1. Econ 522 Economics of Law
Dan Quint
Fall 2012
Lecture 3

2. Logistics HW1 is now online Reminder: no lecture Monday
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Reminder: no lecture Monday
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3. Also lecture notes – try View  Notes Page

4. Monday, we defined efficiency
Efficiency: “all available Kaldor-Hicks improvements made”
roughly, maximizing total value, or total surplus, or total payoffs, to everyone in society…
…where everything is translated into dollars, so we’re able to add/compare across people
Means that…
each scarce resource is owned by whoever values it most
goods are produced whenever their value is greater than their cost
and so on

5. And we discussed some forces that lead to inefficiency
Externalities
People make choices based on private cost and private benefit
Efficiency is based on social cost and social benefit
When social cost > private cost, negative externality  people will do something more than efficient amount
When social benefit > private benefit, positive externality  people will do something less than efficient amount
Barriers to trade, taxes
Monopoly/private information

6. Is efficiency a good goal for the law?
or, “should the law aim to be efficient?”

7. Important distinction: positive versus normative economics
positive statements are statements of fact
can be descriptive: “in 2007, U.S. GDP was $13.8 trillion”
can be theoretical predictions: “if prices rise, demand will fall”
“economics of what is”
normative statements contain value judgments
for example, “less inequality is better”
or, “government should encourage innovation”
“economics of what ought to be”

8. Most of this class will be positive analysis
Predicting behavior, and outcomes, that follow from a law or legal system is positive economics
“Law X will lead to more car accidents than law Y”
“Law X will lead to more efficient outcomes than law Y”
But in the background, we’d like some sense of what is the normative goal of the legal system
“Law X is better than law Y”
One candidate for that normative goal is efficiency
(If efficiency is the normative goal of the law, then we can say that one law is better than another law if it leads to more efficient outcomes; or that we should design the law to achieve efficiency)

9. Friedman gives a few arguments for studying efficiency
“The central question [in this book]… is a simple one: what set of rules and institutions maximize the size of the pie? What legal rules are economically efficient?
There are at least three reasons why that is the question we ask.
The first is that while economic efficiency… is not the only thing that matters to human beings, it is something that matters quite a lot to most human beings.
The second reason is that there is evidence that considerable parts of the legal system we live in can be explained as tools to generate efficient outcomes… It is a lot easier to make sense out of a tool if you know what it is designed to do.
A final reason is that figuring out what rules lead to… efficient outcomes is one of the things economists know how to do –
and when you have a hammer, everything looks like a nail.”
- Friedman, Law’s Order, p. 312
There’s definitely some truth to this last bit – focusing on efficiency will make our analysis much simpler in a lot of ways

10. But…
This answers the question, “Why is it interesting to study efficiency?”
Not the question, “Should the law be designed with the goal of achieving efficiency?”
To answer this latter question…

11. Posner gives us one argument why the law should aim to be efficient
Richard Posner (1980), The Ethical and Political Basis of Efficiency Norm in Common Law Adjudication
Starts with the observation: if you buy a lottery ticket and don’t win anything, you can’t complain
Imagine before we all started driving, everyone in the world got together and negotiated a liability rule for traffic accidents
If one rule is more efficient than another, we’d all vote for that rule ex-ante – ex-ante consent
Richard Posner gives one argument why the law should aim to be efficient
Posner is an appeals court judge, and teaches at the U of Chicago law school
Paper on the syllabus: The Ethical and Political Basis of Efficiency Norm in Common Law Adjudication
(he also has a book, “Economic Analysis of Law”)
Begins with the observation: if you buy a lottery ticket and don’t win anything, you can’t complain
By making the bet, you accepted the possible consequences in advance
Even if you don’t win, you’ve already decided you’re content to live with that outcome
You were “compensated ahead of time” for the possibility that you wouldn’t win, by the possibility that you would
Now, imagine before we all started driving, everyone in the world got together and negotiated a liability rule for traffic accidents
People don’t yet know whether they’ll be victims or injurers
Assume everyone is the same age, equally good drivers, etc.
If one liability system is more efficient than another, we’d all vote for that one ex-ante
If I’m driving and hit a bicyclist, I’ll be upset that I live in a world where drivers are liable for accidents they cause
But if that system is more efficient, I would have supported it before I knew which side I’d be on
Posner calls this ex-ante consent

12. Ex-ante consent – simple example
Suppose there are two candidate rules for accident liability
One favors pedestrians, one favors drivers
The one favoring car drivers is more efficient
Posner’s point: before we know who we’ll be, everyone would unanimously agree to the second rule
Expected payoff, drivers
Expected payoff, pedestrians
Expected payoff if you don’t know which one you’ll be
Strict liability rule
-100
-50
Once you’ve already been hit by a car, you don’t care which system is more efficient – you prefer the one that gives you a higher payoff
So you’d rather live in a world with a strict liability rule
But Posner’s point: before the accident happened, if we didn’t yet know which role we’d play (injurer or victim), we’d both prefer a negligence rule
That is, if one rule is more efficient than another, then we’d all agree to it ex-ante
He refers to this as ex-ante consent
So, we both agree society should be governed by a negligence rule
Once you’re hit by a car, you don’t regret your choice
Because you were compensated for it ex-ante – you were compensated for your lower payoff when you’re a victim, by the promise of a much higher payoff if you’re an injurer
This is the lottery ticket analogy: if you buy a lottery ticket and lose, well, that’s life.
He also points out that if you’re that concerned with your payoff if you’re a victim, you can buy accident insurance – and if a negligence system is more efficient, you’ll still be better off ex-ante than under strict liability
So Posner’s idea: we were all compensated ex-ante for the choice of the more efficient system.
And therefore, it’s as if we all consented to it
Negligence rule
-20
-60
-40

13. Things are a little more complicated…
People without cars would prefer a less efficient system if it meant drivers were responsible
Posner deals with heterogeneity with a different example
Landlord-friendly versus tenant-friendly laws
Might think tenants would prefer pro-tenant laws
But rents are determined competitively
If laws become more tenant-friendly, rents might go up to compensate
And if tenant-friendly law is less efficient, it could make both sides worse off!
The argument gets a bit more complicated when people aren’t all homogeneous
If everyone has the same likelihood of being the driver or the victim, maybe this argument is convincing
But some people don’t drive cars, but still get hit by cars
Posner deals with heterogeneity with a different example
There’s one law which is more favorable to tenants, and a different law that’s more favorable to landlords and more efficient
You might think tenants would prefer the first law, landlords the second
But rents are set in a competitive market
If we switch to the tenant-friendly law, rents would probably go up to compensate
And if the tenant-friendly law is less efficient, it might make both sides worse off – so even tenants would have agreed ex-ante to the other one

14. Example: new law requiring landlords to pay for their tenants’ heat
Suppose tenants get $1000 value from apartment, minus rent
Landlords pay $100 for heat, $600 in other costs
Without this law, tenants would pay for their own heat
They’d heat apartment less, get $980 value and pay $60 for heat
Might think tenants would prefer inefficient tenant-friendly law…
But rents are set competitively, would go up to compensate…
So both landlords and tenants do better under the old law!
Tenants’ payoffs
Landlords’ payoffs
Tenants
Landlords
Landlord pays for heat
1000 – rent
rent – 600 – 100
1000 – 850 = 150
850 – 600 – 100 = 150
Tenant pays for heat
980 – 60 – rent
rent – 600
980 – 60 – 760 = 160
760 – 600 = 160

15. Ex-ante consent, ex-ante compensation
Posner’s basic argument: if we choose the most efficient legal system, everyone is “compensated ex-ante” for the choice, and should willingly accept the outcome they get
Of course, all this consent is hypothetical…
…and it does have certain limitations
Posner’s basic idea is that, even if we end up being losers under this system, we were “compensated ex-ante” by the possibility of being bigger winners
If you buy a lottery ticket and you lose, you were compensated ahead of time for that loss – by the possibility that you would win
As members of society, all of us were compensated ex-ante for choosing the efficient rules, since these were the lottery tickets with the highest expected value
Of course, this consent is all hypothetical
No one actually called a giant meeting of everyone (living, dead, not yet born) to vote on a liability rule
But if they had, they’d agree to the more efficient rule
Think of it as deciding between two lottery tickets and choosing the one with the higher expected value
So, Posner argues, if we choose the most efficient legal system, everyone is “compensated ex-ante” for the choice, and should willingly accept the outcome they get

16. Limitations to Posner’s argument
The “lottery ticket” analogy requires risk neutrality
50% chance at $1,000,000 is just as good as 50% chance at $900,000 and 50% chance at $100,000
If $100,000 is “worth more to you” when you’re broke than when you already have $900,000, this argument doesn’t work
Counterpoint to Posner: Hammond (1982)
Efficiency is really a special case of utilitarianism, and subject to the same limitations
“Value” = “willingness to pay”
$1 worth the same to everyone
The “lottery ticket” analogy requires risk neutrality
Implicitly, it assumes that a 50% chance at $1,000,000 is just as good as 50% chance at $900,000 and 50% chance at $100,000
If $100,000 is “worth more to you” when you’re broke than when you already have $900,000, this argument doesn’t work
Counterpoint to Posner: review of Posner’s book by Peter Hammond (1982)
Efficiency is a special case of utilitarianism
Utilitarianism: to decide what society should do, take everyone’s individual utility function, add them up, maximize the sum
Problem: classical utility theory doesn’t allow comparisons across different individuals (utility has no natural “scale”)
Efficiency gets around this problem by assuming someone’s value for something equals their willingness to pay for it
That is, it assumes $1 is worth the same to everyone

17. This highlights some of the things efficiency is not
efficiency is not equity
efficiency is not fairness
efficiency is not maximizing happiness
“Suppose that pituitary extract is in very short supply… and is therefore very expensive. A poor family has a child who will be a dwarf if he doesn’t get some of the extract, but the family cannot afford the price [or borrow the money].
A rich family has a child who will grow to normal height, but the extract will add a few inches more, and his parents decide to buy it for him.
In the sense of value used in this book, the pituitary extract is more valuable to the rich family… because value is measured by willingness to pay, but the extract would confer greater happiness in the hands of the poor family.”
- Posner, Economic Analysis of Law
recall that efficiency equates utility (or how much society wants you to have something) with your willingness to pay for it
efficiency is not equity
efficiency is only about how much wealth exists, not how it is divided up
laws favoring businesses over consumers, or rich over poor, may be efficient, but still may not be socially desirable
(again, if $1 is more valuable to someone poor than someone rich, efficiency can’t account for this)
efficiency is not fairness
for one thing, efficiency considers only outcomes, not process
who has how much matters, but not whether they got it by working hard, or by being lucky, or by having light-colored skin…
a law might be efficient but violate our intuitive notions of right and wrong
example from before: might be efficient for government to seize your car and give it to me, but this might strike you as wrong or unfair
another example: this class is full, several people on waiting list
efficiency: whoever is willing to pay most for a spot in the class, values it most, should get it
how about I auction off the last few seats in the class, and keep the money?
leads to efficient allocation – the “right” people end up in the class
but probably not a rule we want to encourage
Poletown Neighborhood Council v. City of Detroit (early 1980s)
efficiency is not maximizing happiness
by equating value with willingness to pay, efficiency ignores the possibility an incremental dollar might mean more to someone poor
and it ignores the possibility of “really really really wanting something” but not being able to afford it
example: suppose I need a heart transplant, but could only pay $500,000 for a heart, and some rich guy thinks it would be cool to have a human heart in a box, and is willing to pay $1,000,000
a creepy example from Posner, Economic Analysis of Law:
(part of the problem here is the distinction between willingness to pay for something you don’t have, and willingness to accept an offer to sell something you already have. efficiency doesn’t really distinguish between these two ways of valuing something; when they’re not equal, it’s hard to make sense of things.)

18. A more pragmatic defense of efficiency as a goal for the law
Cooter and Ulen (textbook ch. 1)
Efficiency should not necessarily be the goal of society
But efficiency should be the goal of the legal system
If redistribution is desirable, it’s better to make the legal system efficient, and address distribution through taxes
Cooter and Ulen offer four reasons why the tax system is a better way to redistribute wealth than the legal system
Cooter and Ulen (textbook ch. 1)
Efficiency should not necessarily be the goal of society
Redistribution/supporting the poor may be an important social goal
(We may recognize that $1 is “worth more” to someone with very little than it is to someone with a lot, and we may want society to redistribute wealth in that direction)
But even so, efficiency should still be the goal of the legal system
Even if some redistribution is desirable, it’s better to make the legal system efficient, and address distribution through the tax system
Cooter and Ulen offer four reasons why the tax system is a better way to redistribute wealth than the legal system

19. Four reasons the tax system is a better way to redistribute wealth than the legal system
1. Taxes can target “rich” and “poor” more precisely than the legal system can
Distributional effects of legal changes are harder to predict
Lawyers are more expensive than accountants
More narrowly-targeted taxes cause greater distortion than broad-based taxes
1.Taxes can target “rich” and “poor” more precisely than legal system can
If we tried to redistribute wealth through the legal system, we’d have to target broad classes of people
For example, we could pass laws that favor consumers over corporations, or patients over doctors
But some consumers are rich, and some shareholders in corporations aren’t that rich
Taxes are based on income or assets – tied directly to wealth
2.Distributional effects of legal changes are harder to predict
Example we saw before: suppose we try to redistribute wealth by passing laws which are more favorable to tenants
But rental prices might go up to compensate, leaving tenants worse off than before
3.Lawyers are more expensive than accountants
(or really, transaction costs are higher when we try to redistribute via legal system instead of taxes)
4.More narrowly-targeted taxes cause greater distortion
Laws designed to redistribute wealth would be more narrowly targeted: liability laws that are unfavorable to drivers with expensive cars, or to plastic surgeons
These would function like narrowly-targeted taxes – a tax on Lamborghinis, or a tax on being a plastic surgeon
Income taxes tax wealth directly (very broad)
The ponit: narrow taxes cause greater distortion  greater deadweight loss
If you tax bagels, people buy donuts instead
This distortion leads to a greater loss of utility than if you taxed everything, and people just consumed a tiny bit less of everything
We’ll see an example of how this works on Wednesday

20. To make this last point, an example
Two goods: beer (x), pizza (y)
One consumer, with $60 and utility u(x,y) = x0.5 y0.5
a. Given prices p for beer and q for pizza, calculate demand.
(x,y) = (30/p, 30/q)
Beer and pizza are produced at $1 per unit, and perfectly competitive markets
So without any taxes, p = q = $1
b. Calculate demand, and utility, with no tax.
(x,y) = (30, 30) u(x,y) = = 30
c. Calculate demand and utility with $0.50 tax on beer.
(x,y) = (20, 30) u(x,y) = = » 24.49
d. How much revenue does $0.50 tax on beer raise?
20 X $0.50 = $10
e. Calculate demand and utility with $0.20 tax on both goods.
(x,y) = (25, 25) u(x,y) = = 25
f. How much revenue does $0.20 tax on both goods raise?
25 X $ X $0.20 = $10
g. Which is the better way to raise revenue?
We want to maximize x0.5 y0.5 subject to px + qy <= 60. Since more is better, the consumer will always spend his whole budget, so we can assume px + qy = 60, which means y = (60 – px)/q.
And, maximizing x0.5 y0.5 is the same as maximizing its square, xy. So we can just maximize xy subject to y = (60-px)/q, or maximize x * (60 – px)/q.
If we take the derivative of 1/q * (60x – px2), we get 1/q (60 – 2px) = 0, or px = 30 – regardless of prices, the consumer spends $30 (half his budget) on beer, leaving the other half for pizza, so (x,y) = (30/p, 30/q).
The rest of the problem is just plugging different prices into this demand function and calculating the consumer’s welfare.
(Also note that taxing both goods is the same as taxing wealth – just taking $10 away from the consumer but leaving prices unchanged.) 19 19

21. So, summing up… is efficiency a good goal for the law?
We’ve seen two arguments in favor
Posner: it’s what we all would have agreed on ex-ante
C&U: if you want to redistribute, it’s better to do it through taxes
But there are definitely some problems with efficiency
Distribution matters; not everything is monetizable; people might care about procedural fairness
My take
In this class, we’ll mostly focus on the positive questions
But in the background, I think of efficiency as a “pretty good”, but definitely imperfect, measure of “goodness”

22. A nice blog post about why policy evaluation should at least start with efficiency…
Let’s first dispense with the straw man. I’ve never heard of an economist who believes that every efficient policy is good, and I’ve heard of very few who believe that every inefficient policy is bad.
It’s true that most economists do seem to believe that any good policy analysis should start by considering efficiency. That doesn’t mean it should end there.
I think economists are right to emphasize efficiency, and I think so for (at least) two reasons. First, emphasizing efficiency forces us to concentrate on the most important problems. Second, emphasizing efficiency forces us to be honest about our goals.
– Steven Landsburg
Landsburg’s first point is that any time a law or a policy is inefficient, there is, in principle, a different policy that could be better for everyone
And the bigger the inefficiency, the more society potentially has to gain by correcting it
He acknowledges that we don’t always want efficient rules, and we certainly wouldn’t want a rule that always says, “do what’s efficient” – this could have huge problems
(He uses the example of Bill Gates getting a lot of joy from blasting his music loudly, which keeps you awake at night
If Bill Gates is willing to pay $10,000 to blast his music, and it only costs you $1,000 to endure the noise, efficiency says he should play his music
BUT we don’t want a law that says, “Noise is OK as long as it’s efficient”
because then Gates might lie about how much enjoyment he gets from music,
and you might lie about how much the noise bothers you,
and you might even move closer to his house so you can find more things to complain about
The point is just, wherever there is inefficiency, there is the potential to improve outcomes;
and the size of the inefficiency gives us an idea of how big the stakes are)

23. “Emphasizing efficiency forces us to be honest about our goals”
Politician: Here’s my program to make the health care system work better by subsidizing health care for the poor.
Economist: Your program costs a billion dollars and delivers half a billion dollars worth of benefits. That’s inefficient.
Politician: So what?
Economist: Well, the “so what” is that maybe you could take that billion dollars and deliver a full billion dollars worth of benefits instead if you spent it a little differently. Why not just hand the cash out to poor people?
Politician: Because I don’t want to help all poor people. I only want to help sick poor people – and this is the only way I can think of to do that.
Economist: Ah. So your goal here is not to make the health care system work better at all. Instead it’s to transfer resources to sick poor people.
Politician: I guess so.
Economist: That’s fine. Now we can have a healthy debate about whether that’s what we want to do.
To explain the second point, Landsburg gives a hypothetical conversation between an economist and a politician, to show how efficiency analysis strikes down political smokescreens
Again, his point is not that all inefficient policies are bad…
…just that an inefficient policy only makes sense if it’s serving some other important purpose,
and starting with efficiency forces us to be open about what that other purpose is

24. A quick digression
or, “should the law aim to be efficient?”

25. Before we move on, a quick digression…
I don’t have many “absolute beliefs” about economics
Some people do
I hope that doesn’t make things too confusing
If you read Posner, he believes very strongly that efficiency is the right way to design the law, and that the common law will naturally evolve in the direction of efficiency
Posner offers some rational arguments for these positions, but at times, he also seems to take them almost as an act of faith
That’s pretty reasonable – Posner has been a law professor for 40 years, and a judge for almost 30; he knows a lot more than me about a lot of things
But to me, there are very few certainties about economics
If you give me something – the notion that efficiency is the “right” measure to try to get the law to conform to – I can always think of arguments in favor and arguments against
And I have a tendency to make this class more confusing than it has to be, by giving you both
This class would be a lot simpler if I just said, “Efficiency means X. In this class, we want the law to be efficient. Here’s why. Let’s move on.”
But that’s not how I see the world.
I hope that it isn’t too confusing when I do things like this: give both the principle (what efficiency is, and how we’ll use it in this class) but also the reasons for skepticism

26. Before we move on, a quick digression…
I don’t have many “absolute beliefs” about economics
Some people do
I hope that doesn’t make things too confusing
Relatedly, if I don’t see economics as a set of rules to memorize, how do I know what I know?
I need to see a model, or an example, that demonstrates it
This brings me to my other point: Since I don’t see economics as a bunch of certainties, how do I know the things I know?
Well, the way I believe something is true in economics is to see how it works
That is, to see a model, or an example, that demonstrates it
Tuesday, I made the claim that narrower taxes cause greater distortion, and therefore greater inefficiency (or deadweight loss)
But I know this not because someone told me; I know it because I can give a simple model that shows it
And so that was the purpose of the example I showed – to try to SHOW you that narrower taxes cause greater distortion, rather than just asking you to believe me
I’ll often try to do this – introduce an example to prove a point
I sometimes go through these examples a bit fast – please feel free to ask me to slow down, or ask questions if you miss a step
(Also, as some of you have probably discovered, I post my lecture notes online after each lecture, so hopefully this helps if you missed a step) 25 25

27. Rest of today: introduce some basic game theory
begin property law (if time allows)

28. Some basic game theory

29. A brief introduction to game theory
Today, we focus on static games
Also known as simultaneous-move games
A static game is completely described by three things:
Who the players are
What actions are available to each player
What payoff each player will get, as a function of
his own action, and
the actions of the other players
Any complete description of these three things fully characterizes a static game
We’ve already used a little bit of game theory in this class – in the fishing example we did on Monday
Think about the logic of the fisherman we discussed
“I don’t have any control over how much the rest of the village fishes; all I control is how much I fish.”
“And what I’m going to do is decide how much I should fish, given what everyone else is doing, to maximize my own payoffs.”
That’s exactly the logic of game theory.

30. A classic example: the Prisoner’s Dilemma
(Story)
Players: player 1 and player 2
Two actions available to each player: rat on the other, or keep mum
Payoffs:
u1(mum, mum) = -1
u1(rat, mum) = 0
u1(mum, rat) = -10
u1(rat,rat) = -5
Same for player 2
(Story)
Players: player 1 and player 2
Two actions available to each player: rat on the other, or keep mum
Payoffs:
If both keep quiet, both convicted of a lesser crime, both get payoffs of -1 (1 year in jail)
If one rats, he goes free, his friend gets payoff of -10 (10 years in jail)
If both rat, both are convicted, each gets -5
So u1(mum, mum) = -1, u1(rat, mum) = 0, u1(mum, rat) = -10, u1(rat,rat) = -5
And player 2’s are similar

31. In two-player games with finite actions, one way to present game is payoff matrix
Always Player 1
Player 2’s Action
Mum
Rat
-1, -1
-10, 0
Mum
Player 1’s Action
0, -10
-5, -5
Rat
Player 1’s Payoff
Player 2’s Payoff

32. Nash Equilibrium We solve a game by looking for a Nash equilibrium
Nash equilibrium is a strategy profile (an action for each player) such that:
No player can improve his payoff by switching to a different action…
…given what his opponent/opponents are doing
In most games, players won’t have a single move that’s always best
Best move will sometimes depend on what other player (or players) is doing
We solve a game by looking for a Nash equilibrium
Nash equilibrium is a strategy profile (an action for each player) such that no one player can do better by switching to a different action (given what everyone else is doing)
So playing Mum is never part of an equilibrium
Whatever your opponent is doing, you could improve by switching to Rat

33. A strategy profile is a Nash Equilibrium if no player can gain by deviating
If any player can improve his payoff by changing his action, given his opponents’ actions, then it is not a Nash equilibrium
Is (Mum, Mum) an equilibrium?
No, if player 2 is playing Mum player 1 gains by deviating
Player 2’s Action
Mum
Rat
-1, -1
-10, 0
Mum
Player 1’s Action
0, -10
-5, -5
Rat

34. In two-player games, we find Nash equilibria by highlighting best responses
My best response to a particular play by the other player is whichever action(s) give me the highest payoff
To find Nash Equilibria…
Circle payoff from player 1’s best response to each action by his opponent
Circle payoff from player 2’s best response to each action
Any box with both payoffs circled is an equilibrium
Because each player is playing a best-response to his opponent’s action…
…so neither one can improve by changing his strategy
Player 2’s Action
Mum
Rat
-1, -1
-10, 0
Mum
Player 1’s Action
0, -10
-5, -5
In the Prisoner’s Dilemma game, (Rat, Rat), or “Both players play Rat”, is the only Nash equilibrium
Hence the name – only equilibrium is for both to Rat, but both would do better if both kept Mum
Rat

35. Some games will have more than one equilibrium
Another classic: Battle of the Sexes
(Story)
Circle player 1’s best responses
Circle player 2’s best responses
We find two equilibria: (ballgame, ballgame) and (opera, opera)
Game theory usually doesn’t have that much to say about which equilibrium will get played when there are more than one
Player 2’s Action
Baseball Game
Opera
6, 3
0, 0
Baseball Game
Player 1’s Action
0, 0
3, 6
Opera

36. Sometimes, there will be a “good” and a “bad” equilibrium
Growth model
(Story)
Circle player 1’s best responses
Circle player 2’s best responses
Two equilibria: (invest, invest) and (consume, consume)
Some papers explain differences in growth across countries by saying some are in “good” equilibrium and some are in “bad” one
Player 2’s Action
Invest
Consume
2, 2
0, 1
Invest
Player 1’s Action
1, 0
1, 1
Consume

37. Some games don’t have any equilibrium where players only play one action
Scissors, Paper, Rock for $1
Look for Nash Equilibria by circling best responses
No square with both payoffs circled
No equilibrium where each player plays a single action
In this class, we’ll focus on games with a pure-strategy Nash equilibrium
Player 2’s Action
Scissors
Paper
Rock
0, 0
1, -1
-1, 1
Scissors
-1, 1
0, 0
1, -1
Player 1’s Action
Paper
1, -1
-1, 1
0, 0
Rock

38. That’s a very quick introduction to static games
Now on to…
Skip

39. Property Law

40. To begin, a story
I buy a house out in the countryside. This is my neighbor. Here’s the property line – the line separating his land from mine.
One summer, I put in a pool.
The next year, my neighbor plants a bunch of new trees along the property line…
…and now, in the late afternoon, my pool is completely shaded.
I go to my neighbor and ask him to cut down the trees, as they’re ruining my swimming pool
And he says they’re on his land, and he likes them, so they stay.
Who’s right?

41. Why do we need property law in the first place?
We already saw one reason
Tragedy of Commons – overuse of land is held in common
For another example, imagine two neighboring farmers
Each has two choices: farm his own land, or steal crops from his neighbor
Stealing is less efficient than planting my own crops
Have to carry the crops from your land to mine
Might drop some along the way
Have to steal at night  move slower
If I steal your crops, I avoid the effort of planting and watering
Once we have property, we’ll inevitably have some amount of property conflicts
But why do we need private property in the first place?
We’ve already seen one reason why we might want private property: the Tragedy of the Commons example from Monday 40 40

42. Why do we need property law in the first place?
Suppose that planting and watering costs 5, the crops either farmer could grow are worth 15, and stealing costs 3
With no legal system, the game has the following payoffs:
We look for equilibrium
Like Prisoner’s Dilemma
both farmers stealing is the only equilibrium
but that outcome is Pareto-dominated by both farmers farming
Player 2
Farm
Steal
10, 10
-5, 12
Farm
Player 1
12, -5
0, 0
Steal

43. So how do we fix the problem?
Suppose there were lots of farmers facing this same problem
They come up with an idea:
Institute some property rights
And some type of government that would punish people who steal
Setting up the system would cost something
Suppose it imposes a cost c on everyone who plays by the rules

44. So how do we fix the problem?
ORIGINAL GAME
MODIFIED GAME
Player 2
Player 2
Farm
Steal
Farm
Steal
10, 10
-5, 12
10 – c, 10 – c
-5 – c, 12 – P
Farm
Farm
Player 1
Player 1
12, -5
0, 0
12 – P, -5 – c
-P, -P
Steal
Steal
If P is big, and c is not too big, then 12 – P < 10 – c
In that case, (Farm, Farm) is an equilibrium
Payoffs are (10 – c, 10 – c), instead of (0, 0) from before

45. So the idea here… Anarchy is inefficient
I spend time and effort stealing from you
You spend time and effort defending your property from thieves
Instead of doing productive work
Establishing property rights, and a legal process for when they’re violated, is one way around the problem
Keep in mind, though, that there is still inefficiency here – the cost c of administering the system
That is, payoffs of (10-c, 10-c) are better than payoffs of (0,0), but not as good as (10,10)

46. Overview of Property Law
Cooter and Ulen: property is
“A bundle of legal rights over resources that the owner is free to exercise and whose exercise is protected from interference by others”
Property rights are not absolute
Appendix to ch. 4 discusses different conceptions of property rights
Any system has to answer four fundamental questions:
What things can be privately owned?
What can (and can’t) an owner do with his property?
How are property rights established?
What remedies are given when property rights are violated?
Cooter and Ulen define property as “a bundle of legal rights over resources that the owner is free to exercise and whose exercise is protected from interference by others.”
Of course, property rights aren’t absolute. In the appendix to chapter 4, they give examples of different conceptions of property rights. Without getting into the philosophy behind a property rights system, it’s clear that a conception of property rights has to answer four fundamental questions:
What things can be privately owned?
Clearly not everything can be owned – nobody owns the ocean, can’t own another person, etc.
Ancient Jewish law – ownership over sold land was not permanent, it reverted to its ancestral owner after 50 years
Cultural artifacts; Intangible property – copyrights, patents, trademarks
What can (and can’t) an owner do with his property?
Again, not everything - property rights can’t be absolute, because my exercising my rights might interfere with you exercising your rights – I want to sleep, you want to have a party next door
Typically, you can’t use your own property in a way that creates a nuisance to others
Many of the examples when we discuss Coase will have to do with limiting what a person can do with his property.
I own my kidneys, but I can’t sell one
If I own a building that has historical significance, I can’t necessarily destroy it or change it in certain ways.
How are property rights established?
In the whaling example, what does it take to establish ownership?
In many cases when government wanted to encourage migration into new areas, free land, conditional on you farming it or developing it.
And on the flip side, when can property rights be revoked?
Eminent domain – the government’s right to seize private property
Negligent landlords.
What remedies are given when property rights are violated?
Rights – my right to use my property in certain ways – and prohibitions – other people can’t interfere – have no meaning unless they are enforced
So how do I get compensated if my property rights are violated?

47. Answers to many of these seem obvious
BUT…
What’s my point?
Not that it matters much who ended up with ownership of a guy’s severed leg. (Matters a lot to Wood, a little to Whisnant, they had their 15 minutes.)
My point is that even if most things in property law seem obvious – this is my iPhone, you can’t steal it, I can use it however I want – the law has to deal with the unexpected, off-the-wall cases as well as the anticipated, obvious ones
So we’d better try to come up with some principles we want our property law system to satisfy, so we know how to deal with the unexpected
(In 2007, after the case got some media attention, Whisnant and Wood ended up going on Judge Mathis, who awarded the leg back to its original owner.)
source:

48. Next Wednesday: Coase
Take a look at Coase, “The Problem of Social Cost”
See you next Wednesday (no class Monday)