Econ 522 Economics of LawLogisticsLast week, we…Today: efficiencySlide 4First concept: Pareto improvementPareto superiority is not that useful a measure for evaluating a legal systemNext concept: Kaldor-Hicks improvementExampleTo check if something is a Kaldor-Hicks improvement, we can…So…EfficiencyExample: is it efficient for me to drive to work instead of taking the bus?Some other, similar measuresSlide 14To see whether something’s efficient…But what do people actually do?So externalities cause inefficiencyA classic example of this: the Tragedy of the CommonsTragedy of the Commons – exampleSo, externalities cause inefficiencySlide 21So we know externalities can lead to inefficiencyAnother thing that leads to inefficiency: barriers to tradeAnd another: taxesAnother: monopolyBut, saying these things lead to inefficiency doesn’t automatically mean they’re badSlide 27Important distinction: positive versus normative economicsMost of this class will be positivePosner gives us one argument why the law should aim to be efficientThings are a little more complicated…Posner’s argument does have its limitations…This highlights some of the things efficiency is notA more pragmatic defense of efficiency as a goal for the lawFour reasons the tax system is a better way to redistribute wealth than the legal systemSo, summing up… is efficiency a good goal for the law?(Friedman has his own take on why we should study efficiency)Finally…Econ 522Economics of LawDan QuintSpring 2010Lecture 22If you’re still trying to get into the class, see me after lectureSample exam questions posted onlineTA sections begin this Friday“Fake homework”Logistics3defined law and economicssaw some brief history of the common lawand the civil lawand discussed ownership of dead whalesLast week, we…4what is efficiency?is efficiency a good goal for the law?Today: efficiency5What is“efficiency”?6a Pareto improvement is any change to the economy which leaves…everyone at least as well off, andsomeone strictly better offexample of a Pareto improvementyour car is worth $3,000 to you, $4,000 to meI buy it for $3,500an outcome is Pareto superior to another, or Pareto dominates it, if the second is a Pareto improvement over the firstFirst concept: Pareto improvementVilfredo Pareto(1848-1923)7Pareto improvements are “win-win”but most new laws create some winners and some losersso the Pareto criterion usually can’t tell us whether one policy is “better” than anothereven the car example might not be a true Pareto-improvementso we need another way to compare outcomesPareto superiority is not that useful a measure for evaluating a legal system8a Kaldor-Hicks improvement is any change to the economy which could be turned into a Pareto improvement with monetary transfers also called potential Pareto improvementcar example againyour car is worth $3,000 to you and $4,000 to megovernment takes your car and gives it to meI’m better off, you’re worse offbut if we combined this with me giving you $3,500, it becomes a Pareto improvementso me getting your car is a Kaldor-Hicks improvementa Kaldor-Hicks improvement may create winners and losers, but gains outweigh the lossesNext concept: Kaldor-Hicks improvement9You and I are neighbors, you want to throw a partyThe party would make me $100 worse off……and make you $50 better off……and make each of your 30 guests be $5 better offIs the party a Pareto improvement?No – it makes you and your guests better off, makes me worse offIs the party a Kaldor-Hicks improvement?Yes – because the party, combined with the appropriate money transfers, would be a Pareto improvement(Example: you throw the party, you give me $40, each of your guests gives me $3 – that’s a Pareto improvement)Example10To check if something is a Kaldor-Hicks improvement, we can…look for transfers that turn it into a Pareto-improvement……or, just count up the gains of the winners and the losses of the losers, and see which is biggerKaldor-Hicks improvements may make some people worse off, but the gains outweigh the lossesif you have the party…I’m $100 worse offYou’re $40 better off30 guests are each $3 better off– $100 + $40 + 30 X $3 = $30 > 0Gains outweigh losses, so party is a Kaldor-Hicks improvement11So…A Kaldor-Hicks improvement is any change that“creates value…”But, value is equated with willingness to payThat is, we said the party made me $100 worse offWe equated my disutility from you making noise with the amount of money that would replace the inconvenienceIf you threw the party and gave me $100, I’d be just as well off as beforeBy equating utility with money, we create a way to compare utility across individualsBut assuming that how badly you want something is equal to how much you’d pay for it has problems of its own…12a situation is Kaldor-Hicks efficient, or just efficient, if there are no available Kaldor-Hicks improvementsIn other words, efficiency is when there’s no way to make some people in the economy better off, without making some others worse off by morewe’re already getting maximal value out of all available resourcesWe’ll also say A is “more efficient” than B if moving from B to A is a Kaldor-Hicks improvementEfficiency13Example: is it efficient for me to drive to work instead of taking the bus?Bus to school from where I live is freeDriving is more convenient, but costs me $1 (gas)Driving also imposes costs on other people: there’s more traffic, less parking, more pollutionSuppose when I drive to work, it makes 1,000 other people worse off by $0.01 eachIf the benefit to me of driving to work is at least $11, it’s efficient for me to drive; if it’s less than $11, it’s not14our definition of efficiency: all possible Kaldor-Hicks improvements have already been madeEllickson: “minimizing the objective sum of(1) transaction costs, and(2) deadweight losses arising from failures to exploit potential gains from trade”Posner: “wealth maximization”Polinsky: “Efficiency corresponds to ‘the size of the pie’”Some other, similar measures15What forces lead to inefficiency16To see whether something’s efficient…Compare gains to everyone in society (total social benefit)……to costs to
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