Law & Economics Part I Class Notes

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Kaldor Hicks: Potential Pareto Improving - move could be KH efficient if gains could be redistributed so than no one is worse off. Maximizes total utility.
Potential Pareto Improving: Kaldor Hicks - move could be KH efficient if gains could be redistributed so than no one is worse off. Maximizes total utility.
Types of Commone Law: Property
Torts (accidents)
Contracts
Criminal Law
What is a good law?: Law & Economics: A law that is efficient, not necessarily fair/just.

Not everything that is (KH)efficient is permitted (i.e, selling babies).
On redistribution of wealth: Legal rules are not the best way to redistribute:
If coporations pay the little guy through legal action, consumers absorb higher costs.
Lawyers eat up a lot of surplus when trying to transfer wealth.
Sources of Law: Constitution - rules of the legal system/game.

Statutory - passed by federal and state governments

Judicially Created Law:
1)Statutory interpretation - some laws are vague (i.e. "reasonable", "due course") that allow a lot of room for judicial interpretation.
2)Common law - evolution of legal rules over time, looking to precidents
Common law: evolution of legal rules over time, looking to precidents
Stare Decisis: Adherence to precident.
Procedure to go to (civil) court.: 1) Plantiff files a complaint - describes the situation and why you deserve to be compensated
2) Defendant answers the complaint and asks for a motion to dismiss (asumming everything in the complaint is true, didn't violate the law).
3) If MtoD is denied, Discovery - parties exchange the facts, prove things that were previously alledged to happen. Depose witnesses.
4) Summary Judgement (trail on paper)- discovery closed. Defendent says that no rational jury would find me guilty so no need to go to trial. Plantiff might respond saying that since many material facts are disputed need a trial or that a rational jury would rule for us.
5) Trial
6) Post trial motions - Judgement not withstanding the verdict - judgement as a matter of law - like a summary judgement after the trial, where judge explains why she overturned the jury verdict.
7) Appeal (not a retrial, questions techinicalities of the trial)
Explain the court structure: State: Trial -> Appeals -> Supreme -> US Supreme
Federal: District -> Circuit Court of Appeals -> US Supreme
Assume one short game: A -> Tort feaser B -> Victim X -> Damages R -> Prob (B wins) C-> Litigation costs What is thet expected value of going to trial for each party?: Expected value of going to trial (Vn)
VB= RX - C (positive X because could win money)
VA= -RX - C (negative X because could lose money)
Assume one short game: A -> Tort feaser B -> Victim X -> Damages R -> Prob (B wins) C-> Litigation costs What is the rule for going or not going to trial?: NO TRIAL: If A's expected loss from trial is greater than B's expected gain from trial.
-VA > VB
RX + C > RX - C

TRIAL: If A's expcted loss from trial is less than B's expected gain.
-VA < VB
RX + C < RX - C
Tort feaser: The person who commited the the tort. Defends against the victim.
Why should the two parties have similar predictions on who will win at a trial?: Attorney's are repeat players and as long as it isn't a novel case, should predict chances of winning near each other.

Also, as parties exchange information in discovery, R's get closer and closer so can push a settlement.
When is a liability rule efficient?: If it paces the liability on the lowest cost avoider (minimizes total costs)
If Repeat players: A B -> Victim X -> Damages R -> Prob (B wins) C-> Litigation costs If A is liable when will it go to trial?: Total long run cost of assigning liability of a legal rule to A (TA):
TA = NaX (#expected accidents) + Sa (cost of care to avoid such accidents, since A is liable)
Tb = NbX + Sb

A libable means (R > 0.5):
-Va < Vb
RX - (1-R)Ta + C < RX + (1-R)(-Tb) - C (if B loses, will have to pay Tb rest of life)
If this holds:
(1-R)(Ta-Tb) > 2C then it goes to trial.
B is victim.
What increases and decreases the probability of going to trial if A is liable (R > 0.5)? Both have long run interests. B is the victim.: (1-R)(Ta-Tb) > 2C then it goes to trial.

A is comitter.
B is victim.

Increases:
1) Larger Ta - Tb

Decreases (less likely to litigate):
1) R increasing (precident is entrenched)
2) C increasing
3) If Ta < Tb, no incentive to litigate if liability is already assigned to the lowest cost avoider

TA = NaX + Sa
Tb = NbX + Sb
What increases and decreases the probability of going to trial if B is liable (R < 0.5) and A is a one shot player?: R*Tb > 2C then will go to trial

Tb = NbX + Sb

Increases:
1) R increases
2) Tb increases

Decreases:
1) If C increases
If Repeat players: A B X -> Damages R -> Prob (B wins) C-> Litigation costs If B is liable and has a long run interest and A is a one-shit player when will it go to trial?: If B is liable R < 0.5

Expected loss -Va < Vb Expected Gain
RX + C < RX + RTb - C (precident is overturned so B is no longer liable and will gain Tb)

R*Tb > 2C then will go to trial

B has a lot to gain because he is a repeat player, so willing go to court if saves more than 2X the court cost.
How can you determine what party is liable?: Look to precident. If R > 0.5 (R is prob of B winning), then A is liable (less likely to win).
Explain under what condition the law becomes efficient.: 1) Ta, Tb = 0 (No LR interest, both one-shot players), then there is random drift, no tend towards efficiency.

2) Ta, Tb > 0 (both have LR interests), then only going to court if liability on the highest cost avoider (law inefficient). Incentive drives law towards efficiency.

3) Ta>0, Tb=0 or Tb>0, Ta=0, then rules change to favor party with LR interest (may or may not be efficient).
Posner's view on judges: hey would be inclined to rule on efficiency by default. The appeals court distant from parties and will be guided from the invisble hand toward economic efficiency.
Zywicki: Attacks Posner's supply side:
1) Even if judges wanted to rule efficiently, very few are trained in economics.
2) They might judge fairness, rather than economic efficiency.

Supply Side:
1)Precidient important, otherwise no demand side push towards efficiency.
2) Where there is no stare decisis, there is no incentive to engage in rent-seeking.
3) Before Erie, the presence of overlapping legal jurisdictions was a source of freedom that allowed individuals to escape the clutches of special interest-oriented rules. Without less access to federal courts, it eliminated access to the many skilled federal judges and efficiency-enhancing law that they ha dcreated over many decades. Created a series of territorial monopolies (rather than competitive) that encouraged forum shopping that create incentives for lwayers to demand pro-plantiff rules and for judges to supply them.
4) There used to be more competition between the courts to provide speedy, fair, and efficetive justice. This lead to efficient legal rules (English courts, American courts pre-Erie).
5) With legal monopolies and less competition between courts, efficiency benefits of forum shopping gone. Increased rent-seeking.

Demand?
1) What tends towards efficiency, is that you don't know whether one day you'll be the plantiff or defendant (Rawles born into a just society). Don't know where you are going to be so the incentive is to create the biggest surplus.
What is property?: A bundge of rights:
1) Posession
2) Use
3) Exclusive
4) Transfer (sell)
Why do we have property rights?: 1) Wasted cost trying to exclude
2) More efficient if done by the state
3) Creating rights can give rise to surplus (which can be divided)
What is the benefit of private (not communal) property?: Allows internalized externalities to avoid the "tragedy of the commons".
If fish is a common good, can over-fish to extinction. If you own the pond, you'll bear the costs yourself, so you will not over-fish and you will take care of the pond.
You bear all the costs and benefits.
What are the costs of private property?: 1) Administrative
2) Physical (demarking property)
3) Enforcement (threat of punishment)
When do you create private property rights?: When the MC=MB, when the cost of establishing is not greater than the benefits.
Explain the Bailey article: 1) There is a positive correlation between private property and scarcity
a) Beaver trade, before Europeans MC>MB of creating private property rights, scarcity over fur made MB > MC of creating a private property system. Internalized the cost of overhunting beavers.
b) In the winter private property, in the summer communal (MB < MC of establishing private property).

2) Property rights varied (communal vs private) by type/use and the cost of establishing.
a) Buffalo hunt - high transaction costs for one person to contract out responsibility of the hunt, instead done communally.
b) Economies of scale, need a lot of people then communal.
c) If high varience in individual sucess (bad & good years) then insurance in diversifying (communal rights) because risk adverse.
Coase Theory of the Firm: Why we have a secretary when you could have kinkos do the work.

What decides how much a firm will do in-house vs. market-based contract? Transaction costs to using the market (bargaining, writing contract, etc). Internal workers no longer have a profit motive, now being paid a salary.
Coase Theorem: When transaction costs are zero, an efficient use of resources results from private bargaining, regardless of the legal assignment of property rights.

Corollary: When transaction costs are high enough to prevent bargaining, the efficient use of resources will depend on how property rights are assigned. (now care about efficiency of the law)

Professor: assuming transaction costs are low, doesn't matter how you define who get property rights, just a different distribution of wealth.
Transaction costs: Three types:
1) Search
2) Enforcement/monitor
3) Bargaining

When dealing with lots of parties (public nusiance against a community), transaction costs tend to be higher.
Pigou: Tax the producer of the externality. Coase says incorrect, everyoning imposing a cost including the corn farmer next to the railroad and people who moved next to the polluter.
How do you determine production output?: When MR = MC (never MR < MC)
How do you calculate marginal profit?: MR-MC
How do you calculate MSC?: MC (of externality producer) + MC of lost profit (of non-polluter)
How do you determine production between two parties?: Not MR = MC, but MR = MSC (MC + MC (profits lost) )
Calbresi and Malamed (book): When there are obstacles to cooperation (i.e., high transaction costs), the more efficient remedy is the award of compensatory money damages.

Where there are few obstancles to cooperation (i.e., low transaction costs), the more efficient rememdy is the award of an injunction against the defendant's interference with the plantiff's property.

Updated version: Where there are few obstacles to cooperation (i.e., low transaction costs), the more efficient remedy is the award of an injunction when the plantiff can estimate the defendant's compliance costs more readily than the defendant can estimate the plantiff's damages.
How should we assign property rights?: Calabresi and Malamed:
1) If transaction costs are LOW, assign a property right (ie injunction). Even if you get it wrong, parties will work it out efficiently. Ex ante contract (parties work it out).

2) When transaction costs are high, use a liability rule which allows one party to pay for damages. ex post damages (determined by the state)
What are the types of property rights?: Right to:
1) Injunction (property) - ex ante prohibition
2) liability - have right to go onto property, but if I damage it then you hvae a cause of action to be reimbursed. Ex post damages.
3) Inalienable - if both parties agreed, still would not be allowed (can't sell yourself into slavery). A form of paternalism by the state.
You have two parties (polluter and victim), what are the types of rulings?: 1) Polluter has property right - V must pay P (ex ante) to stop.
2) Victim has the property right (injunction on P) - P must pay B (ex ante) to pollute
3) Victim has the liability right - P can pollute but must pay V ex post damages (determined by state)
4) V can stop P (perhaps through eminent domain), must pay P for damages (lost profits), ex post state determined.
P gets $1000 in profits from polluting. V is harmed $2000. No transaction costs.: Assuming no transaction costs:
1) P has property right - V will pay P btw 1000=<x=<2000 No pollution
2) V has property right (injunction) - No bargain, no surplus to be divded. No pollution.
3) V has liability right - P would have to internalize costs of pollution and pay V how much he's been harmed. No pollution.
4) P has liability right - V would pay at least $1000 "damages" (perhaps through eminent domain). No Pollution.

This proves the Coase Theorem - air used most efficiently regardless of the legal rule, assuming low transaction costs.
P gets $1000 in profits from polluting. V is harmed $2000. $1500 transaction cost for B.: Transaction cost is paid by the person trying to overturn status quo.

1) P has property right - This time no bargan since B only has $500 value after cost. Pollution
2) V has property right (injunction) - No pollution
3) V has liability right - No pollution
4) P has liability right - Pollution

This prove Callabresi - depends on how you assign the rules because can lead to inefficient outcome. In this case, inefficient allocation of resources because of high transaction costs depending on legal ruling.
How should you assign the rule?: When transaction costs are high, if you don't know the highest value user, assign liability rule.

Otherwise if no transaction costs, there will be efficient outcome so it doesn't matter how you assign the rule.

For example if transaction costs were $700 for vicitim (who values $2000), polluter values $1000. With property rule to Polluter, B can bargain in range of 1000<x<1300 but eats up $700 in surplus to get the efficient outcome.
Spur v Webb: 1) Court assigned Spur a liability right because using the power of the state to shut down but Webb pays damages (kind of like emminent domain, rule 4).
2) If Spur had a property right, Web and Spur would have come together and whoever values it more gets to do what they want (efficient outcome). Sput could have been better off with a property rule because could be a bigger suprlus then the court ordered damage.
3) Error in reasoning - To protect a private nuisance, use liability. To protect a public nuisance, use an injunction. Calbrasi would say this is backwards because publich nuisance has higher transaction costs with more people involved.
Public vs. private nusiance: Public nuisance - affects many people
Private nuisance - between individual parties
Taking: Derived from 5th Amendment
14th Amendment for the states (bill of rights can't be violated by the states)
When property is protected by a liability rule.
1) State takes the land
2) Must jusly compensate (if government didn't have to it could take it to finance, narrow taxes more inefficient then broad taxes)
3) For public use - If government could take from X to give to Y, then could have non-benefitial exchanges
What are the costs to takings?: 1) Possible inefficient transaction - owner could value more than fair market
2) *biggest cost* reduces the value of property rights - important to have clearly defined property rights
What is the rationale for takings, rather than have the government buy on the open market?: Hold out - if you know it's worth more, try to wait to get more of the surplus, so project could never happen.
Regulatory takings: government regulares so heavily, reduces the value of the property (can't make full economic use).

landowners take too few precautions against regulation if it is compensated (moral-hazard, no incentive to take any precaution)

If government has to pay for regulation, then they internalize the cost.
Kelo v. City of New London: Qualifies as public use, doesn't have to be owned by the public (Berman and Midkiff - transfer from public to private).
Legislature determined public use, planning for a decade.

Dissent- point of 5th amendment is for courts to decide public use, if legislature did then can't exclude any takings. Berman and Midkiff were different because they benefited the public immediately. Kelo is different because they were not public nuisances.
Why is intellectual property different?: 1) Most of cost is in creation, low cost of dissemination (high fixed, low marginal)
2) Consumption is non-rival - once a copy is distributed, copier copier can charge MC of coping (P=MC), creator must cover the cost of creation P = MC + F/X (fixed cost/# sold)
What is the max profit in a world without copying?: Profit = QP - Qc (c isn't cost of copying)
= Q(a-bQo-c)
der wrt Q
Q*o = (a-c)/2b
P*o= (a+c)/2
When does a consumer buy a copy?: Vo-Vc > Po - r

Vo = value consumer places on original = Po = a-bQo
Vc = a*Vo
0<a<1 higher the alpha the closer Vc subsitutes for Vo
Po = Price of original
r = cost of illegally copying
When is a copy a good substitute for the original?: Vc = a*Vo
0<a<1 higher the alpha , the closer Vc subsitutes for Vo

Vo = value consumer places on original = Po = a-bQo
Vc = a*Vo
r = marginal cost of copying (NOT produce original, which is c)

As alpha approaches 1, the copy gets better, willing to pay less of a markup and price of original CD in world of copying gets lower POc = r
Derive the demand curve for a world with no copying and a world with copying.: No copying: Vo = Po = a - Qo

Demand curve for original with copying:
PCo = Vo - Vc + r
PCo = (a-bQo) - (a-bQo)alpha +r
PCo = a(1-alpha) - b(1-alpha)Qo + r
What are the intercepts on the graph?: World with no copying:
y axis: a
cost curve at c
Remember to draw MR curve

Copying:
y axis: Po
hits old demand curve at: r/alpha
How do you derive the end point of the copying world demand curve?: PCo=VCo=Vo-Vc+r
Vo-VCo (value of original over value of original with copying) = Vc -r (value of copy minus cost of copying)
Vo-VCo (0 because equal) =alpha*Vo-r
Vo = r/alpha
Types of IP law: 1)Patents - bundle of exclusive property rights for a non-obvious invention. Breadth refers to how similar another invention can be without infringing on the original patent. Duration is how long it's in effect. Trade-off in IP law, better protected, more profits, but stiffles improvements. According to Coase Theorem, it doesn't matter who has property right as long as TC low so the parties will bargain an efficient solution.

2) Copyright - right to distribute copies of an artistic expression, life of creator +70. Ideas vs. Expression - too strong a copyright can stiffle creativity (art is derivative)
Fair Use- permited unauthorized use of copyrighted materials, court ruling economizes transaction costs of each party having to negotiation fair-use contracts

3) Trademakrs - no producing something new, lower consumer search costs allowing firms to internalize the benefits of quality.
What laws encourage people to innovate/create?: Patents, Copyrights (not Trademarks)
Grokster: Copyright infringement through P2P. Sony case - VCR capable of substantial non-infringing uses, producer not liable, time-shifting fair-use.
Balance of copy right protection so not to decrease innovation.
Grokster induced copyright infringement, don't have to revist Sony because other infringement issues at work.
Purpose of contract law: Prevent opportunistic behavior that would prevent otherwise benefitial exchange.
Perfect expectation damages: what you would have recieved if the other party did not breach the contract (the expected value of the bargain). -X party that breeched contract, +X to party that didn't breach.

baseline uninjured state is the promisee's position if the actual contract had been performed
reliance damages: the uninjured state is the promisee's position if no contract had been made.

benchmark status quo before contracts

victim indifferent between breach and no contract
specific performance: go back and make the victim right (not paying a monetary damage)
Goal of Contract Law: 1) enable people to cooperate by converting games with noncooperative solutions into games with cooperative solutions. (discourage inefficient breaches from opportunistic behavior)

restated - enable people to convert games with inefficient solutions into games with efficient solutions.

Enforceable contracts makes cooperation more likely because of damages penalty for appriopriation.

2) encourage the efficient disclosure of information within the contractual relationship

3) secure optimal commitment to performing.

4) secure optimal reliance.

5) the court should respond to gaps in the contract by allocating obligations efficiently and adjusting the price reasonably.

6) foster enduring relationships, which solve the problem of cooperation with less reliance on contracts.
How do you minimize transaction costs of contracts?: cost of allocating a risk > cost of allocating a loss X probability of a loss --> leave gap
cost of allocating a risk < cost of allocating a loss X probability of a loss --> fill gap
When is a breach efficient?: Compare the joint-profits
Efficient breach when the profit from new contract exceeds damages you'll have to pay (expectation damages - profit the person was going to make)

DOES NOT REDUCE SURPLUS
How do you set a problem for breaching a contract.: Compute
1) Performance profit = revenue (q*p) - cost (add to other persons profit)
2) Breach profit = revenue (paid) - revenue (returned) + new profit (q*pnew - cost) - cost of damages (add to other profit)
Gap filling contracts: Ex-ante transaction costs vs. ex-post ligitation

Why contracts have gaps
Default rules: If gaps, courts to develop these:

1) assign to low-cost bearer, by doing this, assinging what parties would have agreed on (to maximize surplus)
2) penalty default rule - penalize the low-cost preventer for not filling the gaps in the first place, goal is to get people to reveal private information (Hadley v Baxendale). Parties wouldn't have agreed to this without being force to.
Hadley v. Baxendale: Transport company would have charged more if they knew the risk of running late. Ended up an inefficient solution. Instead ruling was a penalty default, creating an incentive for parties to reveal private info to create efficient contracts. Must tell the expected surplus up front, so they understand expectation damages and internalize cost of breach. Set the default rule D=DL (unless you reveal yourself, you will get lower damages).
pooling equilibrium: high cost try to pretend to be low cost (no one has incentive to reveal true type)
separating equilibrim: incentive to reveal true type.
How do you get marginal product?: Py*MPL = w
MPL = w/Py

multiple this by change in x over change in y. Now multiply by the price of the good and that is how much x is willing to pay y at equilibrium.
Duress: One party not willing. Someone is trying to destroy surplus, not creating anything. Exploiter created the problem.

Alaskan crew, won't work when they get to Alaska unless they get more money.

Want to discourage people from ever doing it.
Necessity: Both parties are willing. Exploiter didn't create the original problem.

Whaling ship with cargo is sinking, another boat wants $1 million, instead court orders unfair compensation.

Don't want to discourage an exchange because value can be created.
Explain why necessity situation can be value creating.: EVloss= 1 million (benefit of avoiding sinking ship) * .10 (prob ship will be in distress) = $100,000

Cost of helping a ship in distress is $50,000.
1 ship expected profit = 50K
2 ships (50% chance of finding) = 50K-50K= 0

2 Ships wipes away surplus. Want to spend less resources and just have one ship.

More money court gives over cost, more incentive to rescue.
Standard From Contracts: Contracts of adhesion (rental car, warrenty).
1) main purpose is to lower transaction costs
2) reduce product differentiation (helps reduce prices, Bertrand model)

Courts are usually friendly to consumers, but raises costs for everyone when they do. Courts ignore horizontal situation, consumer has a choice to go to another company or just not buy at all.
Williams v. Walker Thomas Furniture: Everything bought previous is collateral. Threw out contract as unconscionable, shocks the conscious.

Poor can't afford down payment, terms fill gapbetween resell value of depreciated goods.
Torts: goal of tort law is to make the victim whole, put them to a utility they were before the accident.
1) Duty - in an accident did you have a duty?
2) Causation - Did breach the duty cause the accident? Proximate cause
3) Breach - Did you breach your duty? Did you take appropriate care?
4) Damages - Egg shell rule
Economic goal of torts: Concerned with creating incentives for people to take optimal care.
Difference between Torts and Contracts: In contracts, the Hadley world makes people reveal private information, to take optimal care, ex ante. In torts, it is ex post.
What affects cost of torts?: The probability of of the accident and the level of damages.

So if airbags were invented, D would make the cost curve shift down, lowing the optimal level of care.
How do you determine optimal level of precaution/care?: Minimize total cost, an optimal x solves it:
min TC = wXi + P(Xi)*D
FOC wrt x: w + P'(x)D = 0
w = -P'(x)D
MC of care = MB of care

Xi = units of care per activity (effort)
w = MC of care (cost of an additional unit of care)
P(x) = Prob of accident
P'(x) < 0
D = Damage
Torts - want to create incentives to minimize.
Explain how courts determine optimal level of care: Hand Rule. Barge was tied up to a pier, but tied incorrectly and sank. The Plantiff's barge was unattended, so he didn't verify the ropes were tied correctly.

Expected loss P * L > B (cost taking precaution , then you are held negligent. Cheaper to have the guy on board then the expected loss from losing the barge.
Coal Pit: Weigh the expected loss (injury) vs benefit (kids playing).
How do courts decide what is sufficient precaution?: Reaonable man standard
Kid with trolley wire: Cost of remote risk are greater than the MB of not having kids hurt by the wire.
Why have liabilites?: In torts, can't negotiate ex ante with a contract because the costs are too high, so instead assign a liability (internalize cost)
Compare tort liabilities: Comparative Negligence is fairer than Negligence w/ defense of contributory negligence, but it takes more cost to find proportion at fault.

In 2-5 victim is residual bearer of activity, because injurer takes necessary precaution and victim bears and internalizes full risk. No rule for both parties to take optimal activity level that is left with residual bearer (victim, unless strict liability).
Explain how probability of outcome affects tort law.: More difficult to determine the probability of outcome, then more litigation because of the uncertainty. Trail attorneys like more uncertainty to make more money.
Compensory: paid to make you whole (has market value), easy to calculate.
Loss of Life and Limb: can't be fully compensated (lost a chid) so hard to get you back to previous indifference curve. Possibile methods are future expected income.

Market based risk premium - get paid to do more risky things (Alaskan fisherman get paid more than normal fisherman) Inverse Hand rule
Market based risk premium: get paid to do more risky things (Alaskan fisherman get paid more than normal fisherman) Inverse Hand rule

Difference of death rate * value of life and limb = Difference in salary
Diff Pr*VL = Diff salary
Types of Tort Damages: 1) Compensory
2) Loss of Life & Limb
3) Pain & Suffering (Non-compensory)
4) Punative Damages
Pain and Suffering: Also called Non-compensatory Damages (for Torts).

Metnal damage. Cost of losing a child goes beyond monetary, compensates for non-pecunary (non-monetary) damages, but criticism is that you don't insure for non-monetary damages.
Problem with tort damages: Pain and suffering makes the price (P = C + ED) go up. Price of a lawnmower includes ED/cost of litigation, so you are paying for an insurance policy. NP damages are in the price, paying more today for litigation damges in the future.

ED = C (compensory, good to internalize cost) + NP (Pain and suffering)
Punitive: Tort Damage for punishment in intnetional torts. For example, you owe money for a car damage, but you were drunk so you throw a fine on top of it. Don't want people to just pay a fine for what they did (allow people to hit others in the face for a price).

A buttress to compensatory damages - deterring people to an optimum level.
P = Prob of detection < 1
l = Prob of liabile <1
ED = H*p*l < H (so tort feasor would be undeterred)
wx + P(x)D (D is lower than actual D, and takes less than optimal care (x < x*)
Pros and cons of Punitive Damage: Pro: Punative damage multiplier (1/P*l) shows percentage of time they actually have to pay, so rational to compensate for others they've harmed and create incentive to internalize cost, and take optimum care.

Con: Deterred by publicity, stock going down, follow-up lawsuits.
What affects criminal behavior?: Punishment, gain from crime, probability of conviction.

Risk loving - more criminal
Risk adverse - less criminal
Rubin: Used Panel data (cross-section obs over time) so the concealed weapon affect overstated. Holds all else constant (while using concealed weapon dummy variable) but a suspect assumption. Saying other variables will be constant throughout all counties. Letting the parameters be felxible, shell cerry deterred murder in a few states, but not all the negative deterrence.
Why have antitrust law?: Prevent anti-competitive behavior. Increases the surplus (consumer welfare), and decrease DWL when prevent anti-competitive behavior.
What are the tools of antitrust law?: 1) Sherman Act
2) FTC Act
3) Clayton Act - deals with mergers that create monopolies
4) Robinson-Patman - prohibits price discrimination between businesses.
What makes an antitrust law good?: Able to easily distinguish pro from anticompetitive behavior. Avoids deterring competitive behavior.
Sherman Act: 1) Agreement in restraint of trade (N>1, more than one person involved) Joint-conduct.
a) Price-fixing
b) Collaborative Activity Amoung Competitors to produce something but creates efficiences (Joint Venture)
c) Vertical

2) Conduct that tends to lead to monopoly (N=1, one person, ie Microsoft)
a) Unilateral behavior (looks most competitive)
Types of anticompetitive conduct: From looks most anticompetitive to looks competitive.

Joint
a) Price fixing
b) Collaborative Activity Amoung Competitiors to produce something/ creates efficiences
c) Vertical

Unilateral
a) below cost pricing
b) bundled rebates
c) refusals to deal with competitors
Price fixing: Per se illegal - to win a case, just need to show that prices were agreed upon, not just higher prices or ever changed. It's because price fixing is never good so saves litigation costs to not investigate the harm.

Bertrand equilibrium P=MC, but cooperative would be monopoly price and split profits.

a) Territorial Allocation - deprives competition
b) Restraints on advertising - restricting competition amoung themselves, ads a form of competition.
Per se illegal: to win a case, just need to show that there was an agreement to do that banned thing, not that it cased harm or happened. Don't waste litigation/court costs seeing the harm of something we know is wrong.
Bertrand equilibrium: P=MC, but if price fixed then the efficient outcome would disappear.
Collaborative Activity Among Competitiors: An agreement to produce something/ create efficiency.

A joint venture is typically a good thing. Agreements outside JV are per se illegal (increase P for all other cars).

"Rule of Reason" - Burden is on the plantiff to find the anti-competitive effects of agreement. (ne car reduces competition somehow - inefficient)
FTC vs Austin Real Estate: Section one action.
MLS is a joint-venture, before buyer had more search costs. If house isn't on the website, you are at a competitive disadvantage. Some realtors who only chared $500 were shut out of the electronic listing (by joint-venture owners of MLS, the agents who mostly make 3%)

Section 1 violation, rule of joint-venture harmed comptitor's and inefficient agreement.
Vertical Restraint: Between two levels of distribution. Vertical externality created because upstream and downstream don't have the same incentive. Cause: retailer doesn't take the manufacturers margin into account.
a) Pricing externality - double mark-up
b) Service externality - retailers need to put in more service effort.

Vertical mergers have low likelihood of reducing competition.
Now analyzed under the rule of reason (excepct minimum RPM where a seller can't set price below a certain point, which is still per se illegal).
Pricing Externality: Caused by Vertical Restraint
Double Mark-up (if monoply, price would be lower)
Cause: Retailer does not take the manufacturer margin into account.
profitr = profiti + (w-c)Q

Solution:
1) Maximum RPM - this was illegal until 1997. Pr = Pi* (integrated price), but have to compensate retailer
2) Firms can integrate
3) Non-linear pricing (two-part tariff) - manufacturer charges w=c (acts like perfect competitor) but charge fixed fee, like a francise fee (McDonalds up front fee and future fees)
4) Introduce more retail comp - starbucks close to each other, sells to many franchises and none of the retailers have power to raise price above MC.
What is the problem with Vertical Restraint?: 1) Pricing externality (price too high, output low)
2) Service externality (provides less service)
Service Externality: retailers need to put in service effort, profits a funtion of service. Retailer decides service to provide (where MB=MC). The price minus the wholesale cost is the margin for retailer.

System margin is P - C = (P-w)+(w-c)
Retailer margin is only P-w (doesn't take into account upstream margin).
Provides less service.
Solutions to Service Externality: Solution:
1) min RPM = P - w = Pmin - c (this is per se illegal). Makes price higher so has incentive to provide service
2) Exclusive territories to reduce intrabrand competition - relax competition btw Best Buy and Circuit City to sell more RCA, pump up services because higher margin. Like a little monoply in region commands higher price so promotes interbrand competition (against Sony, Samsung)
Margins on Sony is lessSolution:
1) min RPM = P - w = Pmin - c (this is per se illegal). Makes price higher so has incentive to provide service
2) Exclusive territories to reduce intrabrand competition - relax competition btw Best Buy and Circuit City to sell more RCA, pump up services because higher margin. Like a little monoply in region commands higher price so promotes interbrand competition (against Sony, Samsung)
Margins on Sony is less than bumped up RCA price than bumped up RCA price
Sylvannia: Before it was per-se illegal. Supreme Court over-ruled Schwinn because territory agreements can sometimes be good, not always bad. Per se rules should only be used for things we know are anti-competitive, so you don't waste legal resources. Good for consumers vs. bad for consumers should guide antitrust law. Vertical restriction creates intra-brand competition, can create more efficiency and improve consumer welfare.
Free-rider problem: Service. Go to a store with lots of service, but then buy it at the discount place with no service. Service guy then cuts service to get closer to discount price. High-end manufacturers prevent discounts to keep service (only available online from manufacturers website). Exclusive territory incentive weakened with online stores.
Section 2 violation: Unilateral behavior
a) below-cost pricing - predatory pricing to drive competitor out of business
b) bundled rebates - competitor at a disadvantage because can't supply the other good (monoply)
c) refusals to deal with competitors - Trinko case
What's wrong with anticompetitive legal standard: Hard to distinguish AC behavior in unilateral and don't want Type I error. So set bar really high so likelihood ratio is greater than 1
Trinko case: Verizon wasn't helping ompetitors with service of network (looks like comp b/c wants to beat them). Outcome - there are other ways to solve problem rather than change way anti-trust law is applied. Avoids false positives or Type I error in ruling by keeping standard really high.

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Law &amp; Economics Part I Class Notes

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Law & Economics Part I Class Notes