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UW-Madison ECON 522 - ECON 522 Lecture Notes

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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 improvementTo check whether something is a Kaldor-Hicks improvement…EfficiencySome other, similar measuresWe can also consider the efficiency of a single action, in isolationSlide 12We can better understand efficiency by considering what forces lead to inefficiency1. Externalities lead to inefficiency1. Externalities lead to inefficiency (cont’d)2. Barriers to trade lead to inefficiency3. Monopoly power leads to inefficiency4. Taxes lead to inefficiencyOf course, that doesn’t mean these things are always bad…Slide 20Important distinction: positive versus normative economicsMost of this class will be positiveRichard Posner 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 system(Example of why narrowly-targeted taxes cause greater distortion)So, summing up… is efficiency a good goal for the law?That’s it for todayEcon 522Economics of LawDan QuintFall 2009Lecture 22Chao’s office hours: Mondays, 11-1My office hours: Wednesdays, 1:30-3:30If you’re not registered (and want to be), see me after lectureLogistics3defined law and economicssaw some brief history of the common lawand the civil lawand discussed ownership of dead whalesLast week, we…4what is efficiency?is efficiency a good goal for the law?Today: efficiency5What is “efficiency”?6a Pareto improvement is any change to the economy which leaves…everyone at least as well off, andsomeone strictly better offexample of a Pareto improvementyour car is worth $3,000 to you, $4,000 to meI buy it for $3,500an outcome is Pareto superior to another, or Pareto dominates it, if the second is a Pareto improvement over the firstFirst concept: Pareto improvementWhat is efficiency?Vilfredo Pareto(1848-1923)7most new laws create some winners and some losersso the Pareto criterion usually can’t tell us whether one policy is “better” than anothereven the car example might not be a true Pareto-improvementso we need another way to compare outcomesPareto superiority is not that useful a measure for evaluating a legal systemWhat is efficiency?8a Kaldor-Hicks improvement is any change to the economy which could be turned into a Pareto improvement with monetary transfers car example againyour car is worth $3,000 to you and $4,000 to megovernment takes your car and gives it to me  Kaldor-Hicks improvementa Kaldor-Hicks improvement may make some people better off and others worse off, but “the gains outweigh the losses”also known as potential Pareto improvementsNext concept: Kaldor-Hicks improvementWhat is efficiency?9To check whether something is a Kaldor-Hicks improvement…we could look for the transfers that would make it a Pareto-improvementor, we can just count up the gains of the winners and the losses of the losers, and see which is bigger the car example (again)Kaldor-Hicks improvements may make some people better off and others worse off, but “the gains outweigh the losses”What is efficiency?10a situation is Kaldor-Hicks efficient, or just efficient, if there are no available Kaldor-Hicks improvements(Pareto efficiency: no way to make some people in the economy better off without making some others worse off)Efficiency: no way to make some people in the economy better off, without making some others worse off by morewe’re already getting maximal value out of all available resourcesEfficiencyWhat is efficiency?11our definition of efficiency: all possible Kaldor-Hicks improvements have already been doneEllickson: “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 measuresWhat is efficiency?12We can also consider the efficiency of a single action, in isolationan action is efficient if its total social benefits are greater than its total social costssame as saying, a change is efficient if it is a Kaldor-Hicks improvementexample: is it efficient for me to drive to work?What is efficiency?13What forces lead to inefficiency?14ExternalitiesBarriers to tradeMonopoly powerTaxesWe can better understand efficiency by considering what forces lead to inefficiencyWhat forces lead to inefficiency?15Efficiency weighs social benefits and social costsBut individual decision-makers consider only their private benefits and private costsExternalities are whenever people not involved in making a decision are affected by itExample: is it efficient for me to drive to work?1. Externalities lead to inefficiencyWhat forces lead to inefficiency?16In general,actions that impose a negative externality will tend to be done more than the efficient levelactions that impose a positive externality will tend to be done less than the efficient levelIn contract and tort law, we will try to design the law to make people internalize their externalities1. Externalities lead to inefficiency (cont’d)What forces lead to inefficiency?17If some guy in Canada owns something worth $100 to him, and worth $150 to me, then it’s a Kaldor-Hicks improvement for him to sell it to meOne approach to property law: make it as easy as possible for people to trade among themselves(This may seem like an obvious point; but then, there are lots of things we’re not allowed to sell…)2. Barriers to trade lead to inefficiencyWhat forces lead to inefficiency?18CSProfitExampleDemand for some good given by P = 100 – QMonopolist can produce good for $40/unitMonopoly price is 70, demand is 30Deadweight loss is inefficiencyCustomers willing to pay more than marginal cost but unable to trade3. Monopoly power leads to inefficiencyP* = 70P = 100 – QQ* = 30MC = 40DWLWhat forces lead to inefficiency?19I value my free time at $40/hourWorking in a factory, I can build things


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UW-Madison ECON 522 - ECON 522 Lecture Notes

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