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Linardakis – Law and Econ Outline – Rutgers Newark – Prof Latin – Spring 2005 – No case book.
I. Theory of the Consumer Product Warranty
A. Priest – Chicago School of Analysis
 Priest says warranties is an like an insurance policy
 Chicago school of Analysis –
a. Consumers are Perfect maximizers who can make well informed decisions about purchases.
b. Consumers are well informed Calculating machines
c. Latin doesn’t agree with it or Priest
d. Priest is rigid Chicago School Theory – Latin can’t stand him
 Priest acknowledges that consumers don’t read the warranties most of the time
a. So why does he still subscribe
 Consumers don’t read the warranty usually unless it breaks – unless major major purchase
 Why assigned – Priest is rigid but gives latin something to work off of
 Chic School of Analysis dominates Law and Economics
B. Basic Economic Theory
 Hypo – You want to buy a Car
a. Economics – You have a very high interest to Pay for a car
i. You have willingness to pay but can’t afford it
ii. You have a willingness and can Pay for it
iii. We will treat them the same in this course
 Economists – Redistribution of Wealth rather than Subsidizing
a. Poor people can decide what is important to them to decide to buy rather then subsidizing
where the Govt decides what people needs
 Back to Hypo – People who want to buy a car (assume only one type of car)
a. Person 1 - You want to buy a car and willing to pay for it
b. Person 2 – Wants to buy a car but is poor
c. Person 3 - Want to buy a car but not willing to pay as much for it
(Figure 1) Demand Curve - Keep making units of that product until there is no one left who
Y axis is Value/Demand that a particular person values the product.
Cost curve
Number of Units
Supply Curve – Cost Level
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When does it no longer make sense to make the product – most efficient level
Marginal Value = marginal price = marginal cost (which includes some reasonable profit)
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Mfct price driven down until it is determined by the cost of the next unit and the value of the
next unit
Area above cost curve is cost Consumer Surplus
a. The last guy is the one whose cost is going to be equal to the value
b. Always looking/caring about the next guy down on the chart
c. Efficient approach is keep making units until the marginal value of the next guy is not worth
making any more. (I,.e, until the marginal cost = the mariginal value)
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So how does Unit Reliablity/Warranties come into play
a. There is some expectation of unreliability of a Car for example
i. Risk of unreliability – Flaw of Priest argument
1. How can you make an assessment if you don’t know how unreliable a
certain product is – priest assumes consumers know what risk of
unreliability is.
b. Assume each car is equally unreliable
c. Car is less valuable because of unreliability
d. If User bares all losses – (FIGURE 2)Drops the demand curve (hypotenuse) down by amount
of unreliability
e. If Strict Liability – mftr bares all loses (FIGURE 3)– cost curve goes up
f. Either way, number of units where product is making money drops.
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Warranty doesn’t mean anything if all losses on either Consumer or all on Manufacturer
Look at it from Mftr point of view
a. How much is the first unit of reliability (one unit of reliability)
i. Mftr is going to look for the cheapest way to provide the first unit
ii. Unit 2 will be more expensive than unit 1 but also cheaper then all other units
iii. See Figure 4
C. Latin Criticism of Priest Article
 Priest says that consumers will gradually agree to accept some risk themselves, and pay mftr through
warranty to accept other types of risks – Insurance policy
 Priest says Users are also influences/increases reliability of the product (Figure 5)
 Rational Utility Maximizing will determine whose costs of providing increased reliability is most
efficient
 Need to accept all behavioral assumptions (people know what they need to know) in order for Priests
analysis to appear coherent – Which latin does not
D. 3 Theories Presented in Priest Article
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Exploitation Theory
- Warranties are adhesion contracts which limit consumers power due to the uneven bargaining
power
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Signal Theory
- Signaling that their product comes with some sort of reliability through the warranty and giving
the people the information to decide
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Investment Theory (Priest)
- Consumer knows risks and chooses whether to make investment in accepting/reducing risk on
their own part. (people are maximum utility maximizers)
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Criticizes first two theories WHICH ARE BASED ON IMPERFECT COMSUMER INFORMATION
REGARDING THE RISKS/RELIABILIYT (only makes senses in light of consumer imperfections)
However, Priest’s theories assumes CONSUMER KNOWS RISKS/RELIABILITIES
a. ONLY MAKE SENSE if consumers KNOW everything (what they need to)
b. AND ONLY MAKE SENSE if manufactuers DON”T KNOW everything
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i. If they did know everything (how each consumer uses each product) it would charge
more for consumers that are higher risk.
E. Warranties Compared to Insurance Companies
 Insurance Companies separates people into risk categories which get charged more (smokers, etc)
 A warranty is an insurance policy in one respect
a. An insurance company, however, discriminates between high risk and low risk
b. Priest says that Manufact. don’t discriminate - Latin says they do
 Priest says if Mftr have to pay for risk, they will charge an average equal risk premium across the board
 Priest Does Assumes people know how risky they are
- If a person is high risk, it makes sense to get warranty since it is subsidized by low risk users
- Doesn’t make sense if low risk user
- A wash if average risk user
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Priest says People KNOW, so they can make the right decision (perfect decision making by consumer)
Priest says Mftr DOESN”T KNOW, so they CAN”T make the right decision about how much to charge
in light of consumer risks, so have to charge average amount (imperfect decision making by mftr)
Priest says that normally, market decision making should determine warranties, which would mean mftrs
would only provide what they want to, and consumers will bare the rest of the risk.
- Therefore the high risk consumers will subsidize the low risk users which would drop due to the
lack of benefit
- But if the cosumers bore the risk, high risk and low risk consumers could each decide how much
risk to bare.
HOW WOULD MFTR KNOW WHICH CUSTOMER IS RISKIER:
- Latin says they could (look at number of children for large appliances)
- example 2 - Assume higher income people are willing to by more expensive model and may treat
them more carefully or replace them more frequently so they may be considered lower risk then
low income users
F. Priest - Moral Hazard (pg. 1313 in handout)
 If people are protected against the risk (making Mftr always liable), they will have less incentive to avoid
the risk.
 Example in insurance area
a. No fault system – your insurance covers all losses
b. Will those people take less precaution because they’re covered (
i. Chicago School Analysts believes this
ii. Latin doesn’t necessarily hold it to be true – Still protecting against self injury
c. Life Insurance – Smoker charged more
i. Financial reason may make smokers quit since they are engaging in riskier behavior
 Reason against Tort liability from Chicago point of view
a. May increase risk you are going to take since your fully covered from an economic point of
view
b. Latin says NO from a non-economic point of view (self preservation)
 Seatbelt Example
a. Did Seatbelt Law induce more speeding?
i. Did it induce riskier behavior? – one study says yes but Latin skeptical of empirical
data which supports researchers theory.
II. Class from 1/20 in notebook because computer crapping out
G. Priest – Chicago School of Analysis
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Priest says warranties is an like an insurance policy
Chicago school of Analysis –
a. Consumers are Perfect maximizers who can make well informed decisions about purchases.
b. Consumers are well informed Calculating machines
c. Latin doesn’t agree with it or Priest
d. Priest is rigid Chicago School Theory – Latin can’t stand him
Priest acknowledges that consumers don’t read the warranties most of the time
a. So why does he still subscribe
Consumers don’t read the warranty usually unless it breaks – unless major major purchase
Why assigned – Priest is rigid but gives latin something to work off of
Chicago School of Analysis dominates Law and Economics
When a manufacturer makes a Bad decision, how does the market system correct/discipline/adjust to bad
manufacturing decisions? What is the mechanism in place that does this
i. Competition - Competitors will make better decisions and consumers will go with them
and thus penalize the bad mftr decision
ii. Market System Doesn’t need outside intervention (GOVT regulation, etc)…fixes it itself
When a Consumer Makes a mistake about what they want to buy, is there a mechanism in place that will
correct this behavior
i. NO – no competition. Nothing similar to competition that would help consumers
ii. When people don’t know enough info, or don’t know where to get the info, there is no
mechanism to correct this – manufactures will respond to bad choices by people
1. McDonalds – good at provided some things that people want but may not have
all the info necessary that says the product might be bad for them…therefore,
McD’s keeps providing unhealthy products based on people’s bad decisions (I
love mcd cheeseburger and fries and don’t agree with this in this case)
2. Market can’t solve this so LEGAL intervention is required to restrict what Mfctr
are doing or REQUIRE DISCLOSURE
Ongoing theme of course –
i. what are justifications for legal intervention
ii.
III. Property Rights
A. The commons and the Anitcommons in the law and Theory of property (Munzer Article in HO#2)
 Fijian Turtle Example
a. Govt can’t protect turtles
b. Local Chieftains can protect turtles if you allow them to still hunt for turtles because they
have more influence and stake in protecting them
 Munzer is a Philosopher of property
- Right of Access
- Right of Use
- Right of Exclusion
- Eg. In some region – Cattle is wealth
i. In order to support wife(wives…lucky bastards) need cattle
ii. Sub-Saharan economy to the right of using the commons where people have the right
of access and right of use but NOT the right of exclusion
 Commons problems up to the ceiling
 Anitcommons problems at the nap of the rug
- Instead of calling it anticommons problems, need everyone to agree
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What does private property mean – right of use and right of exclusion
Later on we use it differently
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Preferred Environmental Approach – Governmental because no one would do it otherwise
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Puts them into tension with people with using property for 100’s of years in their cultures
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Water Rights laws –
- appropriation doctrine
i. only way to get use of water had to appropriate it and reroute it, impound it, reservoir
it, and use it
1. Result of it was people who benefited from natural water flow, were not
appropriating it, and were just letting it go by and environmentally sensitive
and enjoying the Bounty of Nature…had no right.
- Other Doctrine
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Promoting Development if west
- View in congress was that there is a limited amount of water, so let each person take amount
of water they need…but they have to use it.
- What if there is a drought – Seniority Rules
- Very destructive from environmental rule
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East – Reasonable Use Doctrine
- Have right to use water as much as you need as long as it does not interfere with others use.
- Water far more abundant
Property Rights - Calabresi 1) Property Rule - you own a resource and the only way another can use it is by paying the owner through a
contractual agreement. – you get to choose
2) Liability Rule – Didn’t have right to keep them from infringing on property, just got liability from that
infringement – work better for complicated transaction where unknown effects or lots of people involved –
They get to choose
3) Limited category of non-alienability - Can’t do something even if you want to (drug laws, sex laws –
prostitution, statutory rape)
If someone is willing to take your property and assume liability, what does that say
- In a Law and Economics analysis, then it is essentially saying that he can pay off your
damages and still make a profit.
Abstract discussion with labels -
From matt
1) Property Laws - you own a resource and the only way another can use it is by paying the owner through a
contractual agreement.
2) Liability Laws - if someone infringed on your property right you do not have the right to keep them from
doing some, instead you have the right to damages for that infringement.
3) Anti-Alienation Laws - someone can't do something even when that person wants to, e.g. slavery, statutory
rape, prostitution.
IV. Coase Problem of Social Cost
 Coase article is a response to Externalities (a market imperfection)
 Also a response to another market imperfection (Cost Transactions)
 People having property rights and invading other property rights
 Single most widely quoted/referenced article in Law and Economics
 Positve and Negative Externalities
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Social Costs – all the costs of a given activity - overall
Private costs – what the individual has to pay
The External Costs is the difference between the two (Social – Private Costs)
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Hypo – Widget factory pollutes river affecting local fishermen
- Fishermen make 50 on fish
- Factory pollution kills off all wish
- Factory makes $100 on widgets
- Factory Private Costs – (assume $80)
i. Building
ii. Utilities
iii. Materials
- Factory Net profit 100 – 80 = $20
- Social Costs = Private Costs + Fishermen loss (external costs) = 80 + 50 = $130
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Pre-Coase (Pigouvian) Analysis – The guy who makes an externalities (his behavior is affecting other
people – he is the externalizer), it is his behavior that must be corrected.
- Would impose Tax/Damages on the Factory for the loss suffered by the fishermen
i. Old tort system would award $50 directly to victims
ii. Pigou didn’t agree with this, because if fishermen getting fully compensated,
fishermen would not have any incentive to reduce the loss (by moving taking
precaution)
1. So therefore, instead of awarding damages directly to fishermen, proposed a
Tax which would be equal to the externalized social costs ( Harm).
2. Govt could decide how much to give victims
3. But not as much as they have directly lossed, still given fishermen incentive
to help improve/fix the problem
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Harmful Externalities lead to inefficient use of resources
Market System doesn’t have a mechanism to fix harmful externalities (harms caused to
others) –
i. Need to force the factory to internalize the social costs either through Damages or
Tax
ii. Need Legal Intervention to Impose either the Damages or the Tax
iii. Making the Factory bare all liability –
1. Would be Giving the Manufacturer the choice whether to stay in business,
pay damages/taxes, and continue polluting or get out of the game
completely.
2. His private costs need to equal the overall social costs in order for him to
change his behavior.
Externality
A consequence of an economic activity that is experienced by unrelated third parties. An
externality can be either positive or negative.
Investopedia Says: Pollution emitted by a factory that spoils the surrounding environment and
affects the health of nearby residents is an example of a negative externality. An example of a
positive externality is the effect of a well-educated labor force on the productivity of a company.
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Coasian critique of externality theory:
- It’s not about one guy hurting another - it’s Mutually incompatible Resource Usage (in our
hypo, it the incompatible resource it the river)
- Coase is great fan of market system, but realizes there are property rights
- Chicago School People (including coase) are all gaga over property rights (otherwise anarchy
would ensue) even though prop rights are not created by a market system but rather by
law/govt.
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Coase Theorem – No matter who has the property right (whether the factory or fishermen) as
long as the property is alienbility (can sell it), and as long as there are no/low transaction costs
to sell/alienate, the resource will wind up with the most efficient user (no matter what the
initial allocation of property rights were…it will move to the most efficient user…let market
system do it’s thing and market forces will take over to accomplish)
i. If Fishermen has the Property Right to the river
1. Factory would buy out fishermen – Most factory would spend to get
fishermen’s right ($99)
2. Fishermen will only take a minimum of $51
3. Bargaining process will determine where end result would be since there is
middle ground
a. Fishmermen can make more by selling their right then they can by
fishing
b. Factory will still make money by buying out fishermen
ii. If Factory has the Property Right to the river
1. Most fishermen would spend to get fishermen’s right ($49 – if they make
$50)
2. Factory will only take a minimum of $101 (if making 100)
3. There is no middle ground – so factory will keep property
iii. More examples info on this theorem:
 1.The doctor wins his his case,
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but the efficient outcome is to move
the consulting room, not the factory. So the candy maker pays the
Doctor to move the consulting room and let him continue to
operate his factory.
2. As long as there are net gains from changing the outcome, there
is some way of allocating the gains that makes everyone better off,
so the change should occur. More precisely:
3. The Coase Theorem: If transaction costs are zero, any initial
allocation of property rights will lead to an efficient outcome.
4. Here "transaction costs are zero" means "if there exists a
transaction that benefits all parties, it will happen."
L&E 7th Class - Mattie’s Notes
2.1.05
A. Transaction Costs
-for harmful externalities we want to impose costs on the actor to make his harmful acts
equal to the overall profits.
-Beneficial Externalities – give a subsidy to the actor to make his private benefits equal to
the overall profits. We pay him an additional amount of money than what he can get
himself.
-Farmer wants to farm his area, so he sprays it w/pesticides. The pesticides go onto the
neighbors farm and kill the insects on the neighbors farm. The neighbor benefits as well.
The overall benefits are greater than what the private actor gets, and therefore the private
actor doesn’t do all he can
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-Coase – which activity can produce the greatest amount of social benefits, value, dollars,
efficiency. Under Coase, pollution is not any worse than fishing, it is a necessary part of
the desirable manufacturing process. Fishing can be destructive if fishermen over fish
and deplete the population.
-The issue is which will produce more net social value. This is reached by allowing the
two parties, factory and fisherman, to bargain over the rights to the land.
-Bargaining, under Coase, takes place b/c they believe both parties will be better off once
the bargaining is complete. And if both parties are better off, there is a benefit to social
welfare.
-Coase assumes that the willingness to pay a certain value reflects the real value.
-If you have resources with incompatible uses, do they move to the better user?
-there is a large amount of literature supporting both sides of the argument.
-The Coase Theorem is that as long as transaction costs are low, resources will move to
the more efficient use regardless of property rights.
-The first level of Coase Analysis is a strong argument for eliminating restrictions on
alienability; let people bargain.
-Under Coase, usury laws are a restriction on alienability. Laws say we will not allow a
higher interest than 20% and therefore, some cannot get loans.
-Transaction Costs-High transaction costs may prevent the actual transaction from taking place.
-Sometimes transaction costs are low enough and the bargaining will still take place,
therefore, the property will move to the more efficient user.
-if farmer owns tract of land that a RR runs across. If Land is worth 50 to Farmer, and
100 to RR and Transaction Costs @ 20 are Born by RR. The lowest the Farmer will take
is 51, and in this situation the most the RR will pay is 79. 100-20=80. in order for RR to
have Net Gain, the most they can pay is 79, and Net Gain will be 1.
-If Net Gain is higher than transaction costs the bargaining will still take place.
-If Transaction Costs are higher than Net Gain, the bargaining will not take place and the
resource will not move to more efficient use.
-Coase bases his argument on anti-Government; the best way to reach maximum value is
to let the parties decide.
1st Step – Low Transaction Costs – Bargains Take Place
2nd Step – TC are High, but if Net Gain is Higher – Bargain still takes place
3rd Step – TC are too high and prevents bargaining from taking place
3rd Step
-When the TC are too high, Coase evokes Government intervention in a manner that
gives the resource to the party that would have gained it through bargaining if the
transaction costs were lower (Mimicking/Simulating the market).
-in this step, Coase says the Government should give control of the resource to the more
efficient user. In the first 2 steps, Coase believes that the Government should not
intervene/interfere.
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-Government regulation based on Cost/Benefit Analysis to decide he will be the more
efficient user.
-Individualized decision making by Government when the Government has to intervene
to look at the relevant efficiency in each setting, and therefore, it is a bitter denunciation
of legislation or regulation, which is almost always inefficient.
-Coase- Regulation is inefficient b/c in some areas it may be better to farm, and in other
areas it may be better to have RR tracks in lieu of farming.
-Coase – is a strong denunciation of using Government.
-4th Step – in making the judgment as who the more valuable or individual user is, do it
individually based on each incompatible resource use, rather than using general rules and
statutes, which will create sufficient uses in some cases and insufficient uses in other
B. When Government Should step in according to Coase (Chic School Analyis) – 2/3/05
a. 1st Step – Low Transaction Costs – Bargains Take Place
i. Law should only assign initial property rights
ii. But after that, law should not interfere with alienability of property and
bargaining between parties
iii. Govt – Hands off after setting initial property rights
1.
iv. Let resources be alienable – hands off movement of resources
v. Let parties bargain for most efficient use
b. 2nd Step – TC are High, but if Net Gain is Higher – Bargain still takes place
i. As long as the net gain is higher than TC, than same as 1st step – HANDS
OFF
c. 3rd Step – TC are too high and prevents bargaining from taking place
i. Govt should on a case by case (or resource by resource) basis facilitate the
transfer of the property to the most efficient user or the one that would
produce the greatest social benefits
ii. Have Govt Mimic the Market – simulate the market
1. Figure out what result the market would reach if TC weren’t so high
and give it to that most efficient person (the person that would
produce the most efficient gain/greatest social benefits)
iii. Courts or Agencies using individualized cost balancing in each specific
context.
d. 4th Step – If cost of Individualized cost analysis (Individualized Decision-making)
is prohibitive, what should Govt do?
i. May Need Categorical decision ONLY in this case as opposed to his
preferred individualized case by case analysis
ii. Rule or Regulation only in this context
iii. Coase article completely ignores all other benefits to Rules and Regulations
1. Only one sentence in Coase Article
C. What is Economic Efficiency
a. Pareto Optimality definition of efficiency –
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i. the "best that could be achieved without disadvantaging at least one group."
ii. A situation is not Pareto-optimal, then, if you can make someone better off
without making anyone else worse off.
iii. A change that can make at least one individual better off, without making
any other individual worse off is called a Pareto improvement: an
allocation of resources is Pareto efficient when no further Pareto
improvements can be made.
iv. Not Used by Economists for Public Policy Efficiency
b. Kaldor-Hicks Efficiency
i. If the winners have enough of a gain so that they could (not should) pay off
the losers…that is considered efficient.
1. Many ways to achieve this
ii. Easy to Define K-H- Very difficult to say who is winner or loser
1. Interpersonal Utility Comparisons (IUC)
2. CSA people hate doing this type of comparison
3. If can’t do IUC, how can you tell someone is a winner and how
much their winning and who is a loser and how much they are losing
iii. Could lead to Evolution of One Zillionaire who can buy up all resources in
the world and make more use out of the resources of the world
1. Should he have to share – No...that’s a distribution issue not an
efficiency issue
2. doesn’t matter if one person controls all resources or millions own
iv. type of economic efficiency that occurs only if the economic value of social
resources is maximized. A Kaldor-Hicks improvement is any alternative that
increases the economic value of social resources.
v. Under Pareto efficiency, an outcome is more efficient if at least one person
is made better off and nobody is made worse off. Under Kaldor-Hicks
efficiency, a more efficient outcome can leave some people worse off.
vi. Here, an outcome is more efficient if those that are made better off could in
theory compensate those that are made worse off and lead to a Pareto
optimal outcome.
vii. While all Kaldor-Hicks efficient situations are Pareto efficient, the reverse is
not true. Conversely, though every Pareto improvement is a Kaldor-Hicks
improvement, most Kaldor-Hicks improvements are not Pareto
improvements
c. In order to say one thing is more efficient than another need a scale to be able to
compare – Need way to Compare
i. Two Scales
1. Willingness to Pay (WTP) – Market Efficiency - How much people
are willing to pay to get what they want (WTP) – CSA People use
this
a. CSA – let people make up there own mind for what they
want to spend their money on
b.
2. Voting - How much political capital/resources people are willing to
devote to get what they want. Non-CSA people use this
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d. Efficiency of WTP versus Voting
i. Voting with your Dollars
ii. Political Voting
iii. Which is better
iv. CSA say WTP is better since people have to put up the goods to get what
they want
1. People can’t make utopian/idealized choices but actually have to pay
v. CSA says Voting with Political votes instead would let people make
decisions/vote for things without having to lose/pay anything – idealized
voting
e. Hypo
i. X willing to pay $100 for anthrax
ii. Y willing to pay $50 for vaccine
iii. Under WTP, anthrax more socially valuable
D. General Theme of this part of Course– Imperfections in private decision making
which justify social or legal intervention
E. Atomistic v. Communitarian Views
a. atomistic view
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atomistic - each person free to pursue own goals, social efficiency is just the
summing together individual choices and desires
 People only care about themselves and what they want
 Don’t care what anyone else does – not reality
Individualized Decision Making – Cannot have the following advantages which
rules and regulations could provide:
 uniformity and
 consistency and
 Predictibility and
 Fairness – burdens are widely distributed and everyone pays for it
Catalytic Converters Example
 When first came out – no one wanted to pay for it on their own
 When statute required them, no big uproar and people seemed willing to
pay as long as everyone had to.
 Couldn’t get that degree of uniformity without Legislative regulations
Coasians don’t see benefits of Regulations which address the above advantages
Effect of Precedent to create uniformity – not talked about by Law and Econ
people
Coasians and Law and Econ literature minimizes effects and value of treatments
which create uniformity, predictability, and an appearance of being fair
Need some form of Legal Intervention to create efficiency
Coasians say No Intervention – bargaining will lead to more efficient result
 Rules and Regulations should be avoided as much as possible despite its
benefits
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General Theme of this part of Course– Imperfections in private decision
making which justify social or legal intervention
b. Communitarian view - Ellickson(sp?) Analysis
- When there was a problem in a rural CA county (Shasta county) of farmers,
ranchers, etc, they didn’t go to the law, they bargained to reach an
efficient/fair resolution when what they were doing was effecting other
people
 Just common decency
 Reputations at stake
- Bargaining in the light of reputation instead of the light of law, did reach
efficient resolutions
- Theory of the firm
 In order to reduce bargaining costs, some people agree to be told
what to do so they don’t have to bargain on every point.
- Lighthouse Article – Coase
 Even without law, lighthouses were built anyway. Why?
 If you were part of merchant community, and you refused to
contribute to lighthouse construction, no one else in the
community would deal with you
- Jamaican Fisherman
 Fisherman wouldn’t agree to use larger nets which would let smaller
fish escape to grow because of fear that other fisherman would use
smaller nets and put them out of business
 Not efficient – no bargain
 Need Community effect to implement
- Some places Community Pressures are more influential then market
bargaining, legal interference, etc
 Chicago School people ignore these influences
c. New School – Psychological Economics (in response to Chic School of Anal).
i. Critical Legal Studies people looking to literary deconstruction of legal
words to mean anything you want – latin says this type of analysis is
petering out….not sure why he mentioned it
ii. New School – Psychological Economics (in response to Chic School of
Anal).
1. Uses clinical psychology to explain people’s decision making
processes
2. Risk Aversion Theory – People would rather avoid a loss than gain a
gain
3. If 50/50 chance to win/lose $10
a. Under Risk Utility Maximizer – pick either one – choices are
equivalent
b. Under Psycho Econ – rather avoid chance at losing $10 so
will never take that chance rather than going for the gain.
4. Bet $100
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a. 55% chance of winning
b. 45% chance of losing
c. Risk Averse people will not make that bet
d. Rational Utility Maximizers would make that bet
5. Endowment effect
a. People would rather maximize their stability even if it makes
more economical sense to sell off their endowment
b. More agonizing to lose what you already have even if the
benefits might outweigh the risk of loss
d. Latin Theory – The anti-theory - There is no One type of scheme/theory that
describes everyone
1. As a result, Law cannot have a uniform definition of how people will
behave
2/10/05
-
Tues – Common Goods/free rider – non-payers/non-excluding
Thur – Public goods – non-rival , not depletable
Tues – Selling off Natl forests
Water rights and bilateral monopolies
He mentioned some assignment what is it??
F. Possible Justifications for legal intervention – continued
a. Axlerod article – satirical article in response to Swartz (Harvard/Chicago school)
i. Swartz says Legal limits should keep their hands of creditor remedies
1. let market decide – bargaining
2. Limits usually precludes parties from reaching most efficient results
ii. Borrowers blah blah blah…..
iii. Classic example – if law doesn’t allow landlords to evict widows, no
widows would ever be able to get housing since landlords would either not
rent to them or charge high rents
iv. Corpse Collateralization
1. CA, NV statutes related to mining
2. Some miners only could put up their corpse for collateral to get
mining equipment
3. State Legislatures limited this right
4. Who loses if creditor is able to enforce provision and take miners
corpse
a. The Family of the decedent loses even thought they were not
legally liable/obligated for it….it played on human
emotions/religious beliefs
b. Serious enough a problem for legislatures to take action to
protect families of the miners (statutes protecting third party)
c. Borrowing is gaining by getting the “grub steak” better loan
terms or actually benefiting just by being able to get the loan
itself
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d. (statutes protecting third party) – not an atomistic view (not
a two person deal) – it involves other people (nonconsenting) and not just the borrower and the creditor
e. If not properly buries, some people believed decedents would
not get into heaven.
f. Statute should be viewed as a recognition the corpse
collateralization is not atomistic and effect other people
i. - Law recognized that people do things that have
effect on other people
ii. Chic school fails to recognize this
v. Debtors Prison
1. Families again lose since they would be responsible for bailing out
borrower – imposes a psychological burden on families
2. Creditors obviously would check to see if borrower had family
before agreeing to terms
3. Creditor not obligated to provide food/water to debtor prisoners.
4. Why abolished and bankruptcy put in place
a. To protect people’s feelings (latin’s and Bob’s view)
b. To protect familes and bleeding heart liberals from coming to
rescue
c. Law recognized that people do things that have effect on
other people
i. Chic school fails to recognize this
vi. Bankruptcy Laws – argument came up again
1. creditors say too many people declaring BR
2. Congress persuaded to fix it
3. Last TV, house, cars, etc allowed to be kept even if declaring
bankruptcy….especially in Texas
4. legal limits required??
vii. Legal Limits placed to protect people who have not consented to terms and
plays on people’s feelings
viii. Example – If community rule enforced that didn’t allow minorities in a
certain neighborhood it probably would increase the values of all the houses
in the neighborhood
1. under chic school of anal, this is ok – atomistic view
2. but it’s not atomistic – it effects other people
3. law does not allow this – it effects other people not directly involved
in transaction and law protects other people’s feelings and rights
ix. Danger of consideration of other people’s feelings – in contrast to the
benefits stated above
1. would justify Legal rules against aboration because of the feelings of
other people
2. the more the law takes other people’s feelings into account, the more
justification for legal limits on social behavior of all types
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x. Most Chic school people don’t recognize effects on other people
1. they have little to contribute to this debate
2. millions of people make decisions to what they are willing to pay for
– everyone else be damned. Don’t care of other people’s feelings or
the effect on them
xi. Chicago School on Zoning
1.
xii. Chicago School on Public Utilities
1. Would support Consolidation of phone companies
2. Would not want limits placed by FCC on media/phone services
3. the market will correct
a. it will either be efficient monopoly or
b. new companies will pop up to compete
xiii. Chicago School on Minimum Wage
1. Hurts people whose labor is valuable enough to make minimium
wage since they would work harder to make themselves more
valuable if it weren’t around,
xiv. Even when they recognize there are market imperfections, even where they
don’t work, they don’t submit that legal intervention is the solution, and in
fact, may be worsen the situation (bad market is still better than legal
intervention)
1. imperfect market is better than imperfect legal program
xv. Law taking into account other people’s feeling/rights is a communitarian
view.
1.
2. imperfect market is better than imperfect legal program
V. ???
A. Private goods –
a. excludible (can exclude other people)
b.
can exclude people from using your shoes
depletable
B. Common goods –
a. People can enjoy common goods without having to pay for them
b. Are they not paying because they don’t want the common good or are they not paying because other
people are paying for it and they don’t have to – FREE RIDER PROBLEM
c. Free Rider Problem
- Distorts market system since people want these things but are not willing/don’t have to
pay for them
d. Is that fair?
- Don’t know how much people are willing to pay for it but people enjoy the benefits of it
- National Parks
e. Market System cannot correct for this because of the unknown highlighted above
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-
Catalytic Converter example – why would you pay for it if you benefit from it if
everyone else doing it and conversely if you do pay for it and no one else does, why
should you since your not getting the benefit of being the only one willing to pay for it
1. Regulation required here to force people – fairness – govt says everyone has to pay
C. National Parks
a. Option value –
-
b.
People are willing to pay for national parks because they might go there
People willing to pay even if not going there because they believe in
preserving parks for the common good
Some people won’t pay as long as other people will pay and can enjoy the
parks
o Under Willingness to pay, the usefulness of national parks is
diminished
Could exclude people who don’t want to pay, but the cost of Exclusion would be very high
D. Options available
a. Legal Regulations to force people to pay as opposed to willingness to pay
-
A
E. Fisheries Example
a. Other countries taking too much of resources that their country depended on
b. Law of the Sea Treaty – create Exclusive Economic Zone (EEZ)
- Countries can control resources up to 200 miles from their coast line\
- Gave countries a clear legal right
- US has largest EEZ (considering Hawaii, Alaska, pacific islands)
- EEZ an attempt to ??
c. Use of Gun boats to enforce EEZs
d. US gave NOAH the responsibility for managing fisheries (NMFS)
- Each Committee Dominated by Commercial Fishing interest
- Why? Because Commercial Fishing interests were the more interested parties
- People in general are more likely to fight not to lose something than fight to get
something they never had…so commercial fishermen had most at stake
e. Incentive to Commercial Fisheries was to catch as much as you can
f. Going from a International regulation, to national regulation, to local regulation did not good to the
common goods problem….
g. Tried to restrict the dates of when commercial fisheries could fish
- Catch everything you can (good or bad fish you didn’t intend to catch) in that amount of
time…stay awake for 7 days straight to indiscriminately rape ocean of everything and
keep only what you really wanted
h. Only way to Restrict, get rid of overcapacity of fishing boats
- Latin says environmentalists should have just bought out commercial fishing enterprises
than investing money/time trying to get countries to sign/enforce treaties which have
failed time and time again.
- Only solutions is to create forms of excludability to exclude those who aren’t paying
1. Make people pay more for the right to fish – bidding on fishing rights
2. However there is an unwillingness to Social Dislocation which is a hard short term
decision that benefits everyone in the long term
3. Consumer Education Does Not Work and is unrealistic
4. Need Govt regulation and intervention
F. Need a Mixture of Market Economics and Regulations
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L&E 12th Class
2.17.2005
Public Goods are non-depletable, non-rivaled=if one person eats a carrot that carrot won’t be
available to others. Examples of Non-depletable goods:
1. Aesthetic Gardens
2. Roads – (Roads are Congestion Goods- if they are over-used the ability for other
people to use
the road is reduced)
3. Libraries and Museums – one persons pleasure from a library does not reduce the next
persons
pleasure (this is also a congestion goods).
4. Parks – also a Congestion Good
5. Ideas are public goods b/c they are not rivaled, i.e. when one person uses an idea others
are not
restricted from using that idea.
A good is public if one person’s use of it does not restrict others from using it.
-A TV is a private good, when one person is using it to watch what they want, if another person
wants to watch another channel they are restricted. It is rivaled. However, the terrestrial
television and cable television or Public Goods b/c everyone can enjoy the same signal w/out
reducing the amount of enjoyment available to other people.
-Although some goods require a price, e.g. cable television, road/bridge tolls, they are still public
goods.
-Common Goods – cannot exclude people b/c it is either, (1) totally impossible, or (2) too
expensive in comparison w/the benefits. Common Goods may be depletable.
-Public Goods – we can exclude people, e.g. not everyone is willing to pay for cable television,
or not everyone is willing to pay the toll for the Bklyn Battery, when they can take the Bklyn
Bridge.
-The essential characteristic of a public good is that one persons enjoyment of the public good
does not reduce the amount available to other people.
-Some goods are non-excludable and non-rivaled/non-depletable, e.g. endangered species. As
long as some people enjoy it you cannot prevent others from enjoying (non-excludable), and if
some can enjoy
-We do not know how valuable common goods are b/c we do not know how many people are
paying for them, and if they are not paying for them we do not know how much they are desired.
-Charging for public goods prevents people from enjoying the public good who would be able to
do so at no additional cost if it were a common good.
-if you put a toll on a road you prevent some people from driving on the road who would
have
been able to do so w/out the additional cost.
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-National Defense is both a Public Good and a Common Good – you cannot exclude people and
it is non-depletable/non-rivaled.
-the marginal cost for a public good is zero b/c it is non-rivaled and one person using it does not
reduce the amount available to the next person.
-the efficient level of consumption for a public good is to keep producing until there is no one
left who wants it b/c the marginal cost is zero. Since a public good is non-depletable the cost of
the next unit is zero.
-Public Goods the efficient level of consumption is as much consumption as necessary.
-The fundamental failure of the market system for public goods is that the Efficient Level of
Consumptionis different than the Efficient Level of Production and you cannot have a different
price for consumption and production of the same good. Efficient Price of Consumption is to let
everyone enjoy it as long as it is non-depletable. And any price above zero will reduce the level
of consumption from the maximum level.
-when the cost of the next unit equals the value, then you don’t want to produce more b/c the
costs will be higher than the additional value, and you don’t want to produce less b/c there will
be people willing to pay for the value but production quantity will be to low.
-when the marginal costs equal the marginal of value/demand for private goods, production will
cease, but for public goods, the efficient price, from a consumption point of view is 0 b/c any
price higher than zero excludes those that would like to enjoy the good but not to the point where
they want to pay for it.
Production of Public Goods
-At the Efficient Consumption Price we will get no production, b/c the Efficient Consumption
Price is zero. And since the Efficient Production Price is not zero, the market system is not
capable of coming up with a price that achieves both Efficient Consumption and Efficient
Production.
-There is a public policy choice: if we want more production, we need to sacrifice consumption
by puttng a price on the public good. If we want more consumption, we will have to subsidize
the producer so that he will not charge a price. The theoretical approach if you want to
maximize consumption is to subsidize. If you want to maximize production you charge, but that
reduces consumption below the maximum level of consumption. There is no way for the
market system to determine which is better.
-if we treated a public good by peoples’ willingness to pay for the public good, you have a
demand curve and the price set by the producer. Anyone who pays the price can enjoy the good,
and those that do not pay are excluded. Therefore, the Efficient Production Price will never
be zero, the level at which the Efficient Consumption Price is.
-some uses of public forests convert the resources to private goods and others keep the resources
as public goods. Does society benefit or lose from choosing one use over the other? Latin does
not know the answer to this. However, w/in the market system, there is no incentive to make a
public good unless you can charge for it or receive a subsidy.
-can you produce public goods through private initiative, e.g. museums, television, gardens?
Yes, but by putting a price, we are decreasing consumption below the efficient level.
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-Market Imperfections that justify Legal Interventions. Market Imperfections that prevent
markets from reaching an ideal efficiency for public goods.
-If you have to pay for a good it is not a Common Good; when you have to pay for a good
manufacturers can determine the quantity to make by looking at peoples’ willingness to pay.
-if we have a congestion problem, we should increase the amount of goods. However, the
market does not tell us if we should issue a subsidy or charge for it. the market approach has an
advantage b/c it shows that the people who really want the good will pay for it.
L&E 13th Class
2.22.2005
-the incentives for the people who work in government do not receive a benefit for the work they
do.
-Stroop and Baden criticizes Government mechanisms as being grossly inefficient whenusing
forest resources.
-S&B proposes to hold an auction so that the Government captures as much value as people will
pay in the auction and sell off the National Forest to private investors.
-Private Investors will have an incentive to protect and efficiently exploit the resources.
-Privatizing the Nat’l Forest will evince its value by way of the consumers’ willingness to pay.
-A Private Investor will have a personal stake, and try to sell the resources to people who are
willing to pay. S&B would say that it is desirable that consumers, through their willingness to
pay, can show that the land is more valuable in the form of a condo development as opposed to
the resources being used for logging.
-What benefits can people receive from auctioning off a National Forest?
-Wood, condos, mining of ores, commercial development, large potentially industrial
land,
parks, farm land, wild life preservation, watershed preservation,
-the economic analysis in S&B does not touch on how difficult it will be to provide the same
level of protection that the government does now, even though governmental protection is poor.
-need to compare the externalities made by the public officials against the externalities of the
private system.
-there are many resource uses that could emerge from selling off the national parks. The highest
pay out would be development and timber. The resources in these two instances would become
private goods.
-there is always uncertainty as to what type of use you get, so by cutting down the wood,
building condos immediately you reduce the uncertainty.
-Latin: the S&B presentation is not a fair balance discussion. Auctioning off these resources
would have a systematically private approach and diversion to many public goods that we now
enjoy, albeit that the benefits are given to society to free, but 20 years from, we will still be
getting those benefits as opposed to private development where we come across great
uncertainty.
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2/24/05
VI. LA Water Board and Owens Valley Water Rights
The view that it was “water theft” comes from the fact that LA values increased $400 million
(times some multiple) versus the $12million
A. Billateral Monopoly
a. Two parties who need to negotiate
b. Each group can hold out for better price.
c. LA needs water but didn’t want to pay too much…
d. Better for farmers to be bought out but wanted high prices for the water rights..
e. The transaction has to take place but there are no other competitors so each hold leverage over the
other
f. Farmers want piece of LA profit even though they were offered 4x (and more) of what the land was
really worth for agricultural purposes
g. LA wanted to used Owen’s Valley prop values
h. Farmers wanted to use LA prop values
i. Klamath River Example – Drought v. Endangered Fish
i. Dept of Int opted to save fish
ii. 800 Farmers lost their farms
iii. No right or wrong answer
iv. Govt intervention – seemed necessary in this case but goes against those who favor free
markets.
v. However, under a takings rational, where Govt needs to compensate for the water taken (as
happened in Klamath) then the Govt would be less likely to implement such protections
due to budgetary constraints and the feasibility of paying out every commercial enterprise
that was damaged
1. But it has been ruled that polluting companies should not be compensated for
implementing govt required pollution controls
j. Is a monopoly situation one in which the Govt should intervene
i. yes…
ii. But look at utility regulation – a far from sterling example but deregulation leads to Enron
and CA style energy crisis
iii.
k. Unregulated economic activity has led to crashes and other problems where monopolies involved
l.
Limited number of property owners which own unique resources. Each group/pool holds out (each
their own monopoly) to get biggest return and effects the total process.
i. Could break up pools
ii. Latin doesn’t like the Govt solution here or the Market Solution…no good answser
m. Law of 2nd Best
i. Law of first best - In well functioning market, allow each party to pursue own interests
which will produce a demand curve for the most efficient social welfare. Combining each
individual decision into an economy etc
1. Eg- all players in a market would trade equally to produce an efficient result by
pursuing their own interests
a. 3 Shelters
b. 3 Foods
c. 3 Waters
ii. Law of 2nd best applies when market NOT well functioning – fly in ointment. Like a
monopoly as one of the players.
1. when a monopoly in place, the shelter monopoly can demand more from the others
a. 3 Shelters Form a Monopoly
b. 3 Foods
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c.
2.
3 Waters
law of 2nd best - When there is a significant imperfection in the market, you cannot
assume the best way to respond to have everyone else operate as efficiently as you
could to make up for this imperfection – we don’t want the water and food people
to create better efficiencies…that is not the 2nd best solution
a. The 2nd best solution may be to add another imperfection (form a water
monopoly) to compensate for the shelter monopoly…the other would
then be no worse off (market intervention). Or legal or govt intervention
to compensate and create a 2nd best solution.
b. Best situation (1st best) no monopolies…all competing…all becoming as
efficient as possible
c.
B. Property Rights
a. Rights don’t say who will benefit in individual cases (i.e., Klamath example)
b. Simplistic views – if was passed down through generations, government shouldn’t be able to take it
c. but…
The assignment for next week – first two articles in 4th handout
- case on damages
- article on discounting for the future.
3/1/05
VII. Discounting Future Earnings/Costs/Benefits
The view that it was “water theft” comes from the fact that LA values increased $400 million
(times some multiple) versus the $12million
A. Discounting Algoritm
a. Hypo – Invest 100M in a Dam.
- Hypo in Handout 4– How many benefits will you get after a year after building
Dam
- Dam will produce 20M in benefits each year for 10 yrs
b. Compound Interest (CI) – P x (1 x R)t
- P is Principle
- R is interest rate
- t is the period (years in our example)
- If invested CI:
- After 1 year CI = 100m x ( 1 + .1) 1 = 110M
- After 2 years CI = 100m x ( 1 + .1) 2 = 121M
- etc
c. Discount Rate (DR) - P / (1 + R ) t
- Assume interest rate of 10%
- After 1 year DR = 20m / ( 1 + .1) 1 = 18M
- After 2 years DR = 20m / ( 1 + .1) 2 = 16.5M (why does he have 16.2 in h/o
???)
- etc
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d. Interest Rate – Real Rate of Return
- Someone gives you money for a real rate of return
- Paying someone for the use of their money since they could be doing something
else with that money.
- Posner - If you are going to factor inflation in the growth of earning through
compound interest, then in you to factor it in the discount rate.
e. O’Shea case in handout – discount on future earnings
- How much do you have to give her now so she receives the full amount in the
future…need to consider safe investments, interest, inflation, discount rate, etc.
- Paying someone for the use of their money since they could be doing something
else with that money.
- Posner - If you are going to factor inflation in the growth of earning through
compound interest, then in you to factor it in the discount rate.
f. Federal Discount Rate
- Congress said that FDR will be determined by looking at long term bond rates
- Environmentalists want FDR to be higher so that this public works projects
which are bad for the environment would appear as to not provide as big a
benefit in the future
- Developers wanted low FDR so that they could borrow money easier and the
benenfits would look better in the future.
- Interest Rate and the Discount rate are the Same -- ?? latin stated this….clear
this up
- But Environmentalists say that discounting human lives, forests, etc minimizes
the value of those things in the future when they will be just as, if not more
valuable in the future.
- Making decisions today makes the long distance future benefits negligible (say
500 yrs from now).
- Makes it hard to justify Long term Decisions….makes people focus on short
term decisions and benefits.
3/3/05
VIII. More Discounting – Missed class
3/8/05
IX. Discounting Con’t
A. Opportunity Cost
a. Farber
- s
b. People want benefit now as opposed to future
c. Same Discounting rate used for all things (Marriage, having kids, etc)…that is a wrong
assumption according to latin
d. Really need different discount rates for different things (protecting forest, dams, etc)
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e. Why discount – Don’t have enough resources not too
f. Latin – The further into the future you go the harder/less clear things are and people are
concerned it may not work out well…rather take sure thing now than taking future
benefit even if in the aggregate it would be better – Risk Aversion
g. Latin - Low discount rate – what does it do?
Assignment over break – Zechhouser article – analyze it
X. Cost Benefit Analysis
A. 4 elements that go into assessing cost benefit Analysis
1. Identifying the benefits
2. Ident. The costs
3. How long will you calculate the benefits and costs for (in torts it’s life expectancy, in
dams – project life)
- limits the amounts of damages in torts or the amounts of benefits/costs for
projects
4. Discounting
B. Flood Planes
a. Should people be allowed to live in those areas where the government subsidizes they
people
b. 5 yr – 10 yr – 50 yr – 100 yr floods
c. Major reason for building a Dam is to reduce/minimize flooding effects at the sacrifice
of the reservoir
a. Flood control benefits
i. Houses and structures- to protect buildings
1. Identify Benefits
a. What buildings are likely to be built – what kinds
of development will be built
b. Estimate what values of structures are
c. Multiply by amount of development anticipated
from a comparable area
- Identify Costs
ii. Agriculture
1. Identify Benefits
a. Identify the acreage that can be used
b. what crops grow in this area
c. generated yield
d. times market value per ton.
- Identify Costs
iii. Saved lives and property
1. Identify Benefits
a. Depends on contour of river and actual flood
plane
b. Not a large component.
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b. Recreation benefits
i. Rerservoir/lake recreation
ii. Channel-ized river recreation.
c. Reliable Water Supplies
d. Jobs
e. Real Estate Amenities – waterfront living – increased real estate values.
f. Electricity – depends on height difference between reservoir height and
river height
i. Identify Benefits
1. multiply output of generater.
g. Recreation.
i. Rerservoir/lake recreation
ii. Channel-ized river recreation.
d. Critical to challenge Cost Benefit Analysis as an Environmentalists to what
comparisons are being used and growth rates
e. Growth v. Transfer effects
a. .
Assignment over break –
Assessing the Costs
Zechhouser article – analyze it
- Tuesday – different kind of benefits and how people view them for food additives
- Thursday assessing toxic risks to people
3/10/05
C. Damn Benefits
a. MP – market Price - Electricity
b. MP – market Price - Agriculture
c. C Mkts– comparable markets - Flood Control – (C Mkts less accurate than MP, but
longs established way of valuing real estate)
a.
d. C Mkts– comparable markets - Residential and Commercial Development
e. C Mkts– comparable markets - Water Supplies
a. Look at comparable water supplies in other areas
f. SP– Shadow Pricing - Recreation
o We started looking at existing markets to determine value
o Fair Market Value – Obtained by looking at similar structures and similar areas….not
exact but it does the job
o Shadow Pricing –
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1st way for SP - Look at what people spend to enjoy this benefit
o How do you know what people will pay for a certain benefit where
there is no existing market
o It’s difficult and imprecise
2nd way for SP –
o Use polling to get people to rate how much people enjoy one activity
over another – Statistical Survery
o Need activities that have market price
o Then rank activities that don’t have market price against the valued
ones.
o Something like running or hiking is little to no value but still
valuable to people
o If they rank hiking near golfing which does have a value then we
extrapolate the value of hiking based on how it ranks against golf.
-
-
3rd technique way for SP –
o Contingent Valuation
o Survey which asks people what the would be willing to spend
(willing to give up) on certain activities but don’t actually have to
pay it
o Less appealing method to economists then Comparative Ranking in
2nd technique
o Used for activities where NO comparable activity exists –
 How much personal freedom are you willing to give up for
greater security – There is no comparable activity/enterprise
so just need to ask flat out
o FLAW - But since people actually don’t have to pay it, not accurate
results
-
D. Zeckhauser – Costs v. Benefits
Costs – Dam Costs Again
 Construction Costs
 Operational Costs
 Dam Costs…again
a.
4/7/05
E. Dreisen Article
Latin – Anti – Cost/benefit analysis
4/11/05
F. Kaiser Article



Goal of this course - Understanding basic economic concepts and see how they
are/are not applied to law
Latin likes the Kaiser article since in includes many of the concepts we’ve covered
Global Climate Change
25
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

26
o In this area, latin thinks it brings out all of the worse aspects of cost benefit
analysis
o Some claim Canada and Russia will benefit from it since they’ll have more
rain and warmer weather
o Other areas will suffer…so is it a wash under cost/benefit analysis
o Doesn’t take into account that everywhere around the world local
ecosystems adapted to seasonal climate changes
 Everything gets effected
 Eg – tree borers migrating to alaska so 3 million acres in alaska have
been blited from this
 Malaria would spread out since mosquitos now can expand their
range
 Frog extinction crisis
 Consequence is that they eat insects…concentrations of
insects in wetlands increasing which has effect on wildlife
and people
o Point is that all established ecosystems changing – no economists can begin
to assess all effects of these changes
o Economists using productive human activities like argriculture output but
don’t consider changes to nature which no on seems to take into account
Uncertainty is the first category Kaiser discussed in article
o Kaiser starts by covering unusually severe catastrophe’s
 Gulf stream being destroyed
 Sometimes it has stopped flowing
 If gulf stream stops, rome, for example, would have severe
winters like NY since on same latitude, which would have
devastating have
 If ocean waters pick up more heat – more frequent and severe
hurricanes
 Rising sea levels due to glaciers melting
o No reliable estimate of what consequence of GCC
o Any cost-benefit done would minimize expected damages and play up
benefits - UNCERTAINTY
 No CB analysis comes close to forseeing the dangers and therefore
nothing comes close to being enough benefit for fixing it since we
don’t know what a majority of the harms are
 Latin doesn’t think Kaiser went far enough in assessing dangers…I
think
Second category is Valuation problems
o Underlying CB analysis is fundamental humanistic philosophy is taking
everything people are willing to pay for are the only things to consider
o Things that people don’t necessary have to or want to pay for like forests,
fisheries, etc are not considered at all.
o Economists might say we might lose 3000 acres of forest but do not
consider the fact that a forest provides many other intangible/uncertain
benefits and therefore cannot be accurately valued.
o Excluding many of the important variables puts holes in CB analysis
Third category is Discounting
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o
o
o
o
o
Discusses Farber article
Kaiser doesn’t discuss using different discount rates for future benefits
Weakness in using same discount rate
Latin didn’t discuss this too much
Global Warming effects extend for 100s of years so by using discounting
you are wiping away future effects
 Saving millions of lives in the future being equiv of one life today
 Latin doesn’t see how you can make judgements on that
 Might as well not even consider it.

Fourth and last category/criticism is Vision
o Vision that CB analysis is narrow
o Doesn’t include collectivisist or communtarism or religious something
o where Critics of CB analysis/willingness to pay fall down since they don’t
have a coherent vision to put in it’s place…not even latin….No Vision
o Need something where you don’t have to rationalize it in quatitative terms
but rather just because they agree to it.
o Anti CB school – no simple way of encapsulating all the things that are
important to people so they can’t put it into a coherent theory that can be
implemented

Costs in eliminating Greenhouse gases
o Developing Coutries only agreed to Kyoto agreement only if they could pay
forest countries or do re-forestation, so they could develop and keep
producing gases – carbon credits
o Only measures that reduce CO2 are new forests.
o Most countries that are receiving credits now are going to be using those
forests in the future and produce even more CO2.
o Why we doing this? – big industrialized countries don’t want to pay to
change their habit.
o Different producers of pollution will have different costs for reducing it
 US – our greatest source of CO2 is power plants and autos.
 Huge costs to us to find new sources of power and replacing
existing combustion engine technology
 What we need is a new political focus on producing nonhydrocarbon industries to replace existing ones which are the most
powerful political force in this country
 Marginal increases will not have impact on global
warming…need equiv of wartime movement/mobilization to
completely alter our current economy/habits/mindset.
4/19/05
A.
Mechanisms for pollution control
o Offset Act
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o if a new polluter wants to come into the area, they need to buy the amount of
pollution that they are going to produce and a portion of the amount or
volume of pollution allocated to an existing polluter, e.g. if a company puts
out 400 tons of sulphur oxide, the new company will have to ask the existing
company if they can buy 100 tons of allocated to the existing company and
that existing company can then only produce 300 tons.
o The Offset Act is called an Economic Incentive Scheme b/c it is not
mandatory that they sell.

-The firms who have an existing right to pollute do not have to sell
that right.

-the firms that sell their rights, are the ones that can cheaply reduce
their pollution output, or are not bringing in revenue with the
division whose pollution allocation is being sold.
o Netting
o -Existing entities that wanted to upgrade their pollution output by more than
30,000 lbs/year had to succumb to an audit/review. However, the EPA
allowed entities to reduce some of their pollution output as a net against the
pollution that they wanted to increase.
o EPA is Achilles heal of environmental regulation
o Very weak
o Bubble Scheme (most publicized)
o Assume you draw a giant bubble around plant
o Instead of saying what each smokestack produces…take the total amount of
pollution put out….say no more than 28 tons for the plant…sounds like
netting
 But netting is only for doing a transition to new pollution
 And netting only works to limit of 20K tons
 Bubbles are for existing pollution and it works for entire pollution
emitted
o As long doesn’t exceed total level formally allowed by each smoke stack
summed together
 Could close down one smokestacks to increase pollution created by
other stacks as long as totatl doesn’t exceed fixed limit
 Plant will cut back on ones that will produce least value
 Ones that cost too much to control pollution

o This kind of scheme hardens emission…no incentive to reduce emissions
 This is not a scheme for reducing pollution, but rather reducing
pollution costs
 This is why environmentalists opposed this.
 Better scheme would have been shrinkage….he said shrinkage
 Have a bubble but lower the total amount allowed over time
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o Would it be easier to monitor Bubble scheme or Netting
o Bubble scheme is harder
 Need to measure ALL stacks and sum them up…hard to do
 Most monitoring is just to see if monitor equipment is working since
samples are expensive
o However, with technology bases standards monitoring is Point source by
point source (smoke stack by smoke stack)
o Incentive based schemes are only for reducing pollution costs…not for reducing
pollution itself
o Allowable Numbers are created by tech bases standards and then turned over to
economic incentive schemes to allow companies to by pass pollution reduction in
favor of reducing pollution control costs.
B.
Acid Rain
o Wind/rain flows from west to east
o Most acid rain in east due to coal burning plants in the west
o Cap
o Congress made (statutory mandate) industries improve emissions by
50%..cap it
 Congress got the values from the EPA probably- tech based
standards
o ERC - Emission Credits. Could be sold
o Sulfur Dioxide credits ($220 per ton…high price)…seems pretty low which
means more shares of credits out there than people need to by….so we are at
a point where additional limits should be placed.
o There is an ongoing market in Chicago for buying/selling credits
o Effect of this program is it reduced by 50% the sulfur dioxide
emissions…but now has no effect.
o Latin says they should keep the cap but eliminate the trading….but
realistically could not get the cap if trading wasn’t allowed.
o Latin skeptical whether plan was benefitial
 Agrees with initial reductions but should have done more
o Why have 9 states passed laws prohibiting co. from selling credits
 Midwest (rust belt) are main buyers of shares from the east
 They increase their pollution so east again gets fallout from the blow
back…he say blow back.
 9 Eastern states now not allowed to sell credits to specified states.
C.
Latin – handout 8
Not on exams – read after exams:
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o www.ecovitality.org/newfiles/savingnature.p1.pdf
o www.ecovitality.org/newfiles/savingnature.p2.pdf
o Competition and what’s involved in competition
o Environmenttalists should view resource exploitation as ….
o Env. Have to come up with ways to help people improve standards of living that are
more attractive to them then exploiting natural resources (Ecovitality…for eg)
o Competing against Resource exploitation companies
o Test is not who is richer
 If so, environ. Would have no hope
o Test is whether how much is a company willing to pay when it compares its
incremental costs with the companies profitability
o Doesn’t matter how wealthy company is, not going to spend more for
resource than it can profitably sell that resource for.
o How profitable is it for them to take remote resources and exploit them.
o Environ. Wouldn’t always win…but would win a majority of times since
Co. would move to areas where there isn’t competition.
o
o Competing against Resource exploitation companies
EXAM
o pick up between 10-12 on Saturday from Dean G
o turn in by 6pm on Monday (dean G or rothman)
o citation is less important here….
REVIEW
Priest Article – How people make decisions under uncertainty –
Don’t need to worry about charts
- Externalities – Intent not a requirement
o Nothing is external to the world as a whole – it is external to the
individual
 Buying SUV – You buy it and you don’t care (not externality
to the actor…he’s getting the benefit…it is external to the
rest o fthe population)
 Other are affected by it
 Drives up oil price
 Saftery
 Ect
-
Common good and Public Good – Difference
- common good is one where you can’t exclude people who don’t pay.
They can enjoy it and not pay for it (FREE RIDER SYNDROME)
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




-
Ocean fisheries – people can keep taking it until there is
nothing there but it is a common good because no way to
exclude people from benefiting from it.
How can you prevent someone who owns owns a boat
Fish in the ocean is the common good
Usual solution to make everyone pay or put restrictions on
who can use it – no market solution – only legal solution
Eg, air pollution – catalytic converters – govt had to mandate
everyone had to have them – make everyone pay.
Public good – marginal cost is zero
 Want everyone to enjoy it
 Marginal price is zero
 But then no one will produce it if there is 0 price
 If you charge, however, people won’t go
 If yo don’t charge, private groups won’t create it since no
profit
 Usual solution to this is Govt (they have a choice) to give a
subsidy, so people can enjoy it cheaply and private parties to
make money
 Eg. Cable TV – govt can allow it but that will reduce
comsumption since private party will charge for it
 Or govt could subsidize it
o Eg bridge, road, etc – one person can enjoy it
without reducing ability for others to enjoy it
o
Coase – Incompatible Resource Uses - reach most efficient result is possible
- Efficiency – what do you mean
 - most common Kaldor Hicks –
 Taken a given amount of resources and producing the most
socially benefitial as demonstrated through Willingness to
pay
Efficiency – analysis based on taking whatever the current wealth distribution model is.
Axlerod paper – communal feelings – antithesis of CSA thought who are not concerned with
anyone else
Discounting – Coming up with Fair Market Value (FMV) – like real esate values
- recreation things – use Shadow pricing.
 Trying to price recreation by seeing with how much people
are willing to spend there.
 Do surveys – contingent valuation in the literature – rank this
experience against those that do have prices
 Just ask people how much they would spend even thought
they don’t have to
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No market prices for certain things –
Life Valuation
Value of Life and risk assessment – multiply value of life * risk assessment
Quality of life years –
Value of Statistical Life Years – doesn’t differentiate between good years
(young/healthy) and bad years (old/sick)
- old people however are willing to pay more to stay alive since they
have more and have shorter time horizon
Risk benefit/utility analysis – try to get beyond intuition to prevent
important risk and not waste it on improbable risks
Policy Issues
- deterrence
- compensation
- fairness
- Look at torts stuff
-
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