Law and Econ_Hillman

I.   3 limits on rationality:

    A.   Bounded rationality

(1)   People make mistakes

(2)   Types of error:

i.  Hindsight bias

ii.  Salience

iii.  Representativeness

iv.  Framing

v.  Overoptimism

vi.  Winner’s curse:

vii.  Sunk costs:

    B.   Bounded self-interest

    C.   Bounded willpower


  1. II.   Pareto improvement:

A.   Another allocation of resources in society that will make at least one person better of & no one worse off

  1. III.   Pareto optimality:

A.   You are out of Pareto superior moves

B.   You can have multiple Pareto optimal points, but you need something other than utility to select between the points

  1. IV.   Caldor-Hicks efficiency:

A.   If the winners would compensate the losers under some policy, it should be done, even if there isn’t any compensation

B.   Problem:  Since you don’t actually require compensation, there isn’t a check to make sure that the winners really would compensate the losers


Ceretis paribus = other things being equal


  1. V.   Communal property

A.   Everyone has the right to use & no one the right to exclude

B.   Problem of externalities:  Cost/benefit is generated by one person but falls at least in part on others

C.   High transaction costs make it difficult to remedy externalities via K

D.   Works fine for abundant resources & there is no way to exclude people from using that resource

E.   Also used if you want to deplete a resource (e.g., non-native fish)

  1. VI.   Private property

A.   Reduces transaction costs & externalities

B.   Private property can be divided too finely: the tragedy of the anti-commons

  1. VII.   State property

A.   Reduces some transaction costs & eliminates the holdout problem.

(1)   Transactions costs are now mainly legislative

B.   Disadvantages:

(1)   Hard to set up incentives to create & maintain


  1. Public goods characteristics:

A.   Nonexclusivity

(1)   Air, national defense

B.   Nonrivalry

(1)   The marginal cost of one additional user is zero or near zero


  1. Coase theorem:  If there are no transaction costs, it doesn’t matter who you assign a right to initially—it will end up w/ the party that values it the most


  1. Transaction costs:

A.   Endowment effects (purchasing party might not have enough money)

B.   Information costs (Who do you deal with?)

C.   Costs of drafting agreements

D.   Strategic behavior (holding out for more than what you’d be willing to accept)


  1. Protecting entitlements (Calabresi & Melman)

A.   Property rules: Can only be transferred by mutual, voluntary exchange

B.   Liability rules: Something can be taken as long as the taker is willing to pay the judicially-determined price

    C.   Inalienability rules:

i.  Market inalienability rule:  Can transfer, but can’t sell

ii.  Absolute inalienability rule:  Can’t transfer


  1. Intellectual property

A.   Ideas have a lot of public goods characteristics

(1)   Nonrivalrous (consumption is costless)

(2)   Nonexclusivity (hard to prevent others from using)

B.   Standardization in the forms of property

(1)   Numerus Clausus

i.  There is only a fixed menu of forms

ii.  Must balance measurement & frustration costs

iii.  K alternative is less effective—property binds the whole world

(2)   Network effects: Market efficiency will dictate # of forms


  1. K Remedies

    A.   Restitution

(1)   Return B to his position before the K was formed

B.   Reliance

(1)   B recovers expenditures made in reliance on the K

    C.   Expectation damages

(1)   Put B in the position he expected to be in after fulfillment of the K

(2)   Secrecy interest requires

i.  Secret

ii.  Repeat play

(3)   Possible solutions:

i.  Average expectations damages

ii.  Liquidated damages clause

iii.  Specific performance

    D.   Specific performance

(1)   Resembles a property rule:  Promisor can only breach w/ promisee’s consent


  1. Efficient gap-filling rules deter inefficient gaps @ the least social cost

A.   What you think the parties would have negotiated—mimic the parties’ will

(1)   Do this when the costs of negotiating are high and it’s cheaper for the court to fill in gaps

B.   What you think at least one party wouldn’t have wanted:  a penalty provision—force parties to negotiate

(1)   Penalizing the better-informed party encourages disclosing info


C.   Unconscionability

i.  Procedural – outside K

ii.  Substantive – terms of K


  1. Craswell says for consumer protection statutes to help consumers requires 2 things:

A.   Consumer must bear cost of the rule

B.   Consumer must value what the law provides more than it costs them

  1. If these criteria are met, consumption will increase after the rule goes into effect

A.   Graphically, the demand curve moves up by more than the supply curve does


  1. Requirements for a prisoner’s dilemma situation:

A.   Known, finite number of rounds

B.   Can’t tell what the other actor(s) is (are) doing

C.   No enforcement mechanism


(1)   2 goals of torts:

i.  compensation

ii.  deterrence


D.   Negligence

(1)   Learned Hand formula: negligent if B < PL

a.   B*, the optimal level of precautions, equals PL

b.   If there are multiple levels of precaution, one must consider marginal (not total) savings

I.   Bhigh – Blow < (Plow – Phigh) x L

E.   Strict liability

(1)   Learned Hand formula is still relevant.  Injurer will consider whether it is cheaper to take the precautions or just pay for the harm.


No liability:

–           V takes precautions & reduces activity level

Negligence w/ contributory negligence:

–           T takes precautions

–           V takes precautions & reduces activity level


–           T takes precautions

–           V reduces activity level

Strict liability w/ contributory negligence:

–           V takes precautions

–           T reduces activity level (or takes precautions)

Strict liability:

–           T reduces activity level (or takes precautions)


  1. Consumer information:  Do consumers know they’ll get cancer from cigarettes?
  2. Judicial information:  Do courts know what happened?
  3. Market price:  Sticker price—consumers always have this
  4. Perceived price:  May vary by consumer based on gas mileage or something
  5. XXII.   Consumer info about a product:

A.   If consumers have full info, they will purchase optimally under any (or no) liability regime

B.   If only manufacturers know the harm from a product

a.   Consumers will make efficient purchase decisions only under strict liability

b.   Under no liability or negligence, the perceived price might be less than the total cost


  1. Punitive” Damages
  2. Damage multiplier: Schavell suggests L/(probability of a successful suit)


(1)   Costs of theft

i.  Direct costs

ii.  Indirect costs

a.   Protection costs

b.   Thieving costs

c.   Purchases may be foregone b/c someone might decide it’s not worth the risk


(2)   Why might increase penalties not deter criminals?

i.  Criminals aren’t rational

ii.  Criminals are rational but the increased penalty isn’t sufficient to deter them

iii.  Optimism bias

iv.  Imperfect information

v.  Rarity

vi.  Criminals tend to discount the cost too much of anything that happens in the future


Reasons the death penalty might not deter

vii.  Heat of passion

viii.  Rarely imposed

ix.  Not increased punishment


B.   The Becker thesis (the form and optimal size of sanctions)

(1)   Expected sanction is actual sanction (S) x probability that sanction will be imposed (P)

(2)   Becker claims S should be high, allowing P to be low; S should be a fine, not imprisonment


C.   If the benefit to the criminal is less than the harm to the victim, optimal sentence: S = Harm / P


  1. Reasons to punish repeat offenders less severely (David Dana):

a.   P is higher—they are more likely to be caught

b.   Marginal deterrence might not be effective

c.   Salience bias

  1. Reasons to punish repeat offenders more severely:

A.   S is perhaps lower for repeat criminals

B.   Dana mentions that you might should jack up the penalties for repeat offenders b/c they get a peculiar benefit out of crime

C.   Incapacitation

D.   Mistake avoidance

E.   Declining (or declining effectiveness of) social sanctions

  1. Dana:  There’s no good economic explanation for punishing repeat offenders more severely.


A.   Characteristics of diverting precautions:

a.   Only benefit the person taking the precaution

b.   Probably need to be observable

c.   Criminal must have other opportunities


(2)   Why might parties have differing opinions on the case?

i.  Asymmetric info

a.   You have an incentive to share info that helps you

b.   You have an incentive to hide info that hurts you

ii.  Strategic behavior goes too far

a.   Both try for too big a share of the surplus and get too greedy

iii.  Lawyer’s incentives may not be aligned w/ client

a.   Lawyers get more money for longer trials

b.   Can’t have contingency fees for criminal defense

c.   Conversely, ∏s’ attorneys might have too much of an incentive to settle

I.   More bang for the buck w/ a settlement if lawyer gets a %

B.   Fee shifting and its effects on settlement

(1)   British rule: Loser pays both sides’ fees

i.  Filing suit (compared to American rule)

a.   If a party thinks she has a better than 50/50 chance of winning, trial is more attractive to her

b.   If a party thinks she’s more likely than not to lose, trial is less attractive.

ii.  Settlement (compared to American rule)

a.   Parties agree on ∏’s chances:

I.   The amount of the spread for settlement doesn’t change

II.   The endpoints of the range both shift the same amount in favor of the party who is more likely to win

b.   Parties are overly optimistic:

I.   Br. rule exacerbates the problem.

(2)   Modified American rule: Prevailing ∏ gets fees from ∆

i.  This asymmetry encourages ∏s to bring suits

a.   Which isn’t necessarily bad—some cases need to be encouraged

b.   Some ∏s might not be otherwise able to pay fees

I.   Esp. a poor client trying to vindicate a non-monetary right

(3)   Usually only reasonable fees are covered

i.  Otherwise, parties who think they are going to win would spend too much on litigation

C.   Nuisance and negative expected value suits

(1)   Nuisance/frivolous/NEV suits (these 3 things aren’t exactly the same):

i.  p could be low (you’re unlikely to win)

ii.  J could be much less than C, even if the suit is meritorious

(2)   3 reasons ∏s would file negative expected value suits:

i.  ∏s & ∆s incur costs @ different times or in different manners

a.   E.g., cheap to file suit, expensive to answer

b.   If answering is more expensive than filing a complaint, it would be rational for ∏ to file suit & ∆ to settle for something less than the cost of the answer

I.   Regardless of p or J

II.   Very possible under FRCP

c.   Unsavory att’y as ∏

ii.  ∆ may be unaware suit is a NEV suit

a.   ∆ is thus unaware ∏ won’t go all the way through trial

b.   ∏s will remember negligence from a large corporation, but the corporation may not realize anything bad happened

c.   If there is a pool of ∏s & ∆ can’t tell NEV suits from PEV ones, & ∆ only gets 1 offer, ∆’s cheapest move may be to offer the minimum settlement amount all ∏s will accept

iii.  Litigation costs are broken up like in Bebachuik article

a.   Determine what a reasonable settlement would be in the last round & work backwards

(3)   Reasons ∆ may not settle

i.  Repeat ∆ might not settle out of fear of encouraging suits

a.   May want reputation for being tough

(4)   Reasons ∆ might settle

i.  J might not capture the full value of losing to ∆.

a.   Michael Jackson probably settled an earlier suit to avoid the public embarrassment of a trial.

(5)   You may get a different settle/not settle decision if you change the bargaining power of the parties

i.  Factors affecting bargaining power:

a.   Current resources

b.   Haste required

c.   Risk tolerance

(6)   ∆s often settle right before trial b/c that’s a big cost

i.  ∆s are also making ∏s incur more costs to get up to trial

(7)   Ways to cut down on frivolous suits:

i.  Rule 11 sanctions against attorneys (common) or the party (uncommon)

a.   But this hasn’t seemed to work so far

ii.  Limit standing

iii.  Increase cost of filing suit

a.   Require more than notice pleading

iv.  Force ∏s to file a bond that they lose if they drop the case

v.  Fee shifting (i.e., the British rule)

a.   Makes bad cases cost more

b.   Makes good cases cheaper

vi.  Have gov’t act on behalf of ∏s more often

vii.  Gov’t screening of cases

a.   Sort of a public defender

viii.  Give ∆ option of telling a court not to enforce a settlement

a.   Now, some ∏s won’t file suit—they will never get a settlement, which is the only way for a NEV suit to work

b.   Commentators increasingly favor this sort of solution, but it seems pretty politically unpopular

ix.  If a ∆ can credibly signal its willingness to fight through to the end, it will discourage ∏s from filing NEV suits

a.   But this is an expensive strategy: You have to fight a number of cases before the position becomes credible

x.  Damage caps

a.   Doesn’t really deal w/ NEV suits, though—in fact, might make more suits NEV suits

xi.  Reduce C

a.   Make legal services more accessible

b.   Would transform some NEV suits into PEV suits

c.   Would help protect ∆s in suits where the ∆ would otherwise settle b/c it’s cheaper to settle than litigate

D.   Private vs. public recovery

(1)   Too few meritorious suits may be brought

i.  Incentives are skewed for private parties

ii.  Can try to fix this w/ a damages multiplier:

a.   You can tweak the multiplier, but you might never be able to have the exact right $ amount of suits filed.

b.   To get around this, you could give the gov’t the punitive damages

I.   Problem w/ decoupling:  ∆ will be fighting a $400 suit, while ∏ is only prosecuting a $100 suit

II.   Parties now have differing perceptions of the probable judgment, shifting them away from settlement

iii.  Public enforcement

a.   We have some:

I.   EPA litigates toxic tort cases

II.   DOJ does some antitrust cases

b.   Good idea when

I.   Lots of small harms

1.   Pollution

2.   (Could also use a class action)

II.   High cost of litigation deters private ∏s

III.   Externalities that an individual litigant can’t capture

1.   Later litigants might benefit from the 1st ∏; 1st ∏ can’t capture any of this benefit

c.   Problems:

I.   Have to prioritize claims

II.   Regulatory capture

1.   You want to maintain private suits if this is a problem

III.   Limited info

1.   Gov’t can’t be aware of everything

(2)   Private enforcement of public causes

i.  E.g., qui tam suits for gov’t fraud

a.   Have to go through the gov’t 1st, who has 60 days to pass on the case & the power to terminate the case or take it over (& pay the relator a smaller %)

E.   The price of law

(1)   Why is law so expensive?

i.  Law school is expensive

a.   Law school is pretty price insensitive

I.   Schools aren’t fungible

ii.  Perverse perception that better lawyers are more expensive

a.   Law services are credence goods—people can’t evaluate their lawyers well

I.   Credence good:  Seller determines buyer’s needs for him

II.   E.g., auto mechanics, doctor

b.   How do we check this?

I.   Ethics rules

II.   Get another lawyer or an accounting firm to check

III.   ABA oversight

iii.  Complexity makes the work harder

a.   Rule against perpetuities

b.   Habeas actions

I.   Have to exhaust state remedies

II.   Need big constitutional violation

III.   Etc. etc. etc.

c.   Complexity forces lawyers to specialize, decreasing supply

d.   Also has indirect affects:

I.   Switching costs

II.   Law is a credence good

III.   Not everyone can be a lawyer—there is a natural limit on supply

IV.   Winner-take-all contest ?

V.   Sunk cost auction ?

iv.  Switching costs

a.   Hard to change lawyers in midstream

b.   Gives lawyers incentives to be lazy

c.   CA has an unusual rule:

I.   Att’y is only entitled to a reasonable fee if client hires att’y on a contingency basis & then fires him & wins the case

1.   There is concern that attorneys won’t take on certain clients b/c they aren’t worth the risk of getting fired & not getting paid much

v.  Not everyone would make a good lawyer

a.   This is a natural limitation on supply

vi.  Sunk cost auction:

a.   Once you proceed w/ a legal case, it can make sense to spend more than the case is worth

b.   (E.g., the $20 bill auction)

vii.  Monopoly effects

a.   W/ perfect competition, price is driven down to cost; under a monopoly, price is determined by wealth of customers.

b.   Unified legal profession

c.   Experience is valuable

I.   The most experienced attorneys get hired & get more experience

II.   All you need is a better attorney that your opponent & you win everything

d.   State has monopoly on use of force

I.   All negotiations are done in the shadow of litigation

II.   Sometimes you can’t avoid the legal system

1.   E.g., in a criminal case

e.   Decrease supply, increase price

f.   Hadfield’s point is that corporations have huge amounts of wealth & drive up the price of law

I.   (But we need a monopoly to do this)

II.   Business lawyers dominate the field of law

1.   Pays more

2.   This decreases the supply of criminal defense attorneys & family lawyers, increasing the cost

(2)   Ways to reduce cost:

i.  Flat fees might help

a.   Lawyer now has no incentive to foot-drag or inflate hours

b.   Lawyer has an incentive to half-ass the case, though

ii.  Contingent fees might help

a.   But only if you’re suing for money

b.   Lawyer doesn’t have perfect incentives

I.   But he still has to win something to get paid

II.   Lawyer seeks optimal return, client wants maximal return

iii.  Make law school more individualized?

a.   It might be too geared towards corporate practice

iv.  Simplify the law

v.  Increase the supply of lawyers:

a.   Anyone can open a law school

b.   No ABA limits on law school enrollment

c.   Don’t require people to pass the bar

d.   Make law school shorter

e.   Make everyone do a clinical year or two at Davis’s clinics

I.   Sort of like medical residences

vi.  Segment law school

a.   Different law school focus on different topical areas

I.   Such as family law, IP

b.   Mikos isn’t sure the broad education is worth it for everyone

c.   This could make you a better attorney faster

d.   If law schools had certain #s of slots for different specialized tracks, they could increase the supply of family lawyers w/o greatly increasing the supply of business lawyers

(3)   Normative Q:  Is the price of law too high?

i.  61% of middle-income people can’t afford to hire lawyers for legal problems

a.   Should all legal needs be met?  Is this like healthcare?

b.   A lot of things are too expensive for some people

c.   Capping price decreases quantity or quality

d.   Maybe gov’t should subsidize legal services

ii.  [Compare different legal systems?]

iii.  Compare the price of law to the cost to the lawyers.

a.   Under a monopoly, the price of law is determined by the marginal return to lawyers instead of the demand.  The price is thus higher than optimal & the supply is lower than optimal.

b.   Costs to lawyers:

I.   Mainly opportunity costs

1.   No life

II.   Education

III.   Clothes

iv.  Congress wants to take away some of the tobacco lawyers’ fees.

a.   But just because the fees are high doesn’t mean that they are too high

b.   You can’t look at just the absolute amount of fees

v.  Do you get your money’s worth from lawyers?

a.   Do the benefits of lawyers outweigh the costs?

b.   Is the $300K worth the $1m recovery?

I.   What if the lawyer could have recovered $900K for $50K of work?

vi.  Complexity

a.   Law would be cheaper if we had easy rules.  But simplicity sacrifices something.  There is value in complexity.  You might lose fairness.

b.   If the price of law is too high because of the complexity of law, should we simplify the law to bring the cost down?  Should we have more rules than standards?

c.   Hadfield claims the price of law is too high b/c the law is too complex

d.   But there’s no way to know if the current level of complexity is the correct one

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