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Chapter Thirty-Three. Law and Economics. Effects of Laws. Property right assignments affect asset, income and wealth distributions; e.g. nationalized vs. privately owned industry. Effects of Laws. Property right assignments affect asset, income and wealth distributions;

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Chapter thirty three

Chapter Thirty-Three

Law and Economics


Effects of laws
Effects of Laws

  • Property right assignments affect

    • asset, income and wealth distributions;

      • e.g. nationalized vs. privately owned industry.


Effects of laws1
Effects of Laws

  • Property right assignments affect

    • asset, income and wealth distributions;

      • e.g. nationalized vs. privately owned industry.

    • resource allocations;

      • e.g. the tragedy of the commons

      • e.g. patents encourage research.


Effects of laws2
Effects of Laws

  • Punishments affect

    • incentives for illegal behavior;

      • e.g. high speeding fines can reduce the amount of speeding.


Effects of laws3
Effects of Laws

  • Punishments affect

    • incentives for illegal behavior;

      • e.g. high speeding fines can reduce the amount of speeding.

    • asset, income and wealth distributions;

      • e.g. jail time results in lost income.


Crime and punishment
Crime and Punishment

  • x is the quantity of an illegal activity produced by an individual.

  • C(x) is the production cost.

  • B(x) is the benefit.

  • Gain is B(x) - C(x).

  • What is the rational choice of x?


Crime and punishment1
Crime and Punishment

First-order condition is

Notice that marginal costs matter more than

do total costs.


Crime and punishment2
Crime and Punishment

B(x)

C(x), low MC


Crime and punishment3
Crime and Punishment

B(x)

C(x), higher, but

same MC

C(x), low MC

No change to illegal activity level.


Crime and punishment4
Crime and Punishment

B(x)

C(x), low MC


Crime and punishment5
Crime and Punishment

B(x)

C(x), high MC

C(x), low MC

Higher marginal costs deter crime.


Crime and punishment6
Crime and Punishment

  • Detection of a criminal is uncertain.

  • e is police effort.

  • (e) is detection probability; (e) = 0 if e = 0 (e)  as e .


Crime and punishment7
Crime and Punishment

  • Given e, the criminal’s problem is


Crime and punishment8
Crime and Punishment

  • Given e, the criminal’s problem is

  • First-order condition is


Crime and punishment9
Crime and Punishment

  • Given e, the criminal’s problem is

  • First-order condition is

  • Low e  low (e)  low marg. cost.

  • High e  high (e)  high marg. cost.


Crime and punishment10
Crime and Punishment

B(x)

Higher police effort deters crime.


Crime and punishment11
Crime and Punishment

  • Higher fines and larger police effort both raise marginal production costs of illegal activity.

  • Which is better for society -- higher fines, or more police effort?


Crime and punishment12
Crime and Punishment

  • Higher fines and larger police effort both raise marginal production costs of illegal activity.

  • Which is better for society -- higher fines, or more police effort?

  • Police effort consumes resources; higher fines do not.

  • Better to fine heavily.


Liability law
Liability Law

  • An injurer, IN, and a victim, V.

  • x is effort by IN to avoid injuring V.

  • cIN(x) is IN’s cost of effort x; cIN(x)  as x .

  • L(x) is V’s loss when IN’s effort is x; L(x)  as x .


Liability law1
Liability Law

  • Society wishes to minimize total cost; i.e.


Liability law2
Liability Law

  • Society wishes to minimize total cost; i.e.

  • Social optimality requires

  • I.e. IN’s private marginal cost of effort equals marginal benefit of her extra effort.


Liability law3
Liability Law

  • Liability rules:

    • no liability rule

    • strict liability rule

    • negligence rule.

  • Which is best?


Liability law4
Liability Law

  • No Liability Rule:

  • IN faces only private cost, cIN(x).

  • Hence chooses effort level

  • No liability results in suboptimal low care level and excessive injury.


Liability law5
Liability Law

  • Full Liability Rule:

  • IN faces private cost and V’s costs, cIN(x) + L(x).

  • Hence chooses the socially optimal effort level where


Liability law6
Liability Law

  • Negligence Rule: IN is liable for V’s loss if and only if care effort level , a legally determined effort level.


Liability law7
Liability Law

  • Negligence Rule: IN is liable for V’s loss if and only if care effort level , a legally determined effort level.

  • What if the court sets , the socially optimal effort level?


Liability law8
Liability Law

  • So  full liability for IN; hence she chooses


Liability law9
Liability Law

  • So  full liability for IN; hence she chooses

  • And  no liability for IN; hence she chooses


Liability law10
Liability Law

  • So  full liability for IN; hence she chooses

  • And  no liability for IN; hence she chooses

  • I.e. the negligence rule is socially optimal when


Liability law11
Liability Law

  • Both full liability and negligence rules are socially optimal, but

  • full liability fully insures V always, and

  • the negligence rule fully insures V only if IN’s care effort level .


Liability law12
Liability Law

  • Both full liability and negligence rules are socially optimal, but

  • full liability fully insures V always, and

  • the negligence rule fully insures V only if IN’s care effort level .

  • Victims prefer full liability; injurers prefer the negligence rule.


Bilateral accidents
Bilateral Accidents

  • V and IN can each exert effort to avoid a loss.

  • cV(xV) and cIN(xIN).

  • Loss is L(xV,xIN).

  • Society wishes to


Bilateral accidents1
Bilateral Accidents

  • Society wishes to

  • Social optimality requires V’s MC of effort = MB of his effort IN’s MC of effort = MB of her effort.

  • I.e.


Bilateral accidents2
Bilateral Accidents

  • No Liability: Both V and IN face only their private effort costs, not the full social costs of their actions.


Bilateral accidents3
Bilateral Accidents

  • No Liability: Both V and IN face only their private effort costs, not the full social costs of their actions.

  • Hence V and IN both provide too little effort.

  • No liability is socially suboptimal.


Bilateral accidents4
Bilateral Accidents

  • Full Liability: V is fully compensated for all injury costs.


Bilateral accidents5
Bilateral Accidents

  • Full Liability: V is fully compensated for all injury costs.

  • Hence V chooses

  • Full liability is socially suboptimal in bilateral accidents.


Bilateral accidents6
Bilateral Accidents

  • Strict Division of Losses: IN must pay a fixed fraction, f, of loss caused.

  • IN minimizes

  • IN chooses effort satisfying


Bilateral accidents7
Bilateral Accidents

  • IN chooses effort satisfying

  • Optimality requires

  • Since f < 1, IN chooses less than the optimal effort level;


Bilateral accidents8
Bilateral Accidents

  • IN chooses effort satisfying

  • Optimality requires

  • Since f < 1, IN chooses less than the optimal effort level;

  • Strict division of losses is a socially suboptimal liability rule.


Bilateral accidents9
Bilateral Accidents

  • Negligence Rule: IN is fully liable for loss only if her effort level , a legally determined effort level.

  • Social optimality requires V and IN to choose effort levels

and

, where

and


Bilateral accidents10
Bilateral Accidents

  • Suppose V chooses

  • Then IN is fully liable and wishes to

  • I.e. IN chooses


Bilateral accidents11
Bilateral Accidents

  • Now suppose IN chooses

  • Then V wishes to

  • I.e. V chooses


Bilateral accidents12
Bilateral Accidents

  • Now suppose IN chooses

  • Then V wishes to

  • I.e. V chooses

  • The Nash equilibrium of the negligence rule game is the socially optimal outcome.


Bilateral accidents13
Bilateral Accidents

  • Strict Liability with Defense of Contributory Negligence Rule: IN is fully liable unless V’s care level is less than a specified level


Bilateral accidents14
Bilateral Accidents

  • IN is fully liable unless V’s care level is less than a specified level

  • If society chooses and V chooses , then IN is fully liable, so her best reply is


Bilateral accidents15
Bilateral Accidents

  • IN is fully liable unless V’s care level is less than a specified level

  • If society chooses and V chooses , then IN is fully liable, so her best reply is

  • If IN chooses , then V’s best reply is


Bilateral accidents16
Bilateral Accidents

  • IN is fully liable unless V’s care level is less than a specified level

  • If society chooses and V chooses , then IN is fully liable, so her best reply is

  • If IN chooses , then V’s best reply is

  • I.e. the rule causes a socially optimal Nash equilibrium.


Bilateral accidents17
Bilateral Accidents

  • Notes:

    • socially optimal liability rules do not generally fully compensate the victim.

    • socially optimal accident deterrence is distinct from optimal accident compensation.


Treble damages antitrust law
Treble Damages & Antitrust Law

  • The Sherman and Clayton Acts allow an agent damaged by price-fixing to sue and recover treble damages.

  • How does such a penalty affect the behavior of a price-fixing cartel?


Treble damages antitrust law1
Treble Damages & Antitrust Law

  • Assume firms collude to form a cartel with a constant marginal production cost,

  • Market demand is


Treble damages antitrust law2
Treble Damages & Antitrust Law

  • Assume firms collude to form a cartel with a constant marginal production cost,

  • Market demand is

  • Cartel’s goal is


Treble damages antitrust law3
Treble Damages & Antitrust Law

  • Assume firms collude to form a cartel with a constant marginal production cost,

  • Market demand is

  • Cartel’s goal is

  • Solution is


Treble damages antitrust law4
Treble Damages & Antitrust Law

  • Suppose fixing price at results in damages to a victim V.

  • V’s probability of winning suit against the cartel is

  • If V wins, the cartel must pay


Treble damages antitrust law5
Treble Damages & Antitrust Law

  • Suppose fixing price at results in damages to a victim V.

  • V’s probability of winning suit against the cartel is

  • If V wins, the cartel must pay

  • Cartel’s problem is now


Treble damages antitrust law6
Treble Damages & Antitrust Law

  • Cartel’s problem is now

  • Solution is not generally the same as for the original problem

  • So generally cartel behavior is affected by the penalty.


Treble damages antitrust law7
Treble Damages & Antitrust Law

  • Special case -- suppose is the cartel’s profit. The cartel’s goal is


Treble damages antitrust law8
Treble Damages & Antitrust Law

  • Special case -- suppose is the cartel’s profit. The cartel’s goal is

  • Maximizing after-penalty profit requires maximizing before-penalty profit.


Treble damages antitrust law9
Treble Damages & Antitrust Law

  • Special case -- suppose is the cartel’s profit. The cartel’s goal is

  • Maximizing after-penalty profit requires maximizing before-penalty profit.

  • The cartel’s behavior is unaffected by the penalty.


Treble damages antitrust law10
Treble Damages & Antitrust Law

  • What if consumers can seek to be damaged?


Treble damages antitrust law11
Treble Damages & Antitrust Law

  • What if consumers can seek to be damaged?

  • Suppose consumer utility is quasi-linear;

  • Consumer can win damages

  • So consumer’s goal is


Treble damages antitrust law12
Treble Damages & Antitrust Law

  • Consumer’s goal is

  • I.e.


Treble damages antitrust law13
Treble Damages & Antitrust Law

  • Consumer’s goal is

  • I.e.


Treble damages antitrust law14
Treble Damages & Antitrust Law

  • Consumer’s goal is

  • Since consumer’s action depends upon the effective price, rewrite the cartel’s problem as


Treble damages antitrust law15
Treble Damages & Antitrust Law

  • Consumer’s goal is

  • Since consumer’s action depends upon the effective price, rewrite the cartel’s problem as

  • Solution is the sameas the original problem;


Treble damages antitrust law16
Treble Damages & Antitrust Law

  • Solution is the same as the original problem;

  • is the price paid by buyers. Then


Treble damages antitrust law17
Treble Damages & Antitrust Law

  • Solution is the same as the original problem;

  • is the price paid by buyers. Then

  • So


Treble damages antitrust law18
Treble Damages & Antitrust Law

  • The cartel’s price , the price set in the absence of damage penalties.

  • But the effective price to both consumers and the cartel is the same as in the no damages case.