less
crime because potential criminals are more likely to be fully employed, legitimately. Also, full employment implies that not just private employment of potential criminals is up
but so is the public employment of crime-fighters. So, there are more resources devoted
to deterring crime.
12.21. (p. 480) Unobservable: phone systems, hidden cameras, plain-clothes detectives,
some auto alarms (such as LoJack). Observable: private guards, some auto alarms (those
that give some indication, such as a blinking light on the dash or door).
12.22. (p. 480) This fact might benefit you if the criminal does not know which homes
have guns and which do not. In that case, the potential criminal might be deterred from
entering any house in the neighborhood, whether it has a gun or not. But there are two
circumstances in which the fact that some homes in your neighborhood have could harm
you. First, if there is some method for the criminal to determine which homes have guns,
then he or she will be diverted to going into those homes that do not have guns. Second,
if the criminal decides to respond to the possible presence of guns by arming him- or
herself, then if you do not have a gun (or even if you do), then you might be in more
danger of harm than was the case before some of your neighbors had a gun.
Chapter 13
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13.1. (p. 491) There is no support at all for this proposition. As we’ve seen already in
this chapter and will see in more detail in the final section, the evidence is that the U.S.
is going through a period of low crime. During the 1990s violent crime was down 40
percent and non-violent crime was down 30 percent. Those declines have continued into
the first seven years of this century. We discuss the reasons for the decline in the final
section of the chapter.
13.2. (p. 491) Not at all. First of all, the costs to victims are real social costs. We would
not save those by not seeking to deter crime. Second, presumably, if we failed to spend
$200 billion on crime prevention, crime would soar, so that the social costs of crime
would probably go up by more than we’re spending to prevent it. At least, if we are efficient in our expenditures on crime prevention, then the total amount we are deterring is
greater than the amount that we are expending. And that happens: we review some evidence from Donohue and from Donohue & Siegelman later that suggests we have been
spending too much on prisons.
13.3. (p. 491) Let’s think about this both theoretically and empirically. First, theoretically. If a society grows wealthier, then three things of relevance to crime happen. First,
because everyone is wealthier, then there is more valuable stuff to steal. Crime can be
more lucrative. So, the expected benefit of crime is greater, all other things equal. Is this
true however if both the average wealth and the variance of wealth increases? Second,
the fact that the society is wealthier may well mean that it spends an increasing amount
of money (perhaps an increasing fraction of its GDP) on law enforcement and other public services. As a result, deterrence may be greater. And third, because the society is
wealthier, the opportunity cost of crime may be greater in that legitimate job opportunities are more plentiful. One of the crime-deterring qualities of legitimate employment is
that it gives the worker a reputation that might be sacrificed if he or she were to commit
and be convicted of a crime.
How do these three factors play out – is there more, less, or about the same amount
of crime as a country grows richer? As we can see, there is no compelling theoretical
argument to answer that question. So, we have to do some careful empirical work. One
of the first things to recognize is that when we do that, we typically measure crime on a
per capita basis, not simply in absolute numbers. To our knowledge, there is no empirical learning on this matter.
13.4. (p. 491) The fact that judges have less discretion in sentencing, means that the
prosecutor is more likely to charge criminal suspects with the highest-sentence crime
that he or she can plausibly establish. Because the defendant knows that if convicted,
there is no discretion for the judge to mitigate sentencing, he is certain to serve the specified time. So, his thinking focuses on the strength of the prosecutor’s case. All other
things equal and assuming risk-averse defendants, this may induce prosecutors to plea
bargain more harshly than when judges had discretion in sentencing. And not only is
there likely to be more plea bargaining, it is also likely that the deals agreed to are more
pro-prosecutor and less defendant-friendly than was previously the case. These are, of
course, empirically testable propositions.
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13.5. (This question is in the box on p. 493.) In criminal cases, the prosecutor attempts
to prove with a very high level of certainty that the defendant committed the crime. Typically, evidence of what the defendant did before this crime or might do after conviction
for this crime is not admissible for the purpose of determining guilt or innocence for this
particular crime. But at sentencing time, these other factors may come into play. If, for
example, this is the defendant’s third conviction for a felony (“three strikes” laws), then
the sentencing may be harsher. Perhaps the way to understand that harsher sentencing is
to say that the record of three prior convictions suggests that future felonies are more
likely than we would like to be the case and so as to deter those future crimes, we are
putting you in prison for a longer time. But we ought to get a little squeamish about
making predictions of future behavior on the basis of past behavior. Rather, we tend to
think—until convinced by future behavior—that the criminal is going to reform—that is,
commit no future crimes. Put somewhat differently, the evidence on future criminality
would have to be overwhelmingly strong to make us comfortable with incarceration
someone solely on the basis of their likely future criminality.
13.6. (p. 499) Without a clear idea of the level of crime, it is impossible to hypothesize
or test hypotheses concerning the effects of deterrence measures on the level of crime.
Indeed, the collection of careful and accurate criminal statistics by the FBI, the Bureau
of Criminal Justice, and others has been one of the most useful additions to the study of
crime in the U.S. Increasingly, other countries are collecting such statistics, making international comparisons of crime a growing field of scholarship.
13.7. (p. 499) Sorting out two offsetting effects that are highly correlated is very difficult. Economic growth creates wealthier targets for crime (thereby increasing the expected benefit of crime) but also creates more stable and rewarding employment opportunities (thereby increasing the expected cost of crime). There is no theoretical argument
that suggests which of these effects dominates. So, we need to do careful empirical
work. And as the text suggests, that empirical work suggests that there is no discernible
pattern between the business cycle and crime (with the exception of automobile theft,
which moves pro-cyclically).
13.8. (p. 499) Criminals may be excessively “present-minded” and insufficiently willing
to wait for future pleasures. One way to lower their discount rate might be to educate
them thoroughly as to the effect a crime would have on their future standard of living.
Additionally, they might be given some demonstration – perhaps in their criminal sentencing – about the value of current sacrifice and future reward. How do the findings of
Wilson and Abrahamse bear on this question?
13.9. (p. 509) The incentive to earn profit in a competitive environment spurs costcutting, technological innovation, and a superior quality output. Could competition among
private prisons accomplish the same goals? Critics of private prisons are concerned that
cost-cutting may lead to a sacrifice in the quality of prisoner care such as low quality
food, shelter and other material conditions for the prison population. We might try to
control those forms of competition by regulating the minimum terms and conditions that
private prisons must maintain. But will there be adequate monitoring and enforcement of
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those regulations? Perhaps not. And, in addition, many states may be unwilling to have
competitive prison systems within their state. They probably would prefer to have one
provider whom they can, at least in theory, closely monitor.
13.10. (p 509) Think again about the opportunity cost of committing crime. When society is fully employed at high wage jobs, the opportunity cost of switching to crime is the
loss of the income from time spent perpetrating the crime and paying the fine.
13.11. (p. 512) The main forms of randomness in criminal law would be the false positives and false negatives that the system generates. A “false positive” is a wrongful conviction, and, as we note in the text, there has been an unfortunate amount of wrongful
convictions in the state criminal courts of the past 15 years or so. Many states have instituted reforms to try to make instances of wrongful conviction much rarer. A “false negative” would involve an inaccurate finding of not guilty. We do not have evidence on
how common that is.
In scientific parlance, a “false positive” is known as a “Type I error,” and a “false
negative” is called a “Type II error.”
13.12. (p. 512) If potential criminals knew that there was a substantial likelihood of a
wrongful conviction, that might deter them from committing more serious crimes. Of
course, they would have to set that likelihood off against the probability of a false negative (being exonerated for a crime that they really committed). If most criminals are riskaverse, then the possibility of a wrongful conviction is likely to loom large in their calculations. This suggests an empirical test: given that many states have taken steps to reduce the possibility of a wrongful conviction and in the assumption that those convictions are now less common, can one discern an increase in crime attributable to those
facts?
13.13. (p. 517) Statistical analysis is a very powerful tool as it often appears to provide
hard answers to difficult questions. Hypothesis tests however are rarely if ever perfectly
formulated. Questions will always arise concerning the choice of variables, the construction of the test, and what the chosen variables actually measure. Still, econometric analysis is a useful tool for analyzing criminal behavior. But notice that very few people will
formulate their final views about the death penalty on the basis of empirical evidence.
That is, few of those who are opposed would change their minds if they were shown
compelling empirical evidence on the deterrent effect of capital punishment. And few
proponents would drop their endorsement of capital punishment if shown compelling
empirical evidence that it does not have a statistically significant deterrent effect. To
quote an old joke, most people use statistical evidence in the same way that a drunk uses
lampposts, “more for support than illumination.”
13.14. (p. 517) Here are several: (1) when concerns about the possibility of a false positive conviction became more widespread, then imposing these horrific harms became
socially intolerable; (2) those practices were frequently done as part of torture to extract
a confession (a confession being the principal if not the only means of obtaining a conviction) and there arose in the late Middle Ages grave doubts about the truthfulness of
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confessions extracted under torture; and (3) society simply determined that this was excessive punishment. Perhaps the same factors that explain the ending of the public spectacle of hangings help to explain the demise of mutilations, branding, and the like.
13.15. (p. 522) Remember that the equilibrium price is determined by the intersection of
the supply and demand schedules. If the price of drugs is falling, then the supply must be
increasing faster than the demand is decreasing. The principal reason that has happened
is that the attempts to interdict supply or to induce people to get out of the criminal business of supplying drugs has failed.
13.16. (p. 522) We already know about the ineffectuality of the current system of proscription, policy (iii). Policy (ii) would certainly reduce the price of drugs and thereby
cut some of the connection between drug use and crime. Policy (i) of asking addicts to
register and, having done so, giving them daily access to methadone has been tried with
mixed success. Methadone, developed in Germany in 1937, operates on the same opiate
receptors as do heroin and opium and is frequently used in treating chronic pain. One of
methadone’s advantages over other powerful pain relievers is its low cost—typically,
$20 per month.
So-called “methadone maintenance treatment” is a common way of dealing with
heroin addicts. Daily doses of methadone reduce the craving for heroin. But the treatment must be supplemented with other treatments, such as counseling, in order to be effective.
13.17. (p. 522) Probably for a hamburger. (Does it follow that eating hamburgers induces crime?) But it is probably true that a greater percentage of criminals test positive for
drugs than in does the non-criminal population. What does that tell us?
13.18. (p. 526) These arguments must be “all other things equal” arguments. And it is
unlikely to be the case that all other things are equal. Nonetheless, it is probably the case
that crime is less and increases in the following order:
a. no private citizen has a gun.
d. only honest citizens have guns.
b. only criminals have guns.
c. everyone has easy access to guns.
13.19. (p. 526) A simple law may state, “No one with any criminal record may purchase
a gun.” Several attempts to restrict handguns to those without a criminal record have
been tried. But they do not seem to work. Criminals can still acquire guns, illegally,
through theft, through corrupt dealers who are more eager to make a sale than to check
forged identity cards carefully, and through the extensive black market in guns.
13.20. (p. 526) Guns lower both the cost of committing crime and the cost of preventing
crime. In the neighborhoods where crime is highest, the potential victims want to have
the ability to deter crime by fighting back with guns or, at least, deterring criminals by
letting them know that they have guns.
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13.21. (p. 526) Owning a gun reduces a household’s cost of crime prevention. However,
the risk associated with possessing a gun so that suicide and accidents become more
likely must be factored in when calculating the total benefit or cost to society of gun
ownership. How those offsetting costs and benefits add up is not clear.
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