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EC 425
Law and Economics
Spring 2002
Tuesday and Thursday 2:40-4:00 pm
110 Berkey Hall
Thomas D. Jeitschko
4C Marshall Hall
Office Hrs: Thursdays 9a – 12n
Tel: 355-8302
E-mail: [email protected]
Economics 425
Law and Economics
Exercise for 1st Midterm
When Abe graduated from the University of California at Berkeley, he bought a diamond
ring with a golden bear insignia (Berkeley’s symbol) to impress his high school friends. The
person most impressed was his old sweetheart, Beth. They grew so fond of each other that Abe
asked Beth to wear his ring. Then the quarreling began. The relationship deteriorated until, in a
fit of anger, Beth enrolled as a student at Stanford (Berkeley’s hated rival). Abe, naturally, broke
off the relationship and asked for the return of his ring. Beth replied that it was a gift to her and
she was not about to return it. He answered that he had only loaned it to her to wear for the
duration of their friendship.
Abe and Beth are now involved in a legal dispute over the ring. Beth possesses the ring
and she declares that she intends to sell it. Abe threatens to sue her. If Abe wins at trial, the
court will require Beth to return the ring to him. The ring is worth $1,000 to Abe. If Beth wins
at trial, the court will allow her to keep the ring. She would then sell the ring for $400 to an
acquaintance. (The acquaintance does not know Abe and will not resell the ring to him.) In the
event of a trial, each one expects to win with probability 0.5. A trial will cost Abe $250 and it
will also cost Beth $250.
Abe and Beth start negotiating to reach a settlement and avoid a trial. The costs of
settling out of court are nil. Supply numerical answers to the following questions concerning the
bargaining situation:
1.
The threat values are:
Abe
.
Beth
.
Sum of Abe’s and Beth’s threat values
.
2.
The total value of cooperation to Abe and Beth:
.
3.
The surplus from cooperation:
.
4.
The “reasonable” solution would be for Beth to return
the ring to Abe and for Abe to pay Beth how much?
.
5.
If the judge were to decide the case by applying the “normative
Hobbes Theorem,” who would win the case and get the
ring? (On the right, circle your answer).
Abe
Beth