Pre-Trial Bargaining (from final exam, Fall 2007, and this semester’s HW3)An accident has occurred, causing $10,000 in harm to the victim. The amount of harm done is undisputed and easy to prove; punitive damages are not applicable, so any damage award would be for exactly $10,000.This type of accident is governed by strict liability, so the injurer is legally responsible, but it may be difficult to prove in court that he caused the harm. The victim can hire a lawyer for $3,000 and go to trial, in which case he would have a 40% chance of winning. He could also hire an expert witness to testify. This would ensure victory at trial, but would cost an additional $10,000, for a total of $13,000. Going to trial costs the defendant (injurer) $5,000,regardless of whether the plaintiff (victim) hires an expert witness. Assume that neither party pays any legal expenses if an out-of-court settlement is reached. First, consider the usual American rule where each party pays its own legal fees.(a) If the case goes to trial, will the plaintiff hire an expert witness or not?(b) Given your answer to (a), calculatei. each party’s threat point during pre-trial negotiations (which is its noncooperative payoff if the case goes to trial)ii. the gains from cooperation if a pre-trial settlement is reachediii. the settlement that would occur if the two parties agreed to divide the gains from cooperation evenly(c) In this scenario, would the American rule lead to over-, under-, or efficient precaution on the part of the injurer?Next, consider the usual British rule where the losing party pays both sides’ legal fees (including the cost of the expert witness, if he was hired).(d) If the case goes to trial, will the plaintiff hire an expert witness?(e) Given your answer to (d), answer the same three questions as before: calculatei. each party’s threat pointii. the gains from cooperationiii. the settlement that would occur if gains from cooperation were divided evenly (f) In this scenario, would the British rule lead to over-, under-, or efficient precaution on the part of the injurer?Finally, consider the following cost-shifting rule, similar in spirit to Federal Rule 68. If the case goes to trial and nodamages are awarded, each side pays its own expenses. If damages are awarded and are lower than a settlement offer the plaintiff (victim) refused, the plaintiff pays both sides’ expenses. If damages are higher than a settlement offer the defendant (injurer) refused, the defendant pays both sides’ expenses.(g) What will happen if the case goes to trial after the defendant offers to settle for $10,001? Is the plaintiff better off accepting this offer or going to trial?(h) What will happen if the case goes to trial after the plaintiff offers to settle for $9,999? Is the defendant better off accepting this offer or going to trial?(i) What do you expect to happen in pre-trial negotiations?(j) In this scenario, would this cost-shifting rule lead to over-, under-, or efficient precaution on the part of the injurer?Eminent Domain and Efficiency (from midterm 2, Fall 2009)The government is interested in acquiring land to build a school. The school will be a public good, creating $5,000,000 in total value. The land the government wants to build on is currently privately owned.(a) First, suppose the land is made up of 30 small plots, each one owned by a different owner. Each owner values his own land at $100,000.i. Would transaction costs be high or low if the government tried to acquire the needed landthrough voluntary negotiations?ii. Would the government’s use of eminent domain to acquire the land be efficient or inefficient?(b) Now instead, suppose the land is in one piece, and is currently owned by a wealthy retiree. The “fair market value” of the land is $2,000,000, but the retiree has lived on the land his whole life and values it at $10,000,000.i. Would transaction costs be high or low if the government tried to acquire the needed landthrough voluntary negotiations?ii. Would the government’s use of eminent domain to acquire the land be efficient or inefficient?Conceptually, eminent domain is similar to using a liability rule (damages), rather than a property rule (injunctions), to protect ownership rights – the government is allowed to take your land and pay you for it, rather than negotiating to buy it from you.(c) Which type of rule, property or liability, is generally more efficient when transaction costs are high, and which is generally more efficient when transaction costs are low? Given this, is the use of eminent domain more likely to be efficient in the presence of high or low transaction costs? Does this agree with your answers to parts (a) and (b) above?The Joy of Skydiving (from final exam, Spring 2009)Skydiving – jumping out of an airplane with a parachute – is incredibly fun, but also dangerous. The risk of dying in a skydiving accident is actually very small – for this problem, we will assume it is zero. However, there is a substantial risk of other injuries.There are standard precautions a skydive operator can take – such as using more modern equipment, hiring experienced instructors, and taking extra care in packing the parachutes – to reduce this risk. The cost of running a skydiving business is $150 per customer without these precautions; these precautions cost an additional $100 per customer, and reduce the probability of injury from 1 in 100 to 1 in 300. The average skydiving injury does $30,000worth of harm to the customer.There are five potential customers, each with one opportunity to skydive; the joy each one would get from skydivingis worth $500, $400, $300, $200, and $100, respectively. (That is, the most enthusiastic customer would get a benefit of $500, the second-most-enthusiastic $400, and so on.)(a) What is the efficient level of precaution for skydive operators to take (high or low)?(b) Given this precaution level, what is the efficient level of activity? (That is, how many customers are there for whom the benefits of skydiving outweigh the total costs?)Suppose there is perfect competition in the skydiving industry – there are many skydive operators, with identical costs, so the price of skydiving is driven down to marginal cost plus expected liability payments (if any).For parts (c)-(f), assume that customers correctly perceive and consider the risk of injury when deciding whether to skydive, and can observe the level of
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