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 202Midterm will be graded by TuesdayNo lecture Tuesday (too many people planning to be gone for Thanksgiving)I’ll hold office hours during that time so you can pick up examsHW3 online today, due December 8Logistics3The legalprocess4Developed theories of property/nuisance law, contract law, and tort lawLooked at how rules of legal liability create incentivesThought about how these rules can be chosen to try to achieve efficient outcomesOver the last 2 ½ months, we have…5To achieve efficiency, we’ve generally tried to set a party’s liability equal to the harm he caused someone elseDamages in nuisance lawExpectation damages in contract lawCompensatory damages in tort lawThat way, he internalizes the externality he imposes, leading to efficient decisionsIn doing this, we’ve been making two big assumptions:The legal system works flawlesslyThe legal system costs nothingOver the last 2 ½ months, we have…6I hit you with my car and did $10,000 worth of damageWe both know I was negligentBut courts aren’t perfectIf we go to trial, 80% chance I’ll be found liable, 20% I won’tIf I’m held liable, damages are correctly set at $10,000So on average, if we go to trial, you expect to recover $8,000But if we go to trial, we both have to hire lawyersSuppose this costs us each $3,000Now your expected gain from going to trial is $8,000 – 3,000 = 5,000And my expected cost is $8,000 + 3,000 = 11,000An example from Polinsky, “An Introduction to Law and Economics”7So…Going to trial gains you $5,000 (in expectation)Going to trial costs me $11,000 (in expectation)Maybe we can settle out of courtIf we avoid going to court and I pay you any settlement between $5,000 and $11,000, we’re both better offSo maybe this happensBut…An example from Polinsky, “An Introduction to Law and Economics”8Suppose I’m more pessimistic about my chances than youYou think I’m 80% likely to be found liableI think I’m 90% likely to be found liableYou think your expected gain is $8,000 – 3,000 = $5,000I think my expected cost is $9,000 + 3,000 = $12,000Now the range of possible settlements is even widerAny settlement between $5,000 and $12,000 is a Pareto-improvement over going to trialSo settling is more likelyAn example from Polinsky, “An Introduction to Law and Economics”9Now instead, suppose I’m more optimistic about my chances than youYou think I’m 80% likely to be found liableI think I’m only 10% likely to be found liableYou think your expected gain is $8,000 – 3,000 = $5,000I think my expected cost is $1,000 + 3,000 = $4,000Now an out-of-court settlement is impossibleThere are no settlements that you and I would both agree toAn example from Polinsky, “An Introduction to Law and Economics”10And, 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 settlementRemember 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 shareSo 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”11So 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 trialIf the two parties are relatively pessimistic, settlement is even more likelyIf the two parties are relatively optimistic, settlement may be impossibleEven 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”12Under strict liability…We said injurers internalize cost of accidents efficient precautionBut this assumes cost of being sued = damage doneIf courts are unpredictable and litigation is costly, private cost of being sued for damages could be > or < cost of accidentWhich could lead to too much or too little precautionBut 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 legalprocess14Once an accident has happened…Victim could sue or not sueThe victim and injurer might quickly settle out of courtIf the case proceeds to trial, the first step (in the U.S.) is a pre-trial exchange of informationAfter that, victim and injurer might still settle out of courtIf the case goes to trial, victim (now plaintiff) might win or loseLosing side at trial can choose to appeal (or not)The legal process15Tort law: efficiency meant minimizing the total social cost of accidentsActual cost of accidentsPlus cost of actions taken to prevent them (precaution)Goal of the legal process: minimize its social costsDirect (administrative) costsError costsThe goal of the legal process16Administrative costsHiring judges, building courthouse, paying jurors…More complex process higher costError costsAny legal process is imperfectErrors are any judgments that differ from theoretically perfect onesAn error in computing damages after the fact only affects distribution, not efficiencyBut anticipated errors
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