Intro Law & Econ


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Introduction to Law and Economics

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Intro Law & Econ

  1. 1. Introduction to Law and Economics <ul><li>Brian Hollar </li></ul><ul><li>Levy Fellow in Law & Liberty </li></ul><ul><li>[email_address] </li></ul><ul><li>August 16 th , 2008 </li></ul>George Mason University
  2. 2. Law & Economics What Is It? <ul><li>What is economics? </li></ul><ul><li>What does economics have to do with the law? </li></ul><ul><ul><li>Criminal Law </li></ul></ul><ul><ul><li>Property </li></ul></ul><ul><ul><li>Contracts </li></ul></ul><ul><ul><li>Torts </li></ul></ul><ul><ul><li>Intellectual Property </li></ul></ul>George Mason University
  3. 3. Law and Economics What It’s Not: Economics of Law Firms George Mason University Law 108
  4. 4. 10 Principles of Economics: Greg Mankiw How People Make Decisions <ul><li>People Face Tradeoffs. To get one thing, you have to give up something else. Making decisions requires trading off one goal against another. </li></ul><ul><li>The Cost of Something is What You Give Up to Get It. Decision-makers have to consider both the obvious and implicit costs of their actions. </li></ul><ul><li>Rational People Think at the Margin. A rational decision-maker takes action if and only if the marginal benefit of the action exceeds the marginal cost. </li></ul><ul><li>People Respond to Incentives. Behavior changes when costs or benefits change. </li></ul>George Mason University
  5. 5. 10 Principles of Economics: Greg Mankiw How the Economy Works as A Whole <ul><li>Trade Can Make Everyone Better Off. Trade allows each person to specialize in the activities he or she does best. By trading with others, people can buy a greater variety of goods or services. </li></ul><ul><li>Markets Are Usually a Good Way to Organize Economic Activity. Households and firms that interact in market economies act as if they are guided by an &quot;invisible hand&quot; that leads the market to allocate resources efficiently. The opposite of this is economic activity that is organized by a central planner within the government. </li></ul><ul><li>Governments Can Sometimes Improve Market Outcomes. When a market fails to allocate resources efficiently, the government can change the outcome through public policy. Examples are regulations against monopolies and pollution. </li></ul>George Mason University
  6. 6. 10 Principles of Economics: Greg Mankiw How People Interact <ul><li>A Country's Standard of Living Depends on Its Ability to Produce Goods and Services. Countries whose workers produce a large quantity of goods and services per unit of time enjoy a high standard of living. Similarly, as a nation's productivity grows, so does its average income. </li></ul><ul><li>Prices Rise When the Government Prints Too Much Money. When a government creates large quantities of the nation's money, the value of the money falls. As a result, prices increase, requiring more of the same money to buy goods and services. </li></ul><ul><li>Society Faces a Short-Run Tradeoff Between Inflation and Unemployment. Reducing inflation often causes a temporary rise in unemployment. This tradeoff is crucial for understanding the short-run effects of changes in taxes,government spending and monetary policy. </li></ul>George Mason University
  7. 7. Criminal Law Gary Becker: Paying the Meter? <ul><li>Nobel Laureate or Parking Ticket Violator? </li></ul><ul><ul><li>BOTH! </li></ul></ul><ul><li>Becker’s key insight was that crime is a function of costs and benefits </li></ul><ul><li>The way to deter crime is to raise the probability of detection or increase the punishment </li></ul>George Mason University
  8. 8. Criminal Law Cost-Benefit Analysis of Crime <ul><li>What is the cost of the crime? </li></ul><ul><li>What is the benefit? </li></ul><ul><li>Does circumstance matter? </li></ul><ul><ul><li>What about a hunter lost in the woods? </li></ul></ul><ul><ul><li>A husband speeding to get his pregnant wife to the hospital? </li></ul></ul><ul><ul><li>A man who murders for pleasure? </li></ul></ul><ul><li>What are the costs vs. benefits in all of these? </li></ul><ul><li>Why not catch all murderers? </li></ul>George Mason University
  9. 9. Criminal Law Should We Count the Criminal? <ul><li>Why should we count the benefit to the criminal in our calculations? </li></ul><ul><li>What is worse – arson or shoplifting? </li></ul><ul><ul><li>What’s the difference? </li></ul></ul><ul><ul><ul><li>Transfer: Shoplifting </li></ul></ul></ul><ul><ul><ul><li>Destruction: Arson </li></ul></ul></ul><ul><li>Costs of imprisonment </li></ul><ul><ul><li>Cost to society </li></ul></ul><ul><ul><li>Lost opportunity for the criminal </li></ul></ul>George Mason University
  10. 10. Criminal Law Defensive vs. Offensive Expenditures <ul><li>Defensive expenditures </li></ul><ul><ul><li>Locks </li></ul></ul><ul><ul><li>Alarms </li></ul></ul><ul><ul><li>Police/security guards </li></ul></ul><ul><ul><li>Court system </li></ul></ul><ul><li>Offensive expenditures </li></ul><ul><ul><li>Guns </li></ul></ul><ul><ul><li>Lock picks </li></ul></ul><ul><ul><li>Jail time </li></ul></ul><ul><ul><li>Criminal fines </li></ul></ul>George Mason University
  11. 11. Criminal Law Crime as a Tax <ul><li>Productive assets are spent avoiding crime </li></ul><ul><li>Inner cities are left depleted of productive resources and social links to build human and physical capital </li></ul><ul><li>Gated communities seclude the rich and wall them off from beneficial exchange with the poor </li></ul>George Mason University
  12. 12. Criminal Law What About Violent Crime? <ul><li>Senseless mugging </li></ul><ul><li>Brutal Rape </li></ul><ul><li>Murder </li></ul><ul><li>Who gains? </li></ul><ul><ul><li>The less gain, the harsher the penalty </li></ul></ul><ul><ul><li>Lifeboat vs. cold blooded murder </li></ul></ul>George Mason University
  13. 13. Property Pollution <ul><li>Dick’s dog is Spot </li></ul><ul><li>Spot barks </li></ul><ul><li>Jane lives next door </li></ul><ul><li>Jane incurs costs when Spot barks </li></ul><ul><li>Dick likes his dog </li></ul><ul><li>Dick does not care about Jane </li></ul>George Mason University
  14. 14. Property Solution Before Coase <ul><li>Market Failure </li></ul><ul><ul><li>decentralized choices don’t internalize costs </li></ul></ul><ul><ul><li>Dick over-consumes dog services </li></ul></ul><ul><ul><ul><li>or, equivalently, under-supplies ‘peace & quiet’ </li></ul></ul></ul><ul><li>Option A: regulate dog ownership </li></ul><ul><li>Option B: a bark tax </li></ul><ul><ul><li>but how much? </li></ul></ul><ul><ul><li>every bark is different </li></ul></ul>George Mason University
  15. 15. Property Solution via Coase Theorem <ul><li>Coase 1960 </li></ul><ul><ul><li>Coase (1959) on radio interference </li></ul></ul><ul><ul><li>Coase wins Nobel Prize in 1991 </li></ul></ul><ul><li>4 Coasean insights </li></ul><ul><ul><li>Dick and Jane are both part of the problem </li></ul></ul><ul><ul><ul><li>‘ barking’ is a by-product of ‘dog services’ </li></ul></ul></ul><ul><ul><ul><li>Dick ‘causes’ problem by producing valuable services </li></ul></ul></ul><ul><ul><ul><li>Jane ‘causes’ problem by locating next door to Dick </li></ul></ul></ul><ul><ul><li>Goal: not to eliminate costs, but get optimal level </li></ul></ul><ul><ul><ul><li>Maximize: value created for Dick and Jane </li></ul></ul></ul><ul><ul><ul><li>Trade-offs not known to central authority </li></ul></ul></ul><ul><ul><li>Solution: let parties purchase inputs in a market </li></ul></ul><ul><ul><li>Policy fix: make sure property rights well defined </li></ul></ul><ul><ul><ul><li>“ owners” necessary for the auction </li></ul></ul></ul>George Mason University
  16. 16. Property And one big result! <ul><li>It makes no difference who gets the rights </li></ul><ul><ul><li>In terms of efficiency </li></ul></ul><ul><ul><li>Assuming zero transaction costs </li></ul></ul><ul><li>Give Jane the right to peaceful tranquility </li></ul><ul><li>Give Dick the right to let Spot bark </li></ul><ul><li>Spot continues to bark at the optimal level </li></ul><ul><li>Market discovers efficient outcome </li></ul>George Mason University
  17. 17. Property Pollution <ul><li>Remedy: not eliminate, find optimal level </li></ul><ul><ul><li>What will producers pay to pollute? </li></ul></ul><ul><ul><li>What will consumers of non-polluted resources pay to avoid pollution? </li></ul></ul><ul><li>Ownership empowers transactions </li></ul>George Mason University
  18. 18. Contracts The Basics <ul><li>Cost-benefit analysis key </li></ul><ul><li>Start with what constitutes a contract </li></ul><ul><ul><li>formal agreement </li></ul></ul><ul><ul><li>consideration </li></ul></ul><ul><ul><li>no duress </li></ul></ul><ul><li>2 important ideas </li></ul><ul><ul><li>Risk </li></ul></ul><ul><ul><li>Expected Value </li></ul></ul>George Mason University
  19. 19. Contracts Risk <ul><li>Future outcomes uncertain </li></ul><ul><li>Invest for a range of possible payoffs </li></ul><ul><li>Important to understand the purpose of contracts as helping to </li></ul><ul><ul><li>coordinate activity </li></ul></ul><ul><ul><li>manage risk </li></ul></ul><ul><ul><li>maximize present value </li></ul></ul>George Mason University
  20. 20. Contracts Expected Values <ul><li>Weighting potential outcomes by probabilities </li></ul><ul><ul><li>Best guess of the future </li></ul></ul><ul><li>Expected value = (prob a )(value a ) + (prob b )(value b ) </li></ul><ul><li>Ex: project has 25% chance of earning $1 million, and 75% chance of paying out $0. </li></ul><ul><ul><li>EV = (.25)($1MM) + (.75)(0) = $250,000 </li></ul></ul>George Mason University
  21. 21. Contracts Risk Management <ul><li>Contracts tie risky outcomes into a bundle </li></ul><ul><li>Aid cooperation among parties to invest to produce positive outcomes </li></ul><ul><ul><li>interests often diverge from ex ante (before) to ex post (after) </li></ul></ul><ul><li>A “perfect contract” binds players’ incentives </li></ul><ul><ul><li>a form of ownership integration </li></ul></ul>George Mason University
  22. 22. Contracts Efficient Breach <ul><li>When contract terms imply inefficient outcomes (due to changing circumstances), it is efficient to scrap them </li></ul><ul><li>Suppose both parties invest $50K and each expect to earn $100K one year later, iff the other performs </li></ul><ul><li>This is an efficient bargain </li></ul><ul><ul><li>Both parties obtain EV = $50K </li></ul></ul>George Mason University
  23. 23. <ul><li>Property rules efficient when private transaction costs are low relative to litigation costs </li></ul><ul><li>Liability rules efficient when the reverse is true </li></ul><ul><li>Tort system to cover damaging ‘spillovers’ where contracts prohibitively expensive </li></ul><ul><ul><li>the “law of accidents” </li></ul></ul><ul><li>Purpose: yield incentives for efficiency </li></ul><ul><ul><li>optimally avoid damage-creating activities </li></ul></ul><ul><li>Liability Rules, Negligence, Etc. </li></ul><ul><ul><li>Least-cost avoiders </li></ul></ul>Torts The Basics George Mason University
  24. 24. Intellectual Property An Economic Theory of IP <ul><li>Two problems </li></ul><ul><ul><li>Drawing boundaries </li></ul></ul><ul><ul><ul><li>Copyrights: Minor problem </li></ul></ul></ul><ul><ul><ul><li>Patents: Major problem </li></ul></ul></ul><ul><ul><li>Enforcement </li></ul></ul><ul><ul><ul><li>Copyrights: well-defined </li></ul></ul></ul><ul><ul><ul><li>Patents: less well-defined </li></ul></ul></ul>George Mason University
  25. 25. Intellectual Property Transaction Costs & Incentives <ul><li>Transaction Costs of moving property to highest valued use </li></ul><ul><ul><li>Copyright violation: deliberate </li></ul></ul><ul><ul><li>Patent violation: sometimes unintentional </li></ul></ul><ul><li>Incentive to create rights </li></ul><ul><ul><li>Copyright – if I write my book, giving me a right over it doesn’t affect you much </li></ul></ul><ul><ul><li>Patent – if I invent something, it may seriously impact you by preventing you from inventing it </li></ul></ul>George Mason University
  26. 26. Intellectual Property Copyrights vs. Patents <ul><li>Copyright – give easily for long time </li></ul><ul><ul><li>Easy to define </li></ul></ul><ul><ul><li>Cheap to enforce </li></ul></ul><ul><ul><li>Easy to transact over </li></ul></ul><ul><li>Patent – difficult to obtain and short term </li></ul><ul><ul><li>Hard to define </li></ul></ul><ul><ul><li>Hard to enforce </li></ul></ul><ul><ul><li>Costly to transact over </li></ul></ul><ul><ul><li>Potential inefficiency from patent races </li></ul></ul>George Mason University
  27. 27. Conclusion <ul><li>Economics  helps explain the law </li></ul><ul><li>Law  helps inform economics </li></ul><ul><li>Cross-pollination is productive! </li></ul><ul><li>Any questions? </li></ul><ul><ul><li>Feel free to e-mail me at [email_address] </li></ul></ul>George Mason University