Econ 522 Economics of Law

1. Econ 522Economics of Law Dan Quint Spring 2012 Lecture 15

2. Reminders • HW3 due tomorrow Thursday (11:59 p.m.) • Second midterm Monday March 26 • Cumulative – covers property and contract law • No tort law – covers everything through middle of today’s lecture

3. Going back amonth…

4. Intellectual property… • IP is a tradeoff between… • dynamic (“ex ante”) inefficiency – insufficient incentives for innovation • static (“ex post”) inefficiency – monopoly deadweight loss • Article in yesterday’s New York Times • Government of India is forcing Bayer to cheaply license patent for one of its drugs to a generic manufacturer • Nexavar (sorafenib) – treats advanced kidney and liver cancer • Bayer charges $5,600 a month for the drug, hardly sells any in India • Being forced to license the patent to an Indian company, Natco Pharma, which will sell drug for $176/month, pay Bayer 6% royalty

5. Results fromMonday’s experiment

6. A two-player game, similar to the investment/agency game • Player A starts with $10 • Chooses how much of it to give to player B • That money is tripled • Player B has $10, plus 3x whatever A gave him/her • Chooses how much (if any) to give back to player A • Four treatments • Anonymous • Private • Face-to-face • Public

7. Results • In the anonymous version, trust was an issue • On average, player A sent $5.91, so about 60% of the potential gains were realized • On average, player B sent back $9.35, so average payoffs were $13.43 and $18.40 • Of those player A’s who sent something, 24% got back less than they sent, and 7% got back nothing • Knowing who you were playing with helped a lot! • In second version, average A sent $8.70, average B sent $16.21 • Two-thirds of A’s sent $10, and 5/6 of those got back $20 • Average payoffs of $17.51 and $19.89 • Only 4% of player A’s who sent something, got nothing back

8. Results ANONYMOUS VERSION(STUDENT ID NUMBERS) PRIVATE VERSION(NAMES) A sent… # obs Avg B % zero # obs Avg B % zero 0 2 $0.00 100% 1 $0.00 100% 1-4 14 $3.02 21% 1 $8.00 0% 5-9 18 $9.11 0% 14 $13.79 0% 10 13 $17.92 0% 31 $18.10 6% Average $5.91 $9.34 11% $8.70 $16.21 6% (7%) (4%)

9. Of the Player A’s who sent $10… Anonymous Private # of Player A who sent $10 13 31 % who got back $0 or $5 8% 6% % who got back $10 0% 3% % who got back $15 or $17 23% 6% % who got back $20 or $21 69% 84% Average received $17.92 $18.10

10. Results • Knowing the name of the person you’re playing with helped • Increased trust significantly; increased trustworthiness a little • Interacting face-to-face completely solved problem • All 5 A’s sent $10, all 5 B’s sent back $20 • That worked even better than playing the game in public! • (Public version: all three A’s sent $10, got back $20, $15, and $0)

11. Returning torepeated interactions

12. Repeated games and reputation • The first purpose of contract law is to enable cooperation, by converting games with noncooperative solutions into games with cooperative solutions • The sixth purpose of contract law is to foster enduring relationships, which solve the problem of cooperation with less reliance on courts to enforce contracts • Law assigns legal duties to certain long-term relationships • Bank has fiduciary duty to depositors • McDonalds franchisee has certain duties to franchisor

13. Repeated games and the endgame problem • Suppose we’ll play agency game 60 times • $50 x 60 = $3,000 > $200, so cooperation seems like no problem • But… • In game #60, reputation has no value to me • Last time we’re going to interact • So I have no reason not to keep all the money • So you have no reason to trust me • But if we weren’t going to cooperate in game #60, then in game #59…

14. Repeated games and the endgame problem • Endgame problem: once there’s a definite end to our relationship, no reason to trust each other • Example: collapse of communism in late 1980s • Communism believed to be much less efficient than capitalism • But fall of communism led to decrease in growth • Under communism, lots of production relied on gray market • Transactions weren’t protected by law, so they relied on long-term relationships • Fall of communism upset these relationships

15. One other bitI like from Friedman

16. Friedman on premarital sex

17. Friedman on premarital sex

18. That’s it for contract law • Purposes for contract law: • Encourage cooperation • Encourage efficient disclosure of information • Secure optimal commitment to performance • Secure efficient reliance • Provide efficient default rules and regulations • Foster enduring relationships • Wednesday, we begin tort law End of material on second midterm

19. Let’s recap ourstory so far…

20. Our story so far • Efficiency • Maximizing total surplus realized by everyone in society • Scarce resources are owned by whoever values them most • Actions are taken if social benefit exceeds social cost • Design a legal system that leads to efficient outcomes • Once we set up the rules, we don’t expect people to act based on what’s efficient • We expect people to do whatever’s in their own best interest • So the goal is set up the rules such that people acting in their own best interest will naturally lead to efficiency

21. Our story so far • Coase gives us one way to do that • If property rights are clearly defined and tradable, and there are no transaction costs, people have incentive to trade until each resource is efficiently owned • So initial allocation of rights doesn’t matter for efficiency • But if there are transaction costs, we may not get efficiency this way • Led us to two normative views of the legal system: • 1. Minimize transaction costs (“lubricate” private exchange) • 2. Allocate rights as efficiently as possible • Tradeoff between injunctive relief and damages

22. Our story so far • Property law works well for simultaneous trade • Contracts allow for non-simultaneous trade • Contract law can… • Enable cooperation • Encourage efficient disclosure of information • Secure optimal commitment to performance • Secure efficient reliance • Supply efficient default rules and regulations • Foster enduring relationships

23. Our story so far • So far, we’ve been talking about voluntary exchange • Coase is predicated on exchange being voluntary for both parties • Contracts are an extension of voluntary trade • Up next: “involuntary trade” • You’re bicycling to class, I’m texting while driving and I hit you • You didn’t want to deal with me, I didn’t want to deal with you…

24. Our story so far • To put it another way… • Property law covers situations where transaction costs are low enough to get agreement ahead of time • Exceptions to property law – private necessity, eminent domain – when this isn’t the case • Contract law covers situations when transaction costs are low enough for us to agree to a contract, high enough that we may not want to renegotiate the contract later • Tort law covers situations where transaction costs are too high to agree to anything in advance

25. Tort law

26. An example

27. An example • punish the choice • criminal law • regulations Choice + Bad Luck  Outcome

28. An example • punish the choice • criminal law • regulations • punish the outcome • “strict liability” Choice + Bad Luck  Outcome • punish the combination of choice and outcome • “negligence”

29. Tort law • Tort, noun. from French word meaning injury • Contract law: situations where someone harms you by breaking a promise they had made • Tort law: situations where someone harms you without having made any promises • “If someone shoots you, you call a cop. If he runs his car into yours, you call a lawyer.”

30. As always, we’ll be focused on achieving efficiency • I hit you with my car, do $1,000 worth of damage • You’re $1,000 worse off • (No damage to me or my car) • Should I have to pay you damages? I owe nothing I owe $1,000 I owe $50,000 Your payoff –1,000 0 49,000 My payoff 0 –1,000 –50,000 Combined payoffs –1,000 –1,000 –1,000

31. Something to remember distributionbut notefficiency efficiency

32. Tort law • Question: how to structure the law to get people to behave in a way that leads to efficient outcomes? • Deliberate harms: make punishment severe (criminal law) • Accidental harms: trickier • Goal isn’t “no accidents”; goal is “efficient number of accidents”

33. Tort law • Question: how to structure the law to get people to behave in a way that leads to efficient outcomes? • Deliberate harms: make punishment severe (criminal law) • Accidental harms: trickier • Goal isn’t “no accidents”; goal is “efficient number of accidents” • Unlike nuisance law, injunctive relief is not an option • Unlike contract law, no agreement ahead of time • Cooter and Ulen: essence of tort law is “the attempt to make injurers internalize the externalities they cause, in situations where transaction costs are too high to do this through property or contract rights”

34. Cast of characters • Plaintiff – person who brings a lawsuit • Defendant – person who is being sued • In a nuisance case, the defendant caused a nuisance, plaintiff was bothered by it, might be asking for injunction or damages • In a contract case, defendant breached a contract or violated its terms • In a tort case, defendant caused some harm to plaintiff, plaintiff is asking for damages • Plaintiff is the victim (person who was harmed) • Defendant is the injurer (person who caused the harm)

35. “Classic” legal theory of torts • Harm • Causation • Breach of Duty

36. Element 1: Harm • For a tort to exist, the plaintiff needs to have been harmed • “Without harm, there is no tort” • Gas company sold gas with a defective additive • Dangerous for cars with turbocharged carburetors • You have a car with normal carburetors • You might be angry; but you weren’t harmed, so you can’t sue • Similarly, no compensation for exposure to risk • Manufacturer exposed workers to some chemical • Exposure will cause 15% of them to develop cancer later in life • Can’t sue now – have to wait, see who gets cancer, then they can sue

37. Element 1: Harm Money Health • Perfect compensation • restores victim to original level of well-being • generally done through money damages

38. Perfect Compensation Tangible harms Intangible harms • Medical costs • Lost income • Damaged property • Emotional harm • Pain and suffering • Loss of companionship • In theory, perfect compensation should cover all losses • Historically, courts have been less willing to compensate for intangible or hard-to-measure losses • Over time, U.S. courts have started compensating for more intangible harms • Pro: the closer liability is to actual harm done, the better the incentive to avoid these harms • Con: disparity in award sizes, unpredictability

39. “Classic” legal theory of torts • Harm • Causation • Breach of Duty

40. Element 2: Causation • For a tort to exist, the defendant needs to have caused the harm to the plaintiff • Cause-in-fact • “But for the defendant’s actions, would the harm have occurred?”

41. Element 2: Causation • For a tort to exist, the defendant needs to have caused the harm to the plaintiff • Cause-in-fact • “But for the defendant’s actions, would the harm have occurred?” • Proximate cause • Immediate cause – defendant’s action can’t be too distant from the harm • Palsgraf v Long Island Railway (NY Ct Appeals, 1928): • Guard pushed a passenger to help him onto train, passenger dropped fireworks he was carrying, they went off, explosion knocked down scales at the other end of the platform, which fell on Mrs. Palsgraf • Guard’s actions were not the proximate cause

42. Element 2: Causation “A tree fell on a moving trolly, injuring passengers. One of them sued. He succeeded in demonstrating that in order for the trolly to be where it was when the tree fell on it the driver had to have driven faster than the speed limit at some point during the trip. Breaking the law is per se negligence, so the driver was legally negligent whether or not his driving was actually unsafe. If he had not driven over the speed limit, the trolly would not have been under the tree when it fell, so, the plaintiff argued, the driver’s negligence caused the injury.” • Court ruled driver’s negligence “had not caused the accident in the legally relevant sense”

43. “Classic” legal theory of torts • Harm • Causation • Breach of Duty

44. (Sometimes required, sometimes not) Element 3: Breach of Duty Strict Liability Negligence • Harm • Causation • Harm • Causation • Breach of duty (fault) • When someone breaches a duty he owes to the defendant, and this leads to the harm, the injurer is at fault, or negligent • Injurers owe victims the duty of due care • Negligence rule: I’m only liable if I failed to take the required standard of care – not if I was careful and the accident happened anyway

45. Hence the language in the trolly example “A tree fell on a moving trolly, injuring passengers. One of them sued. He succeeded in demonstrating that in order for the trolly to be where it was when the tree fell on it the driver had to have driven faster than the speed limit at some point during the trip. Breaking the law is per se negligence, so the driver was legally negligent whether or not his driving was actually unsafe. If he had not driven over the speed limit, the trolly would not have been under the tree when it fell, so, the plaintiff argued,the driver’s negligence caused the injury.”

46. So under a negligence rule… • If I breach my duty of due care and injure you, I am liable • If I exercise the appropriate level of care but still injure you, I’m not liable • How is the standard of care determined? • That is, how careful do I have to be to avoid liability, and who decides? • Is it negligent to drive 40 MPH on a particular road at a particular time of day? What about 41 MPH? 42?

47. How is the standard of care determined? • Some settings: government imposes safety regulations that are also used as standard for negligence • Speed limits for highway driving • Requirement that bicycles have brakes • Workplace regulations • Some standards are left vague • “Reckless driving” may depend on road, time of day, weather… • Common law focuses on duty of reasonable care • Level of care a reasonable person would have taken • (Civil law relies less on “reasonableness” tests, tries to spell out what level of care is required)

48. Strict liability versus negligence • Strict liability rule: plaintiff must prove harmand causation • Negligence rule: must prove harm, causation, and negligence • A little history • Early Europe: strict liability was usual rule • By early 1900s, negligence became usual rule • Second half of 1900s, strict liability became more common again, especially for manufacturer liability in American consumer products • U.S. manufacturers now held liable for harms caused by defective products, whether or not they were at fault

49. “Classic” legal theory of torts • Harm • Causation • Breach of Duty

50. Economic model(didn’t get to this)