Two primary questions of this course



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  • Two primary questions of this course:
  • 1. How does the law effect incentives? Under different arrangements of the law, given the economic assumptions about how people choose, what results do different legal structures achieve?
  • 2. Which structure of the law is efficient, i.e., maximizes the combined gain to all parties?

Three fundamental ideas of economics

  • Scarcity: Resources have conflicting uses. To use them for one purpose is to forego using them for another. All societies at all times have had to solve this problem one way or another.
  • Optimization: Economists assume that people have well-defined goals, and that they rationally seek to do as well as they can given the resource constraints (what resources they control, the competing demands for them) they face.
  • Equilibrium: At both the individual and social levels, there is a well-defined outcome in which everyone is doing the best they can given that everyone else is also doing the best they can. This outcome is called the equilibrium. (Example: Supply/demand intersection)
  • Markets are one of many possible problem-solving devices – a way to resolve conflicting desires over how scarce resources should be used. The presumption is that markets generally succeed in creating the most value – i.e., the most gain for the most people.

But how and why does the law help markets work?

  • First, property rights must be meaningful, i.e. they must be credibly enforced. Here law is a complement to mutually beneficial trade.
  • Second, some property rights cannot be enforced. Here, law is a substitute for trade.

The two sources of Anglo-American law

  • Common law is created when new issues or situations not addressed by statutory law are litigated via the court system. The basic unit of common-law creation is the case. When a dispute not subject to existing precedents occurs, it works its way through the system until the high court (e.g., U.S. Supreme Court) adjudicates it. The common law is thus often evolutionary in nature.
  • Statutory law (including the U.S. and state constitutions) is drafted by the legislative and executive branches. It is the product of the ordinary political process.

Two basic questions about property law

  • What can be owned?
  • What rights does ownership convey?

Benefits of well-defined property law

  • Prevents the deadweight loss of predatory behavior.
  • Makes transfer of property to higher-valued uses easier.
  • Avoids the tragedy of the commons.
  • Makes it easier to cope with complexity and unintended consequences. (Example: highly planned cities become very child-unfriendly.)

Trust, property and contract: how commerce fails to happen without property and contract rights.

  • “My friend goes very happily to his home and sees his wife. She says, ‘Now wait a second. Think it over. This fellow, De Soto, you barely know him. This fellow, De Soto, after a year will know who your clients are, whom to sell to, when to sell, and how to sell to them. After a year, he won’t need you. He will no longer keep on giving you 40% of the business…As a result, my friend will choose instead to associate with a relative – someone in his extended family. And that person won’t produce buttons as good as mine. So they will have a little company that isn’t going to be very prosperous. I’ll have to do the same. I’ll find someone to sell buttons who trusts me because he happens to be family of mine. But he just doesn’t sell buttons the way my friend can sell buttons. And, therefore, the two talents that were required to make a successful industry in Lima will not be able to merge. Then some anthropologists from Cornell University will come to Peru and say, “Look at Peruvians. They like to work in small family units.”
  • - Hernando DeSoto, “What’s Wrong with Latin American Economies,” Reason (October 1989), pp. 39-40.
  • A negative externality is costs imposed by a particular economic activity or transaction on parties external to that activity or transaction.

Different legal rules under property law for deciding a dispute over a negative externality

  • (1) In a property rule, one party is awarded an absolute property right.
  • (1a) With a “no liability” finding, the defendant has the absolute right to continue imposing the externality.
  • (1b) With an injunction, the plaintiff wins the absolute property right, in that the defendant is forbidden to impose the externality.
  • (2) In a liability rule, the defendant may continue imposing the externality but if he does he must pay the plaintiff damages for the harm the externality causes.
  • The Coase Theorem (Coase, 1960): In a world of zero transaction costs, both property remedies yield the same result, in that the property ends up being used in whatever way creates the most value under a no liability finding or injunction.
  • But if transaction costs are high, the initial allocation of the property right is fully determinative. A liability rule is thus preferable, particularly if there is great uncertainty about which side deserves the property right.
  • Source: Edward L. Glaeser, Joseph Gyourko, and Raven Saks, “Why Is Manhattan so Expensive? Regulation and the Rising Housing Prices,” Journal of Law and Economics , October 2005.
  • Source: Randal O’Toole, “The Planning Penalty: How Smart Growth Makes Housing Unaffordable,” http://www.independent.org/pdf/policy_reports/2006-04-03-housing.pdf

Types of intellectual property

  • Patents are given for inventions. In exchange for limited monopoly rights, inventors must reveal knowledge.
  • Copyrights are limited monopoly rights given for works created by the mind, in the arts, literature, the sciences, etc.
  • Trademarks are potentially permanent monopoly rights given to symbols or other widely known representations of a particular firm.
  • Trade secrets are knowledge created by a producer that are not revealed through patenting. If competitors acquire the knowledge in violation of common-law principles (e.g., by an employee quitting and bringing it to the competitor in violation of his previous contractual obligation), they must pay damages. But if they discover it independently, they may use it freely.
  • The Congress shall have power…To promote the progress of science and useful arts, by securing for limited times to authors and inventors the exclusive right to their respective writings and discoveries.
  • - U.S. Constitution, Article I, Section 8


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