ECONOMIC ANALYSIS OF LAW September 12, 2006. ECONOMIC ANALYSIS OF LAW Course.

ECONOMIC ANALYSIS OF LAWSeptember 12, 2006

ECONOMIC ANALYSIS OF LAW

Course


• ECO320Y5Y

• LEC6001P1

• TUESDAY - 19:00 - 21:00

• SE 1104


Syllabus


• Posted at:

• http://www.utm.utoronto.ca/~w3eco320/

• PDF

http://www.utm.utoronto.ca/~w3eco320/


Lecture Slides


• Two Formats at:

• http://www.utm.utoronto.ca/~w3eco320/

• Microsoft

• PDF

http://www.utm.utoronto.ca/~w3eco320/


Specific

Issues


• Standard Microeconomics• No Legal System

(Or A Legal System that is completely dysfunctional)

• Parties will still make contracts, but the focus is on strategy, not design or enforcement• Contracts are instantaneous• No Property Rights• No Enforcement• No Legal Hierarchy


• Where do “laws” come from?• Custom

• Judicial Precedent (Common Law)

• Statutory Legislation

• Executive Decision – Making


• Courts• Beverley McLachlin,

P.C. – Chief Justice of Canada


• In each category, the following questions arise?

• Does a law (rule), over time, become

» More Efficient?

» More Competitive?

» More Optimal?


• The “interesting” or most “visible” legal issues arise in non-market situations

• What does one mean by a non-market situation?

» No pricing mechanism or the pricing

mechanism has broken down

» Imperfect information

» Power, not resources, is paramount


• Bilateral Agency

» Bilateral monopoly is an example of a bilateral agency

» Examples: One union represents the entire workforce of a monopolist

Brand loyalty or brand exclusivity


• Bilateral Agency» Almost all of the legal problems discussed in

this course will involve some form of bilateral agency

» Examples: Landlord and tenant

Spouses in a marriage

Firm and shareholders

Criminal and victim

Tribunal and parties before it


• Bilateral Agency» Two broad types of “bilateral” agency

» Implicit – relationship is exclusively strategic

» Examples: Duopoly – substitutes or complements

» Explicit – relationship is both strategic and has some legal

significance

» Examples: See previous slide


• Bilateral Agency» Two types of “explicit” agency

» Imposed – A law “imposes” a relationship onto parties

» Examples: Parent – child

Car owner – accident victim

» Voluntary – The parties “choose” their relationship

» Examples: Contracts

Some marriages


• Horizontal Agency» A further way of classifying agency

» Horizontal – Two parties are similar and enter into some form of legal venture

» Examples: Two partners in a firm

Two joint property owners

Spouses in some marriages


• Horizontal Agency

AGENT 1 AGENT 2


• The following relationships predominate here

» Prisoners Dilemna

» Battle of the Sexes


• Divorce


• Vertical Agency» Vertical – Two parties agree on a ranking and

order of conduct

Principal – first mover

Agent – second mover

» Examples: Landlord and tenant – (especially residential)

Employer - employee

Buyer – seller

Client - lawyer


• Vertical Agency

AGENT 1

AGENT 2


• Vertical Agency

PRINCIPAL

AGENT


• Agency» No pricing mechanism or the pricing mechanism has broken down

» The focus is on information acquisition in order to maximize surplus (perfect discrimination = optimal surplus)

» Power determines who or what sets the price


• Agency» The focus is on information acquisition in order to maximize surplus (perfect discrimination = optimal surplus)

» Moral Hazard – non-verifiability of agent’s action

» Pooling – treating different agents the same

» Discrimination – treating the same agents differently


• Two “non-market” phenomena that predominate law and economics

» Moral Hazard

» Adverse Selection


• Moral Hazard» The possibility all or part of a contract

might not be performed

» Accidents


• Adverse Selection» Where discrimination is optimal, prohibit

it

(Banning pitbulls)

» Where discrimination is sub-optimal, allow it

(Asking new Canadians to re-qualify their work credentials)


• Cost of Going To Court

• Delay

• Lawyers

• Legal Aid


How does the legal system resolve conflict ?

» Negotiation - Settlements

» Courts – Lawsuits


Background

BACKGROUND

• 1776 – Adam Smith – Legal rules can impact economic growth

BACKGROUND

• England had poorer climate and less arable land than France in 1700’s

• Why did productivity in England outstrip France?

BACKGROUND

• Common law – long lease – the tenant farmer could keep the profits of innovation

»Better breeds»Better crop cycles»Successful enclosure system»Crop specialization

• Common law – not perfect – why? – law of primogeniture

BACKGROUND

• Law of primogeniture – On the one hand it kept good farms intact and continued economies of scale where present

BACKGROUND

• On the other hand the eldest son might end up being useless – Smith regarded this as a major problem and recommended repeal

BACKGROUND

• Recall that on September 11, 2001, in New York, there were acute shortages of water

• What happened?

BACKGROUND

• Opportunistic types took advantage of the need and would sell a bottle for $200.00 or more!

BACKGROUND

• In England, in Adam Smith’s day, there were penalties against such opportunistic behaviour

• What did Smith recommend – get rid of these laws! Let the market rule. Okay to make a dollar (or pound) off someone’s suffering – as long as the conduct is not fraudulent

BACKGROUND

• What was Smith’s answer for people caught stealing or lying in business?

BACKGROUND

• Death penalty?• Do not want these

types around • They pervert and

corrupt the market system which serves to give ammunition to critics of capitalism

BACKGROUND

• Who were the critics of capitalism?

• Not the NDP. It was not around in those days

• Not the Green party. Not necessary. Courts had tough rules against polluters (as we will see) and with which Smith agreed.

BACKGROUND

• Who were the critics?

• The Church. Protestant and Catholic

• Smith and his academic colleagues were regarded as heretics.

• Why?

BACKGROUND

• Smith said greed was usually good provided liars and cheaters were eliminated

• The Church said greed was always bad, but one should show mercy and compassion to the wrongdoers

BACKGROUND

• Smith said courts and Parliament should make rules that make society better off economically – basic model for this course

• The Church said courts and Parliament should make rules that are morally correct even if this makes people poorer – a lot of people including many judges and lawyers believe this still


• The “central problem” in the economic analysis of law:

Recall that the “problem” for consumers was to maximize utility:Outcome: Demand

Recall that the “problem” for producers was to maximize profits:Outcome: Supply


• The “central problem” in the economic analysis of law:

The “problem” for “lawmakers” is to maximize social surplus:Outcome: A law or a rule

BACKGROUND

• Smith said courts in England basically got it right

• Why?

• Competition – courts competed for the business of lawsuits and judges were paid by the case – not by a salary

• Smith believed this encouraged good outcomes over time

BACKGROUND

• Justice Richard Posner – major contemporary scholar in this field – argues that even if lawyers and judges do not “believe” this – over time it is the economically efficient precedent – that prevails

BACKGROUND

• So what happened after Adam Smith?

• Courts in England and Canada were suspicious of economics and were opposed to allow economists to testify as experts until 1976 (in Canada)

BACKGROUND

• United States – different story• Economic argument encouraged on

constitutional and antitrust briefs as early as the 1890’s

• This encouraged the formation of a “law and economics” specialization in economics

• The centre of this specialization is the University of Chicago

BACKGROUND

• By the early 1900’s – economics professors focused policy research on the legislators (not the courts) – use taxes or subsidies – stay clear of legal problems

BACKGROUND

• A.C. Pigou – wrote a leading text on taxes and subsidies – The Economics of Welfare” in 1920 followed by many governments until 1960

BACKGROUND

• For example, Pigou did not believe the strictness of common law rules against pollution did much good

• Why?

• Most firms were monopolistic in some way. Such firms could pass on, at leadt in part, the “expected” costs of lawsuits and other anticipated liabilities in the price charged to the consumers

BACKGROUND

• Solution?

• Put a tax on the product – the producer cuts back and thereby reduces pollution

• What is wrong with this argument?

BACKGROUND

• Challenged by Ronald Coase – in 1960, in an article - “The Problem of Social Cost” (featured on the syllabus) – Coase restored Smith’s view that legal rules do matter and we will study his arguments in considerable detail

ECONOMIC ANALYSIS OF LAW September 12, 2006. ECONOMIC ANALYSIS OF LAW Course.

Documents

Transcript of ECONOMIC ANALYSIS OF LAW September 12, 2006. ECONOMIC ANALYSIS OF LAW Course.