Law and Economics Midterm – Flashcards

also called allocative efficiency. Impossible to change situation so as to make at least one person better off without making another person worse off

(potential pareto improvement) allows changes in which gainers gain and losers lose but gainers gain more than losers lose so gainers could compensate losers and there would still be a surplus.

economics having to do with single factors and individual decisions

comparison of two different economic outcomes; before and after a change.

pattern of interaction that persists unless disturbed by outside forces.

describes preferences

preferences determined outside the economic system

Measures how responsive consumers are to a change in price

represents the relationship between the price of a good and the amount of that good in a consumer's optimum bundle.

at least one input is fixed, usually capital. (all others being variable.)

distinguished by the fact that all factors of production become variable.

occur when the cost per unit (or average cost of production) declines as the total amount of output increases.

one firm in the market. Firm's objective is still to maximize profits (where MU=MC). MR curve is downward-sloping

one of conditions we need absent, can't apply theorems. 4 sources: monopoly and market power, externalities, public goods, and severe information asymmetries

split over costs or benefits of an exchange

commodity that is nonrivalrous (consumption by one doesn't leave less for the other) and nonexcludabile (cost of excluding too high for private firm to buy)

when one party knows more about a product than the other party

the sum of the probabilities of each possible outcome times the value of each of those outcomes.

in consumer behavior, the shape of indifference curves that represent preferences or the tradeoffs that a person would make.

a given curve that graphs all the combinations of x and y that a consumer is indifferent between. All the points will give the consumer the same utility. It is used to derive a consumer's demand curve.

The income restraint that acts as an obstacle that causes consumers to have to make consumer choice. Area below the line represents all combinations of x and y that are affordable, given their income.

change in price may lead to a change in the potential pool of customers

change in price may lead to a change in behavior of consumers

how you allocate scarce resources to satisfy unlimited wants and desires

collection of rules, processes, guidelines

looks at precedent established by previous court rulings. Doesn't rest in legislature but in precedents made by courts in previous cases. Judge neutral. A precedent of sorts, "finding" of law as it already existed, enforceable social norms, called common because they were allegedly rooted in the common practices of people. Not from legislature, rather, from courts. The judge is neutral, juries are more common. Judges back up their decisions with precedents.

from Napoleon, coding common law traditions. Judges plays an active role

taught by reading cases and arguing from them. Has British roots.

lowest level of courts, they are courts of record, the proceedings re written down and saved by the government. Usually organized by county lines. Deal with facts and then applying law.

above trial courts, in most state court systems there is only one court of appeal. Where these courts exist, parties from the trial court may appeal "as of right" These courts deal with a problem with how the law was applied.

where the proceedings are written down and saved by the government.

The jury

dismissing the complaint against the defendant by the judge if it is found that the plaintiff has failed to state a valid cause of action or that the defendant has made a complete and convincing answer to the complaint.

what the jury returns with that says which party wins

a bundle of rights that describe what people may and may not do with the resources they own, and these are protected from interference by others

value created by moving resources to a more valuable use.

all impediments to bargaining. (pg84-5)

Where the parties cannot negotiate and bargain

payoffs to parties in non-cooperative solution

a harmful externality in property law

in some cases defining property rights are not needed for reaching equilibrium (where transaction costs are $0). If costs are significant, efficiency will depend upon whether or not property rights are properly assigned

people sometimes demand much more to give up something that they have than they would be willing to pay to acquire it (ie. clean air). An endowment is an initial assignment of ownership rights. The divergence between buying and selling price is called an endowment effect because the price varies depending on the initial assignment of the ownership.

one of the three forms of transaction costs/steps of an exchange (search, bargaining & enforcement). A bargain is reached by successful negotiation, which may include the drafting of an agreement. Information is "public" in negotiations when each party knows each other's threat values and the cooperative solution. Information is "private" when one party knows some of these values and the other does not. If parties know cooperative solution/threat values they can compute reasonable terms for cooperation. Public info facilitates agreement by allowing parties to compute reasonable terms for cooperation. Negotiations simpler with public info. Ie. negotiations to sale of a fruit are simple bc there is not much to know about it. Private info impedes bargaining bc it must be converted into public info in order for agreement to be reached. Asymmetric info and each party trying to extract info from the other. (ie. selling a house; owner knows about hidden defects buyer knows more about their ability to obtain financing).

one of the three forms of transaction costs/steps of an exchange (search, bargaining & enforcement). It is the locating of an exchange partner/finding someone who wants to buy what you are selling or vice versa. Search costs tend to be high for unique goods and services and low for standardized goods and services (1957 Chevy vs. a soft drink)

"Structure the law as to remove the impediments to private agreements." The Coase Theorem suggest that the law can encourage bargaining by lowering transaction costs. Lowering transaction costs "lubricates" bargaining. One way to do his is to clearly/simply define property rights (ie. public records). More clear how to negotiate when property is defined clearly. By lubricating bargaining, the law enables the private properties to exchange legal rights, thus relieving lawmakers of the difficult task of allocating legal rights efficiently. Normative because it offers prescriptive guidance to lawmakers. The theorem assumes that private exchange, under the appropriate circumstances CAN allocate legal rights efficiently.

"Structure the law so as to minimize the harm caused by failures in private agreements" Hobbes thought that people would seldom be rational enough to agree on a division of the cooperative surplus even with minimal impediments to bargaining. Believed people will naturally quarrel unless a third, stronger party forced them to agree. Theorem focuses on trying to minimize the losses from disagreements/failures to cooperate. The law should be designed to prevent coercive threats and to eliminate the destructiveness of disagreement. When agreement is not reached (and one is possible) the surplus from the exchange is lost. To minimize resulting harm, the law should allocate property rights to the party who values it the most. This makes the exchange of rights unnecessary and thus saves the cost of transaction. The Normative Hobbes Theorem "allocates." Difficulty is that lawmakers often do not know who values rights the most and finding out can be difficult. Lawmakers face tradeoff bw transaction costs and information costs.

an order by the court directing the defendant to perform an act or to refrain from acting in a particular manner. This relief is said to "enjoin" the defendant to do or to refrain from doing a specific act. Usually applied to remedy trespassing/interfering with another's property. Injunctive = "property rule" whereas compensatory = "liability rule." Damages & injunctions are equally efficient when transactions costs equal zero. If transaction costs are high (nor bargaining will happen), the more efficient outcome is damages, not injunction). → laundry and electric company example

Sum of money to compensate the plaintiff for the wrongs inflicted by the defendant. Purpose is to compensate the plaintiff, NOT to punish the defendant. Usually applied in accidents & broken promises. When compensatory damages are perfect, they restore the victim to the same utility curve her or she would have enjoyed without the harm. Damages can be temporary (for damage done in the past) or permanent (damages for past harms plus the present discounted value of all reasonably anticipated future harms). Temporary damages impose high transaction costs for dispute resolution because must return to court if harms continue. Permanent have higher error costs because the future is more difficult to predict. More efficient option depends on how easily damages can be measured & how rapid innovation occurs. In some cases impossible to "make victim whole" (ie. death of child); damages can't be computed by a formula. Compensation is perfect when the victim is indifferent bw having the injury and the damages. Idea of perfect substitute wouldn't apply to immeasurable damages like loss of child. Juries attempt to compute the value of wrongful death.

Joseph Schumpeter referred to innovation as "creative destruction." He was summarizing the fact that innovation can change wages and employment and cause some communities to grow and others to wither. For example, during industrialization cities flourished as people poured in to work for higher wages while people who stayed in the country had harder times finding employment for their skills (ie. plowing) and many buildings were abandoned/boarded up. Most societies value gains from faster growth more than they fear its destructive effects. In the long run, the benefits of innovation are diffused and benefit the whole of society, not just the inventor.

a patent system establishes ownership rights to inventions, processes, and other technical improvements. Temporary monopoly (See copyright for more info). In developing countries focus on dissemination, ie. Microsoft is cheap but low incentive to innovate because copyrights are not protected (different application of innovation-diffusion tradeoff). When thinking about how broad or narrow a patent/copyright is think of duration and breadth. To secure a right to an invention, must submit application to US Patent Office. Must be "non-obvious" and have "practical utility." Patents usually for 20 years. If others use it must pay royalties. Can use trade secret to prevent people from "engineering around patent" since details must be enclosed in a patent application. Too much patent restricting innovation in the pharmaceutical field?

the copyright system grants ownership rights to authors, artists and composers. Copyrights & patents may be temporary monopolies that can vary in breadth and duration. Narrowing breadth/duration decreases monopoly profits and increases dissemination. Narrow copyrights → author of book only owns rights to book. Broad copyrights → author has ownership of book & movie (derivative works). Innovation-diffusion tradeoff: broadening rewards innovator/encourages innovation/ increases diffusion up to a certain point when monopoly power takes over and less of good will be distributed.

Natural monopoly is such a common feature of networks that its occurrence in networks has a special name - network effects. The economic analysis of network effects began with railways in the 19th century. Most efficient organization = radiating from central terminal. This network efficient confers a large advantage on the owner of the central terminal for a region. Similarly, information-based industries apply analogous networks. All software on a comp. must use an operating system. An exclusive owner of the operating system for computers can favor the use of its own software and disfavor rival software (ie. Microsoft). Owning a computer operating system has been analogized to having a patent on the use of the English language.

a monopolist that owes its existence to economies of scale is sometimes called a natural monopoly. Public utilities, telecommunications, cable and power companies are often natural monopolies. Technological advantages would be partially lost if the single firm is allowed to restrict its output and charge a monopoly price so the government typically regulates natural monopolies. Monopolist sets MC=MR. Unlike the competitive firm, revenue declines as the number of units the monopolist sells increases. In a natural monopoly, the largest firm with the lowest costs can drive out the competition. Intellectual property has similar characteristics to a natural monopoly. Monopolists have power over prices. Some people are opposed to patents/monopolies because they discourage incentives for others to develop alternatives.

ie. oil and gas are not the property of anyone until extracted ("first in time, first in right;" easy and cheap rule to apply and has been used to establish ownership rights for centuries. Disadvantage of rule? it creates incentive to preempt others by making uneconomic investments to obtain ownership of property (investing too much too early). Preemptive investment to be able to collect future rent - inefficient bc are investing for the sake of transferring wealth and not producing it

ie. the owner of the surface has the exclusive right to subsurface deposits. This rule dies ownership of fugitive property to settled property. Civil/common law applies rule through principle of accession (ie. newborn cow belongs to owner of the mother cow). In gas example, all the gas is already owned because all the surface rights are already owned. So unlike rule of first possession, no incentive to acquire ownership by acquiring too much gas too soon. If you own the land, you are less likely to deplete the resources. In this sense rule of tied possession can be seen as more efficient.

two ways to establish property rights over fugitive property are first possession and tied ownership. Fugitive property = objects that don't have definitive properties/not easy to assign property rights to (ie. gas extracted by company lies partially under land another lady). Trade-off in property law → balancing incentive to overinvest (first possession) against the cost of administering/enforcing ownership without possession.

related to the question of whether or not a thief can give a good title. Ie. you buy a TV from a guy in a parking lot and it was stolen. Good faith defense does not exist in U.S. → transferors can convey only those property rights that they legitimately have (can't transfer a title that you don't have). Title rests with the person from whom the TV was stolen and in US must be returned/entitled to recover your money from the thief if thief is caught. In Europe, a good faith defense exists. The buyer CAN acquire title by purchasing in good faith. The law may also require the buyer to make reasonable efforts to verify ownership. American rule → places risk on buyer. European/good faith → gives owners extra incentive to protect property. What is more efficient? if cost of verifying ownership is high relative to cost of safeguarding property then a good faith defense is efficient in that it shifts the burden back to the original owner to keep their property from being stolen.

a way of addressing the inefficiency of not knowing who holds the title to a property. If an owner "sleeps on his rights" he might lose them. Someone can acquire ownership of another's property by occupying it for a period of time specified in a statute, provided the occupation is adverse to the owner's interests, and the original owner does not protest or take legal action. It can be seen as economically advantageous because it allows the property to move to higher-valuing users. In general, a rule for acquiring title by adverse possession lowers the cost of establishing rightful ownership claims by removing the risk that ownership will be disputed on the basis of the distant past. Transfers property from unproductive to productive user. Sometimes squatters have acquired land from absentee owners through adverse possession. Historical example, settlement of the West and taking lands form the Natives. The cost of adverse possession? requires owners to actively monitor land. Without adverse-possession statutes, their would be less motivation to monitor and more trespassers would enjoy other peoples land.

answers the question of who owns property that has been abandoned, lost or mislaid. If a piece of property exceeds a certain value, US procedure demands that a finder appear before a court/advertise found item. If not claimed within a time period, finder becomes the owner (this is an example of a typical estray statute). Estray statues discourage theft and help to distinguish good faith finder from a thief. Estray statutes provide an incentive for owners to monitor their property, reduce search costs, and transfer property to productive users.

from English common law. The rule imposes a time limit on property restrictions imposed by the terms of a gift, sale, bequest, or other transaction. Instead of lasting in perpetuity, restrictions automatically laps when a legal time limit expires. Restrictions based on inherence will expire after 21 years, for example. The rule against perpetuities appears to maximize the value of property across generations. A trust is a way of getting around this rule/inconsistent with the rule against perpetuities. Technically, a trust is not an inheritance (it pays money to the beneficiary of the trust). It is a way avoiding inheritance taxes.

the forbidding of a bargaining solution to the use of a property right. It is a way of encouraging the efficient use of property. Inalienable refers to something of yours that you cannot lose by specified means. Thus body organs, sex, and children are inalienable by sale, your voting right is inalienable by sale or gift, and your human rights are inalienable by any means. Sale of sex and children prohibited by law/morality. Regulations restrict transfers whereas inalienability PROHIBITS them. In general, prohibitions on transfers are inefficient bc they prevent people from getting what they want. Is there any economic rationale for inalienability? (donated blood tends to be cleaner than sold blood).