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CONTRACTS – Terms And Conditions October 17, 2006

CONTRACTS – Terms And Conditions October 17, 2006. CONTRACTS – Terms And Conditions October 17, 2006. COLOUR CODE FOR GRAPHS Marginal Cost Curve for Agent (firm, individual) under a strict liability rule Marginal Cost Curve for Agent (firm, individual) under a no liability rule

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CONTRACTS – Terms And Conditions October 17, 2006

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  1. CONTRACTS – Terms And Conditions October 17, 2006

  2. CONTRACTS – Terms And ConditionsOctober 17, 2006 • COLOUR CODE FOR GRAPHS • Marginal Cost Curve for Agent (firm, individual) under a strict liability rule • Marginal Cost Curve for Agent (firm, individual) under a no liability rule • Marginal Cost Curve for Agent (firm, individual) under a negotiated contract that follows the Theoem of Coase • Demand Curve for the Agent’s output • Marginal Revenue Curve

  3. CONTRACTS – Terms And ConditionsOctober 17, 2006 • COLOUR CODE FOR GRAPHS (con’t) • Average Cost Curve for Agent (firm, individual) with no transaction costs • Average Cost Curve for Agent (firm, individual) with transaction costs • Profit of Agent (firm, individual) • Portion of profit traded in exchange for property rights • Portion of profit lost due to a trade in property rights • Portion of profit lost due to transaction costs

  4. CONTRACTS – Terms And ConditionsOctober 17, 2006 • Review of Coase Theorem • Exceptions To Coase Theorem • Transaction Costs - October 17, 2006 • Rules that reduce transaction costs • Asymmetric Information – October 24, 2006 • Rules that compensate for market failure • Empty Core - October 31, 2006

  5. Review The Theorem Of Coase CONTRACTS – Terms And ConditionsOctober 17, 2006

  6. CONTRACTS – Terms And Conditions Agent 1 creates a harmful nuisance that hurts Agent 2 economically. . Agent 2 has the exclusive use to its property rights

  7. CONTRACTS – Terms And Conditions • While cooperation between the agents determines when optimal use or the most efficient use of an asset will occur, what determines what that level of efficiency will be? • Technology

  8. CONTRACTS – Terms And Conditions • Social surplus increases under the contract. • No party can be worse off. • Agent 1 P D S PMC SMC CMC PM a1

  9. CONTRACTS – Terms And Conditions • Social surplus is improved to the most efficient or optimal amount irregardless of which agent has the property rights. • Agent 2 P D S PMC SMC CMC PM a1

  10. CONTRACTS – Terms And Conditions Theorem of Coase What rule applies makes no difference to the optimal level of efficiency. It is the cooperation of the parties that makes the difference. (Cooter, p. 87)

  11. CONTRACTS – Terms And Conditions • Agent 1 • Agent 2 P D CMC Maximum Joint Social Surplus S S PM a1 a1

  12. CONTRACTS – Terms And Conditions Theorem of Coase (continued) Productive or allocatedtransfer of surplus leads to a more efficient use ofthe asset Redistributive transfer of surplus causes no change to the efficient use of the asset Distribution of the social surplus varies in accordance with which agent has the property rights.

  13. CONTRACTS – Terms And Conditions Theorem of Coase (continued): The improvement in social surplus involves the elimination of incompatible uses through bargaining. LEAST COST PRINCIPLE applies as the next example shows.

  14. CONTRACTS – Terms And Conditions

  15. CONTRACTS – Terms And Conditions • Theorem of Coase (continued): • If it is cheaper for the farmer to build a fence around his property, than for the rancher to hire a rustler, than the fence will be built. • Note the LEAST COST PRINCIPLE is a corollary of the Theorem of Coase in these examples.

  16. CONTRACTS – Terms And Conditions Set of Cost Minimizers Set of Profit Maximizers

  17. CONTRACTS – Terms And Conditions • Theorem of Coase (continued): • Note the application of the “cheaper” technology reconciled a “incompatible use” with a compatible use. • Efficiency requires limiting the use to the party that values the property most – higher utility or higher profits - efficiency rule • (Cooter – p. 88)

  18. CONTRACTS – Terms And Conditions • The elimination of incompatible uses through bargaining underlies much of the theory behind urban geography and urban planning • Former Irwin Toy factory - Toronto

  19. CONTRACTS – Terms And Conditions • Perfectly Competitive-Agent 1 • Monopoly Market – Agent 1 P D LATC LATC S MC1 PM PPC a1

  20. CONTRACTS – Terms And Conditions Theorem of Coase (continued): Property rights may be traded for a price. Each Agent does not have an incentive to defect

  21. CONTRACTS – Terms And Conditions Nash Equilibria • Prisoners dilemna works against a collusive duopoly • Prisoners dilemna could be “solved” in a collusive externality agency P.O.E P.O.E and N. E N.E

  22. Cournot Duopoly Negative Externality CONTRACTS – Terms And Conditions Nash Equilibria a2 Axes Iso-Profit Curve For Agent 2 E Iso-Profit Curve For Agent 1

  23. Coase Theorem Short Run CONTRACTS – Terms And ConditionsOctober 17, 2006

  24. CONTRACTS – Terms And ConditionsShort Run • Why the Theorem of Coase might be true in the short run, but not the long run • (See Cooter, p. 90, for a fuller explanation)

  25. CONTRACTS – Terms And ConditionsShort Run • Perfectly Competitive-Agent 1 • Monopoly Market – Agent 1 P D LATC S = MC1 LATC S MC1 SATC SATC PM PPC a1

  26. CONTRACTS – Terms And ConditionsStrict Liability Rule Agent 1 creates a harmful nuisance that hurts Agent 2 economically. . Agent 2 has the exclusive use to its property rights

  27. CONTRACTS – Terms And ConditionsShort Run • Perfectly Competitive-Agent 1 • Monopoly Market – Agent 1 P D LATC S = MC1 LATC S MC1 SATC SATC PM PPC Strict Liability Rule a1

  28. CONTRACTS – Terms And ConditionsStrict Liability Rule - Short Run • Perfectly Competitive-Agent 2 • Monopoly Market – Agent 2 P D LATC S = MC2 LATC S MC2 SATC SATC PM PPC Strict Liability Rule a1

  29. CONTRACTS – Terms And Conditions Short Run - Strict Liability Rule PRINCIPAL Agent 1 Offers a Bribe or a Transfer Payment To Agent 2 promise payment AGENT Agent 2 promises to endure the pollution in exchange for the payment which makes it better off

  30. CONTRACTS – Terms And ConditionsShort Run - Strict Liability Rule • Perfectly Competitive-Agent 1 • Monopoly Market – Agent 1 P D LATC S = MC1 LATC S MC1 SATC SATC PM PPC Strict Liability Rule a1

  31. CONTRACTS – Terms And ConditionsShort Run - Strict Liability Rule • Perfectly Competitive-Agent 2 • Monopoly Market – Agent 2 P D LATC S = MC2 LATC S MC2 SATC SATC PM PPC Strict Liability Rule a1

  32. CONTRACTS – Terms And ConditionsShort Run - No Liability Rule Agent 1 creates a harmful nuisance that hurts Agent 2 economically. . Agent 2 loses the exclusive use to its property rights to protect it against pollution

  33. CONTRACTS – Terms And ConditionsShort Run • Perfectly Competitive-Agent 1 • Monopoly Market – Agent 1 P D LATC S = MC1 LATC S MC1 SATC SATC PM PPC No Liability Rule a1

  34. CONTRACTS – Terms And ConditionsShort Run • Perfectly Competitive-Agent 2 • Monopoly Market – Agent 2 P D LATC S = MC2 LATC S MC2 SATC SATC PM PPC No Liability Rule a1

  35. CONTRACTS – Terms And Conditions No Liability Rule PRINCIPAL Agent 2 Offers a Bribe or a Transfer Payment To Agent 1 promise payment AGENT Agent 1 promises to cutback production or incur the expense of pollution abatement

  36. CONTRACTS – Terms And ConditionsShort Run - No Liability Rule • Perfectly Competitive-Agent 1 • Monopoly Market – Agent 1 P D LATC S = MC1 LATC S MC1 SATC SATC PM PPC No Liability Rule a1

  37. CONTRACTS – Terms And ConditionsShort Run - No Liability Rule • Perfectly Competitive-Agent 2 • Monopoly Market – Agent 2 P D LATC S = MC2 LATC S MC2 SATC SATC PM PPC No Liability Rule a1

  38. Exceptions to the Theorem of Coase Transaction Costs - Fees CONTRACTS – Terms And Conditions

  39. CONTRACTS – Terms And ConditionsTransaction Costs • Rules that reduce transaction costs • Default rules are developed by courts to reduce transaction costs. • For example, if A1 knows how much it will have to pay A2 for breach of contract, it will not incur the cost of consulting a lawyer or losing in court (paying the legal fees of the winner) • (Cooter – p. 267)

  40. CONTRACTS – Terms And Conditions Transaction Costs – Legal Fees What are transaction costs? • Fees paid to lawyers to draft a contract

  41. CONTRACTS – Terms And ConditionsTransaction Costs – Legal Fees • When bargaining costs are low, the efficient use of assets or resources results from private negotiation irregardless of what the legal rules are • When bargaining costs are high, the efficient use of assets or resources results from which legal rules is chosen • (Cooter – p. 89)

  42. CONTRACTS – Terms And ConditionsTransaction Costs – Legal Fees • Which legal rule should be chosen in this case? • Choose the legal rule that favours the party that “most values” the asset or resource. • This is an application of the NORMATIVE HOBBES THEOREM • (Cooter – p. 98)

  43. CONTRACTS – Terms And ConditionsStrict Liability Rule – Short Run • Perfectly Competitive-Agent 1 • Monopoly Market – Agent 1 P D SATC+TC S = MC1 LATC S MC1 SATC SATC PM PPC Transaction Costs a1

  44. CONTRACTS – Terms And ConditionsStrict Liability Rule – Long Run • Perfectly Competitive-Agent 1 • Monopoly Market – Agent 1 P D LATC S PM PPC Strict Liability Rule a1

  45. CONTRACTS – Terms And ConditionsNo Liability Rule – Long Run • Perfectly Competitive-Agent 2 • Monopoly Market – Agent 2 P D LATC MC2 S MC2 PM PM PPC No Liability Rule a1

  46. CONTRACTS – Terms And ConditionsTransaction Costs – Legal Fees a2 • Cournot Duopoly • Negative Externality Axes Iso-Profit Curve For Agent 2 E Iso-Profit Curve For Agent 1

  47. CONTRACTS – Terms And ConditionsTransaction Costs – Legal Fees • Prisoners dilemna works against negative externalities under the exceptions to the Theorem of Coase • Prisoners dilemna works against a collusive duopoly P.O.E N.E P.O.E N.E

  48. Exceptions to the Theorem of Coase Transaction Costs - Enforcement CONTRACTS – Terms And Conditions

  49. CONTRACTS – Terms And ConditionsTransaction Costs - Enforcement What are transaction costs? • Enforcement Fees • Fees paid to lawyers to go to court to enforce a broken contract and obtain remedies for their clients

  50. CONTRACTS – Terms And Conditions Transaction Costs – Enforcement Formation Of Contracts Agent Sends A Signal to the Principal Principal Makes An Offer To An Agent Agent Accepts The Offer Performance Of The Contract

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