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Econ 522 Economics of Law Dan Quint Fall 2009 Lecture 21.

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1 Econ 522 Economics of Law Dan Quint Fall 2009 Lecture 21

2 1 Midterm is graded – pick it up at end of class HW3 due next Tuesday (December 8) Logistics

3 2 The legal process

4 3 Formulated the goal of the legal process Minimize social costs, which consist of: Administrative costs, and Error costs Broke the legal process into a series of steps, and discussed a couple of them Today: More on the legal process A bit on crime and criminal law (more Thursday) Tuesday, we…

5 4 Stages of the legal process… decision to pursue a legal claim bargaining over out-of-court settlements pre-trial exchange of information trial itself appeals process

6 5 Plaintiff might accept settlements S when S > Expected Judgment Plaintiff – Legal Costs Plaintiff Defendant might offer settlements S when S < Expected Judgment Defendant + Legal Costs Defendant So settlement is possible when EJ P – LC P < EJ D + LC D which is when EJ P – EJ D < LC P + LC D Pre-Trial Bargaining degree of relative optimism combined legal costs

7 6 Suppose parties agree on expected judgment EJ If bargaining fails and case goes to trial, Plaintiff gets expected payoff EJ – LC plaintiff Defendant gets expected payoff – EJ – LC defendant So these are threat points during bargaining Combined payoffs are – LC plaintiff – LC defendant If settlement is reached, combined payoffs are 0 So gains from cooperation are LC plaintiff + LC defendant If gains from cooperation are split evenly… Plaintiffs payoff is (threat point) + ½ (gains) = (EJ – LC plaintiff ) + ½ (LC plaintiff + LC defendant ) = EJ – ½ LC plaintiff + ½ LC defendant Pre-Trial Bargaining

8 7 We just concluded… If the two parties agree on expected outcome of trial… …and successfully negotiate a settlement… …and divide gains from cooperation equally… then settlement = EJ – ½ LC P + ½ LC D If going to trial is equally costly to both parties, this is just EJ – the expected judgment at trial But if trial is more costly to defendant, this would be more Pre-Trial Bargaining

9 8 A nuisance suit is a lawsuit with no legal merit If it goes to trial, defendant will definitely win (EJ = 0) Sole purpose of a nuisance suit is to force a settlement Just found: reasonable settlement = EJ – ½ LC P + ½ LC D So if LC P = LC D, nuisance suit is pointless – reasonable settlement would be 0 But suppose going to trial is very costly for defendant Publicity would be bad for defendants reputation Or, developer has to settle lawsuit to avoid delaying construction LC P is just legal fees But LC D includes legal fees plus other costs So even if lawsuit has no merit, defendant might feel forced to pay a settlement Nuisance Suits

10 9 Example Cost of going to trial is $5,000 for defendant, $1,000 for plaintiff Expected judgment = 0 Threat points are -5,000 and -1,000 Gains from cooperation are 6,000 If gains are split evenly, plaintiffs payoff is (threat point) + ½ (gains) = -1,000 + ½ (6,000) = 2,000 So nuisance suit might lead to a settlement of $2,000, even though expected judgment at trial is 0 Nuisance Suits

11 10 Even without relative optimism, settlement negotiations may fail due to private information Ex: defendant made a faulty product, which injured lots of people Some sustained minor injuries, say $2,000 Some sustained major injuries, say $10,000 Before trial, defendant cant tell scope of plaintiffs injuries Suppose legal costs are $500 for each side If ½ of plaintiffs had major injuries, average injury = $6,000 So reasonably settlement offer might be $6,000 But if all defendants are offered a settlement of $6,000, the ones with minor injuries will take it, and the ones with major injuries will go to trial Defendant has two choices: Offer settlements large enough that everyone will accept But then even people with very minor injuries, or none, might sue Or offer only small settlements, and get stuck going to trial in many cases Failures in negotiations

12 11 Stages of the legal process… decision to pursue a legal claim bargaining over out-of-court settlements pre-trial exchange of information trial itself appeals process

13 12 In Europe… Judges in civil trials take active role in asking questions and developing case Inquisitorial system, since judge asks questions In U.S… Lawyers job to develop case Judge is more of a passive referee Adversarial system, since competing lawyers are adversaries Trial

14 13 Lawyers have a strong incentive to win at trial May be working on contingency Value reputation for winning Judges have no stake in outcome of the trial Judges will (we hope) generally do what is right… …but have less motivation to work hard Judges have incentives to do what is right and easy; lawyers have incentives to do what is profitable and hard. Incentives

15 14 In U.K., loser in a lawsuit often pays legal expenses of winner Discourages nuisance suits But also discourages suits where there was actual harm that may be hard to prove In U.S., each side generally pays own legal costs But some states have rules that change this under certain circumstances Who pays the costs of a trial?

16 15 Rule 68 of Federal Rules of Civil Procedure At any time more than 10 days before the trial begins, a party defending against a claim may serve upon the adverse party an offer [for a settlement]… If the judgment finally obtained by the offeree is not more favorable than the offer, the offeree must pay the costs incurred after the making of the offer. Fee shifting rule Example I hit you with my car, you sue Before trial, I offer to settle for $6,000, you refuse If you win at trial, but judgment is less than $6,000… …then under Rule 68, you would have to pay me for all my legal expenses after I made the offer Who pays the costs of a trial?

17 16 Rule 68 does two things to encourage settlements: Gives me added incentive to make a serious settlement offer Gives you added incentive to accept my offer But not actually as generous as it sounds Attorneys fees not always included in fees that are covered Asymmetric Plaintiff is penalized for rejecting defendants offer Defendant is not penalized for rejecting offer from plaintiff Who pays the costs of a trial?

18 17 Kathryn Spier, Pretrial Bargaining and the Design of Fee- Shifting Rules Game-theory analysis of Rule 68 and similar rules Shows that when parties have private information, fee-shifting rules like this increase probability of settlement Then considers designing perfect rule to maximize number of cases that would settle out of court Ideal rule is similar to two-sided version of Rule 68 Take each sides most generous settlement offer Compute a cutoff If eventual judgment is below this cutoff, plaintiff pays both sides legal fees; if above cutoff, defendant pays both sides fees Who pays the costs of a trial?

19 18 Trial has to answer two questions: Is defendant liable? If so, how much are damages? Unitary trial considers liability and damages at same time Economies of scope Segmented trial considers liability first, then damages later (if necessary) Damages phase may not be necessary In U.S., judges have discretion over which type of trial Unitary versus Segmented Trials

20 19 Burden of proof: who is responsible for showing what at trial In criminal case, prosecutors burden to show defendant is guilty, not defendants burden to show hes innocent Similarly, in civil case, plaintiffs burden to make case Under negligence rule, plaintiff has to prove defendant was negligent (rather than defendant having to show he was not) Under contributory negligence, once defendant is shown to be negligent, its defendants burden to show plaintiff was also negligent Burden of proof

21 20 Standard of proof: degree of certainty to which something must be shown in court In criminal cases, beyond a reasonable doubt – very high standard In civil cases, plaintiff usually has to prove case by a preponderance of the evidence Much lower standard –interpreted as anything over 50% certainty For punitive damages to be awarded, high standard of proof is often required: clear and convincing evidence Efficient level depends on relative costs of two types of errors Finding someone liable when they should not be Finding someone not liable when they should be Standard of proof

22 21 Rules for what evidence court can pay attention to Textbook gives examples where rules seem inconsistent, if goal is simply to maximize probability of right outcome When we focus on efficiency, we care only about outcomes, not about process But in real-world legal system, process is important in its own right Rules of evidence

23 22 Stages of the legal process… decision to pursue a legal claim bargaining over out-of-court settlements pre-trial exchange of information trial itself appeals process

24 23 In U.S., three levels of federal courts District courts, circuit courts of appeals, Supreme Court (Many state court systems also have three levels, but this varies by state) Parties in district court cases have right of appeal Circuit court is required to consider their appeal Parties in circuit court cases do not Supreme Court has discretionary review – chooses which cases to hear In common law countries, appeals courts tend to only consider certain issues Appeals generally limited to matters of law Matters of fact generally not considered Appeals

25 24 Recall goal of legal system Minimize administrative costs + error costs Clearly, appeals process increases administrative costs So only efficient if it reduces error costs Reasons why appeals process may reduce error costs Appeals courts are more likely to reverse wrong decisions than right decisions… …which leads to losing parties appealing more often when decision was wrong Appeals

26 25 Criminal Law

27 26 Criminal intended to do wrong Case brought by government, not individual plaintiff Harm done tends to be public as well as private Standard of proof is higher If found guilty, defendant will be punished Criminal law differs from civil law in several ways

28 27 As of 2005, over 2,000,000 prisoners, nearly 5,000,000 more on probation or parole Up from ~500,000 in 1980 93% male In federal prisons, 60% are drug-related Incarceration rate of 0.7% is 7 times that of Western Europe Cooter and Ulen estimate social cost of crime $100 billion spend annually on prevention and punishment 1/3 on police, 1/3 on prisons, 1/3 on courts, prosecutors, public defenders, probation officers, etc. Estimate another $100 billion on private crime prevention Estimate total social cost to be $500 billion, or 4% of GDP Crime in the U.S.

29 28 Crime rates (relative to population) in the U.S… Decreased steadily from mid-1930s to early 1960s Increased sharply in 1960s and 1970s In 1980s, Nonviolent crimes committed by adults dropped sharply Violent crimes committed by adults dropped slightly Violent crimes by young people went up Violent and nonviolent crime rates dropped sharply in 1990s, continued to drop more slowly since 2000 Nonviolent crime rate in U.S. now similar to Europe Crime in the U.S.

30 29 Criminals in the U.S… Disproportionally young males Crime rates generally follow trend in fraction of population age 14-25 Both violent criminals and victims disproportionally African-American Relatively small number of people commit large fraction of violent crimes Tend to come from dysfunctional families… …have relatives who are criminals… …do poorly in school… …be drug- and alcohol-abusers… …live in poor/chaotic neighborhoods… …and being misbehavior at young age Crime in the U.S.

31 30 Hard to answer empirically, because two effects Deterrence When punishment gets more severe, crime rates may drop because criminals are afraid of being caught Incapacitation When punishment gets more severe, crime rates may drop because more criminals are already in jail Kessler and Levitt: natural experiment Voters in California in 1982 passed ballot initiative adding 5 years per prior conviction to sentence for certain crimes Found immediate drop of 4% in crimes eligible for enhanced sentences Do harsher punishments deter crime?

32 31 Imprisonment has several effects: Deterrence Punishment Opportunity for rehabilitation Incapacitation When is incapacitation effective? When supply of criminals is inelastic (When there isnt someone else waiting to take criminals place) And when it changes number of crimes a person will commit, rather than just delaying them Imprisonment

33 32 Direct costs of holding someone in maximum-security prison estimated at $40,000/year In some states, prisoners do useful work Attica State Prison (NY) had metal shop Minnesota firm employs inmates as computer programmers Medium-security prisons in Illinois make marching band uniforms But legal limitations 1980-1990: most state and federal courts moved away from judicial discretion toward mandatory sentencing Recent move in opposite direction Imprisonment

34 33 Sharp drop in crime rate in U.S. in 1990s Several explanations: deterrence and incapacitation decline of crack cocaine, which had driven much of crime in 1980s economic boom more precaution by victims change in policing strategies Donohue and Levitt give a different explanation: abortion Why did U.S. crime rate fall in 1990s?

35 34 Donohue and Levitt U.S. Supreme Court legalized abortion in early 1973 Number of legal abortions ~ 1,000,000/year (compared to birth rate of 3,000,000) Violent crimes largely committed by males of certain ages Donohue and Levitt argue legalized abortion led to smaller cohort of people in high-crime age group starting in early 1990s Evidence: Most of drop was reduction in crimes committed by young people Five states legalized abortion three years before Roe v Wade, saw drop in crime rates begin earlier States with higher abortion rates in late 1970s and early 1980s had more dramatic drops in crime from 1985 to 1997, no difference before Argue this explains 50% of drop in crime in 1990s Half of that from cohort size, half from composition Why did U.S. crime rate fall in 1990s?

36 35 Model of criminal law, what does efficient criminal system look like? Thursday…

37 36 Mean 73, median 74.5, std dev 12 Again, in very approximate terms… > 80roughly AB or A 70-80roughly B 60-70roughly BC below 60roughly C or worse last names A-Llast names M-Z Second midterm

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