Econ 522 – Lecture 3 (Sept 9 2008)First, logistics. Class is full. If there are drops between now and Thursday, we’ll open those spots, so see me after class if you’re still interested.Changing sections.Orientation for majors.Last lecture, we defined efficiency, considered its limitations as a measure of normative “goodness”, and considered two arguments why the law should be designed to be efficient:Posner: if we all negotiated a legal system before we knew which part we’d play, we’d all agree to the one that was wealth-maximizingCooter/Ulen: if we’re worried about distribution/equity, we should still design the law tobe efficient, and use the tax system to redistribute wealthThe last part of Cooter and Ulen’s argument was that an attempt to redistribute wealth through the legal system would function like a narrowly-focused tax. For example, since plastic surgeons are rich, we could make the liability law favor malpractice victims. But this would function as a tax on plastic surgeons. And their point is that narrowly-focused taxes cause greater distortions than broad taxes (such as a tax on wealth or income).But I claimed this pretty quickly, without explaining why this is true. So I wanted to begin today with an example to make that point: why broad taxes will generally outperform narrow ones. And then we’ll get on to property law.Consider a simple model where there’s just one consumer and two goods. The consumer has a utility function u(x,y), which is a function of how much of each good he consumes; and he has $60. To be more specific, let’s suppose the consumer’s utility function is the Cobb-Douglas utility function,u(x,y) = x 0.5 y 0.5which is the same as having utility u(x,y) = xy, which is easier to deal with.Now, suppose the consumer faces prices p and q. Now, whatever he doesn’t spend on x, he’ll spend on y, so px + qy = 60, or y = (60-px)/q. So the problem is to maximizex * (60 – px)/qtake the derivative: (60 – px)/q – px/q = 0, or px = 60/2 – whatever the prices, the consumer spends 30 on x and 30 on y. (This is a feature of Cobb-Douglas utility.)Now, suppose both goods can be produced in any quantity for $1 per unit, and there is perfect competition in the markets for both goods, so their prices are both $1. Given those prices, the consumer demands (30, 30), for utility 30*30 = 900.Next, suppose the government decides to raise some revenue, and considers two possible ways to do it:1. A 50 cent tax on good y2. 20 cent taxes on both goodsI claim that the following two things are true:1. Either tax will raise the same amount of money2. The consumer is better off with the second oneFirst, consider a 50 cent tax on each unit of y. The consumer sees this as an increase in price to $1.50. Now he consumes (30, 20), for utility 30*20 = 600. And the government raises $0.50 X 20 = $10.Next, consider a 20 cent tax on both goods. The consumer seems prices of $1.20 and $1.20. He demands (25,25). The government raises $0.20 * 25 + $0.20 * 25 = $10. Andthe consumer gets utility 25 * 25 = 625.So that’s the point. Taxes will always cause a distortion – if you tax bagels, people buy donuts; if you tax income, people work a little less. But the broader and more evenly the tax is applied, the less distortion it will cause. Bringing us back to Cooter and Ulen’s point: if you want to redistribute money to the poor, do it with a broad tax – on income, or wealth – rather than a narrow tax like a tax on being a plastic surgeon. (Of course, the retort to this: this only works if you’re designing the legal system and the tax system together, from scratch. If the tax system is already distorted, you could try to use the legal system to correct these distortions. But it might be really hard to get it right,for some of the other reasons Cooter and Ulen mention.)Today: Property LawWhy do we need property law at all? In a sense, this is simply a question of why we prefer a “civil society” of any sort to anarchy. Suppose there are two neighboring farmers, who can do one of two things: farm their own land, or steal crops from their neighbor.Stealing may be less efficient than planting my own crops – I have to carry the crops from your land to mine, I may drop some along the way; I have to steal at night, so you won’t see me, so I have to move slower. But if I steal your crops, I don’t have to put in all the effort of planting and watering – I let you do the work and I steal at the end, just before you harvest.Suppose that planting and watering costs 5, the crops either of us could grow are worth 15, and stealing costs 3. If there is no legal system, the game has the following payoffs:Farmer 2Farm StealFarmer 1 Farm 10, 10 -5, 12Steal 12, -5 0,0Just like the prisoner’s dilemma – both farmers stealing from each other instead of growing more crops is the only equilibrium, even though that outcome is Pareto-dominated.Suppose there were lots of farmers facing this same problem, and they came up with the following solution. Institute some property rights, and some type of government that could punish people who steal others’ crops. Obviously, setting up this system would cost something – suppose it imposes costs of c on everyone who behaves well. Now the game becomesFarmer 2Farm StealFarmer 1 Farm 10-c, 10-c -5-c,12-PSteal 12-P, -5-c -P,-PIf the punishment is big enough, and the cost to each farmer is not too big, this would establish (Farm,Farm) as an equilibrium, where before the only equilibrium was (Steal, Steal). So now we’re much better off. The main idea here is that anarchy is inefficient – I spend time and effort stealing from you, or defending my own property from thieves, instead of doing productive work. Establishing property rights, and legal recourse for when they are violated, is one way to get around this problem.One early, “classic” court ruling on property law: Pierson v. Post- Decided in 1805 by the New York Supreme Court- Post had organized a fox hunt, and was in pursuit of a fox- Pierson appeared “out of nowhere,” killed the fox, and took off with it- Post sued to get the fox back, saying that since he was chasing it, he owned it- Lower court sided with Post; Pierson appealed the decision to the NY Sup Ct- (Post and Pierson were apparently both wealthy, and pursued the case on principalor out of spite – both spent far more than the value of the fox in pursuing the
View Full Document
Unlocking...