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UW-Madison ECON 522 - Lecture 20

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Econ 522 Economics of LawLogisticsSlide 2Over the last 2 ½ months, we have…Slide 5An example from Polinsky, “An Introduction to Law and Economics”Slide 7Slide 8Slide 9Slide 10Slide 11So what?Slide 12The legal processThe goal of the legal processAdministrative costs and error costsSlide 17Slide 17Why sue?Slide 20Slide 21Slide 22Slide 23Slide 24So there are three things that directly influence the number of lawsuitsSlide 26Filing costsSlide 28Slide 29Slide 30Class Action LawsuitsLawyers and clientsSlide 32Exchange of InformationVoluntary exchange of informationSlide 36What about involuntary exchange of information?Slide 38Effect of information disclosure on administrative and error costsSlide 39Econ 522Economics of LawDan QuintFall 2009Lecture 202Midterm will be graded by TuesdayNo lecture Tuesday (too many people planning to be gone for Thanksgiving)I’ll hold office hours during that time so you can pick up examsHW3 online today, due December 8Logistics3The legalprocess4Developed theories of property/nuisance law, contract law, and tort lawLooked at how rules of legal liability create incentivesThought about how these rules can be chosen to try to achieve efficient outcomesOver the last 2 ½ months, we have…5To achieve efficiency, we’ve generally tried to set a party’s liability equal to the harm he caused someone elseDamages in nuisance lawExpectation damages in contract lawCompensatory damages in tort lawThat way, he internalizes the externality he imposes, leading to efficient decisionsIn doing this, we’ve been making two big assumptions:The legal system works flawlesslyThe legal system costs nothingOver the last 2 ½ months, we have…6I hit you with my car and did $10,000 worth of damageWe both know I was negligentBut courts aren’t perfectIf we go to trial, 80% chance I’ll be found liable, 20% I won’tIf I’m held liable, damages are correctly set at $10,000So on average, if we go to trial, you expect to recover $8,000But if we go to trial, we both have to hire lawyersSuppose this costs us each $3,000Now your expected gain from going to trial is $8,000 – 3,000 = 5,000And my expected cost is $8,000 + 3,000 = 11,000An example from Polinsky, “An Introduction to Law and Economics”7So…Going to trial gains you $5,000 (in expectation)Going to trial costs me $11,000 (in expectation)Maybe we can settle out of courtIf we avoid going to court and I pay you any settlement between $5,000 and $11,000, we’re both better offSo maybe this happensBut…An example from Polinsky, “An Introduction to Law and Economics”8Suppose I’m more pessimistic about my chances than youYou think I’m 80% likely to be found liableI think I’m 90% likely to be found liableYou think your expected gain is $8,000 – 3,000 = $5,000I think my expected cost is $9,000 + 3,000 = $12,000Now the range of possible settlements is even widerAny settlement between $5,000 and $12,000 is a Pareto-improvement over going to trialSo settling is more likelyAn example from Polinsky, “An Introduction to Law and Economics”9Now instead, suppose I’m more optimistic about my chances than youYou think I’m 80% likely to be found liableI think I’m only 10% likely to be found liableYou think your expected gain is $8,000 – 3,000 = $5,000I think my expected cost is $1,000 + 3,000 = $4,000Now an out-of-court settlement is impossibleThere are no settlements that you and I would both agree toAn example from Polinsky, “An Introduction to Law and Economics”10And, even if our beliefs are compatible and there are settlements that we would both prefer to trial……private information might lead to failure to reach a settlementRemember from before: if our threat points are private information, we might fail to reach an agreement because each of us is holding out for too big a shareSo even if we had the same beliefs about what will happen at trial, private information could prevent settlementAn example from Polinsky, “An Introduction to Law and Economics”11So when litigation is costly…If the two parties agree on the likely outcome of a trial, there are gains from settling out of court, and a range of settlements they would both prefer to going to trialIf the two parties are relatively pessimistic, settlement is even more likelyIf the two parties are relatively optimistic, settlement may be impossibleEven if the two have the same beliefs or are relatively pessimistic, private information may lead to failures in bargainingAn example from Polinsky, “An Introduction to Law and Economics”12Under strict liability…We said injurers internalize cost of accidents  efficient precautionBut this assumes cost of being sued = damage doneIf courts are unpredictable and litigation is costly, private cost of being sued for damages could be > or < cost of accidentWhich could lead to too much or too little precautionBut also…If settlement talks break down and cases go to trial……then total social cost of an accident includes the harm done, and the resources expended during the trial!If trial costs $6,000, then social cost of the accident isn’t $10,000, but $16,000 – which increases the efficient level of precaution!So what?13The legalprocess14Once an accident has happened…Victim could sue or not sueThe victim and injurer might quickly settle out of courtIf the case proceeds to trial, the first step (in the U.S.) is a pre-trial exchange of informationAfter that, victim and injurer might still settle out of courtIf the case goes to trial, victim (now plaintiff) might win or loseLosing side at trial can choose to appeal (or not)The legal process15Tort law: efficiency meant minimizing the total social cost of accidentsActual cost of accidentsPlus cost of actions taken to prevent them (precaution)Goal of the legal process: minimize its social costsDirect (administrative) costsError costsThe goal of the legal process16Administrative costsHiring judges, building courthouse, paying jurors…More complex process  higher costError costsAny legal process is imperfectErrors are any judgments that differ from theoretically perfect onesAn error in computing damages after the fact only affects distribution, not efficiencyBut anticipated errors


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UW-Madison ECON 522 - Lecture 20

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