Econ 522, Spring 2009, Dan QuintLecture 2 (Jan 22 2009)First, logistics…- some people already added, but the process isn’t finished- Please put your name on the (new) yellow pad (again) if you’re not registered- Sections start next week, not this week- Chao isn’t here today, but if you have questions about attending a different discussion section, email him (address on syllabus/website)- also, someone pointed out to me that Law’s Order is available as an online text if you have a City of Madison library cardTuesday, we discussed three things:- the point of this class – using microeconomic tools to evaluate the incentives created by different laws and legal systems, and the actions and outcomes they will therefore lead to- very brief history of the common law and civil law traditions- one example of how the common law responds to existing norms and practicesToday, we turn our attention from the law back to economics.I’ll begin with a useful distinction between two types of economic statements: positive and normative- positive statements are statements of facto “economics of what is”o can be descriptive: “In 2007, U.S. GDP was $13.8 trillion”o or a theoretical prediction: “If prices increase, demand will fall”- normative statements contain value judgmentso “economics of what ought to be”o “less inequality is better”, or “Government should encourage innovation”- 1 -The type of analysis we talked about on Tuesday – predicting the behavior, and outcomes, that follow from a law or a legal system – is positive- in this class, we’ll mostly be making theoretical claims: “if the law says this, it will lead to this outcome”. (For example, “a move from a strict liability rule to a negligence rule would lead to an increase in accidents”)- however, in the background, we’d also like to know when one outcome is better than another, to have a sense of how the law should be designed- that will be today’s topic- in particular, we’ll examine the notion of efficiency, and arguments for whether the law should aim to be efficient(I’ll also note that for now, I’m using the term “outcome” to mean just about everything: how much money each person has, what stuff they consume, how hard they work, how likely they are to get hit by a car, and so on.)One possible standard for when one outcome is better than another: Pareto superiority.- We say outcome A is Pareto superior to outcome B if everyone in society is at least as well off under A, and at least one person is strictly better off.- Or to put it another way, a Pareto improvement is a change that makes nobody worse off and somebody better off.- and an outcome is Pareto efficient if there are no available Pareto improvements- For example, suppose my car is worth $3,000 to me and $5,000 to you, and I sell it to you for $4,000. That’s a Pareto improvement: you’re better off, I’m better off, and nobody else is affected- If one legal system leads to outcomes that are Pareto-superior to another, it’s pretty easy to argue that it’s better- But Pareto improvements are pretty hard to come by.o Most new laws or legal changes will create some winners and some losers – if we can only say one outcome is better if it’s Pareto-superior, there are very few normative statements we’ll be able to makeo Even in the car example, other people might end up worse off when I sell you my car – maybe my car’s loud, so your neighbors end up a little worseoff now that you own it- 2 -A weaker standard for one outcome to be “better” than another is Kaldor-Hicks superiority.- The move from Outcome A to Outcome B is a Kaldor-Hicks improvement if you could turn it into a Pareto improvement by moving money around- To put it another way, something can be a Kaldor-Hicks improvement and still have winners and losers; but the winners have to gain more than the losers lose; so that the losers could theoretically be given enough money to compensate for the change, and the winners would still come out ahead- Back to car example. My car is worth $3,000 to me, and $5,000 to you. It’s got ahole in the muffler, so it makes a lot of noise. You have 12 neighbors who don’t like the noise, but each one would happily accept it if you paid them each $100.- I sell you my car for $4,000. This is not a Pareto improvement, because your neighbors are worse off. Is it a Kaldor-Hicks improvement?- It turns out, yes. After the sale, I’m $1,000 better off, and you’re $1,000 better off. So hypothetically, I could pay $100 each to six of your neighbors, and you could pay $10 each to the other six; and they’d all be as well-off as before, and you and I would still both be strictly better off- So if I sell you my car for $4,000, there’s a way that we could move money around after the fact to turn this into a Pareto-improvement; which means it’s a Kaldor-Hicks improvement- A simpler way to tell whether it’s a Kaldor-Hicks improvement is to just count up the gains and losses- When I sell you my car for $4,000, your gain is $1,000; my gain is $1,000; and your neighbors’ losses are $1,200. So in total, the gains are $800, which is positive- Another way to think of it: Kaldor-Hicks efficiency is about maximizing the size of the overall pie, without any regard for how it’s divided. There can be winners and losers, as long as the winners gain more than the losers lose- One thing that’s interesting. We just showed that you buying my car for $4,000 isa Kaldor-Hicks improvement. It turns out: so is you stealing my car.- Suppose there’s no risk of getting caught. If you steal my car, you gain $5,000; I lose $3,000; your neighbors lose $1,200; the total gain is the same $800 as before- 3 -- Kaldor-Hicks improvements are also called potential Pareto improvements- An outcome is Kaldor-Hicks efficient if there are no available Kaldor-Hicks improvements- (In the car example, any outcome where I own the car is not Kaldor-Hicks efficient, because me selling you the car, or you stealing it, would be a Kaldor-Hicks improvement)Throughout this class, whenever we talk about efficiency, we’ll mean Kaldor-Hicks efficiencyAnd if one outcome is a Kaldor-Hicks improvement over another, we’ll say it’s more efficientA reasonable question to ask: if we’re going to allow potential Pareto improvements, that is, changes where the winners gain enough to compensate the losers and still come out ahead, then why not just
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