Presentation Transcript

1. Lecture 5
2. Introduction Chapter 13 serves as one of the best chapters in the text. I then recommend a complete reading of it. Pay attention to the economic thinking. Special attention should be paid to liability rule.
3. Introduction Liability -- In law, a person is said to be legally liable when they are financially and legally responsible for something. Liability can be considered as a form of (negative) property rights.
4. Introduction An externality is a cost imposed on the third party other than the buyers and sellers. Prior to this chapter, most of our discussion was limited to models of buyers and sellers.
5. Introduction Externalities Negative External costs Ex. factory smoke Positive External benefits Ex. pleasure from Christmas decorations
6. Section 13.1 Costs imposed on others
7. Costs Imposed on Others Example: The doctor and the confectioner Doctor named Sturges live around the corner from a confectioner (candy maker) named Bridgeman, who made candy in the basement. Bridgeman’s machine is so loud that Sturges cannot hear this patient’s heart bits.
8. Costs Imposed on Others In the case of negative externality, private marginal cost is lower than social marginal cost
9. Possible policies Pigou tax versus quantity restriction The key idea of workable policies centers around “internalization” of the externality. Government policies are not the only possible solutions. Under some conditions, market solutions are workable.
10. Pigou’s Analysis Take into account costs imposed on others Internalize externality Taxation as incentive Pigou tax Tax equal to amount of externality Socially optimal output Liable Property right Transactions costs
11. Pigou’s Analysis Tell me who suffers from imposing the tax? Who benefits? There is a major difficulty of implementing a design of Pigou tax.
12. Quantity restriction As an alternative to the Pigou tax, the government could require firms to produce fewer quantity. This sounds reasonable, but whose quantity to be cut? Introducing the design of cap-and-trade.
13. Quantity restriction Cap and trade: a system of tradable permits to produce goods that create externalities. How to distribute permits among suppliers remains an issue, but this distribution does not matter to the final outcome in terms of efficiency. This is because the supplier who is willing to pay most for the permits will obtain them. Again, there is a major difficulty of implementing a quantity restriction.
14. Private solution: merging One intuitive way to internalize externality is merging of the two parties. The externality is therefore naturally internalized.
15. Private solution: trade Coase Theorem The theorem states: In the absence of transactions costs, all externalities are internalized; therefore, social gain is maximized. Transactions costs refer to any cost of negotiating or enforcing a contract. The doctor and the confectioner example.
16. Coase Theorem Let’s compare 2 cases Bridgeman’s candy business is worth $100, and Sturge’s medical practice is worth $200, and The other way around At the same time, there are two possible ruling on the property rights.
17. Coase Theorem with Many Firms The main story remains unchanged when we shift from Coase Theorem involving only one seller and one buyer to the multi-person version. Again, the key assumption is null transactions costs
18. The way out (1) – merging (1/6) Internalization of externality Internalizing an externality involves altering incentives so that people take account of the external effects of their actions. The next few slides show an example of “merging”.
19. The way out (1) – merging (2/6) There are two firms S and F, producing steel (s) and does fishing (f) respectively. By producing a unit of steel, F generates pollution x and dumps it into a river, increasing the cost of fishing. S and F’s cost functions are:
20. The way out (1) – merging (3/6) The market prices of s and f are psand pf, so firms F and S’s profit-maximisation problems are Note that S determines both s and x, but F determines only f while x is given for it.
21. The way out (1) – merging (4/6) The two FOCs of S are: And the 2nd one gives us
22. The way out (1) – merging (5/6) Now suppose the two firms merge and form one firm that produces both s and f, its profit maximisation problem reduces to And the FOCs wrt x is
23. The way out (1) – merging (6/6) Note that This testifies to the statement that externality does not lead to efficiency.
24. The way out (2) – tax (1/4) How about Pigovian tax?
25. The way out (2) – tax (2/4) Now assume that the government imposes a tax of t on every unit of pollution that S produces, so the new profit maxmisation problem becomes: The FOC wrt x is:
26. The way out (2) – tax (3/4) Compare x” and x’ (the socially optimal solution): We learn that to achieve the socially optimal level of pollution, t needs to be:
27. The way out (2) – tax (4/4) The limitation of Pigouvian Tax is that we generally lack information to determine t* The needed information is optimal level of pollution x’.
28. The way out (3) – market (1/4) Using the same example, assuming that F has the property rights of the clean water, and can sell x units of pollution to S. q is the “price” of pollution. The profit maximisation problems for S and F are now
29. The way out (3) – market (2/4) The two FOCs of S are: The two FOCs of F are: (1) (2)
30. The way out (3) – market (3/4) Using FOC (1), we can derive the pollution demand function: Using FOC (1), we can derive the pollution supply function:
31. The way out (3) – market (4/4) The equilibrium quantity of the market is Which is equal to the socially optimal level. So market could be smarter than the policy maker.
32. The Coase theorem The Coase Theorem states that when trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights.
33. A variant of the market example Using the same example, assuming that S has the property rights of units of clean water, and can sell to F. Assignment 5has a question asking you to have the answer worked out.
34. A variant of the market example (4/4) This simple example illustrates that the market outcomes in terms of generated pollution is independent of who owns the property rights. Once the property rights can be freely traded, the socially optimal level of pollution will be achieved. The only difference is the profit division between S and F. Note that transaction costs are important obstacles for trade.
35. Introduction http://www.ted.com/talks/lang/en/rob_harmon_how_the_market_can_keep_streams_flowing.html How the market can keep streams flowing? This is a typical property rights story.
36. Coase Theorem with Many Firms The main story remains unchanged when we shift from Coase Theorem involving only one seller and one buyer to the multi-person version. Again, the key assumption is null transactions costs
37. Coase Theorem with Many Firms Now, a major challenge facing the CT lies in the validity of the underlining assumption of zero transactions costs.
38. Smoking bans in bars revisited It is unlikely that smokers and non-smokers can negotiate and make a deal in a bar. However, there is a way for non-smokers to bribe the boss to ban smoking – simply by paying a higher price.
39. Case study: the Nature Conservancy The heart of environment issues (including wildlife conservation) lies in unclear assignments of property rights, which lead to high transaction costs. The NC purchases land in ecologically areas to preserve threatened species. They bid against other potential users. Free rider issue could be a concern.
40. External Benefits Analogous to external cost analysis Pigou subsidy Application of Coase theorem Ex. fable of the bees
41. Income effects and the CT Strong CT: In the absence of transactions costs, the assignment of property rights has no effect on the allocation of resources. Example: Sturges and Bridgemen.
42. Income effects and the CT Weak CT: In the absence of transactions costs, the assignment of property rights has no effect on the efficiency of allocation of resources. Example: rock-n-roll lovers and classical music lovers. Key: The WCT is always true. The SCT is true whenever the reallocation of property rights does not shift market demands.
43. Example of income effect The reserve clause in MLB. The reserve clause renders a “property right” to the team. Yankees considers himworth $100k; Rangers $75k. Yankees will keep Wangwith or without the clause, implied by SCT.
44. Example of income effect Now suppose Wang hates living in NY, and he is willing to pay $50k to move to Texas. Rangers will have Wangwith or without the clause, also implied by SCT.
45. Example of income effect Now additionally suppose Wang is willing to pay $10k to move to Texas when his income is low and $50k when he is rich. In this case, the clause leads to different outcomes. But in either case, WCT holds.
46. Transactions Costs Efficiency and cost Railway engines create sparks, which sometimes set fire to crops planted near the tracks. Liability rule does not matter, implied by CT. However, an efficient outcome does not imply that it is the least costly outcome.
47. Urban Redevelopment Act In Taiwan, the URA 25-1 states that a redevelopment case holds when involved owners whose ownership amounts to at least 4/5 of the area reach an agreement on the case. This is an typical example of externality. However, property rights are seriously violated.
48. Transactions Costs Reciprocal nature of problem People are ignorant about the solution for farmers to move back the crops. This is mainly because the trains are considered as the cause of the problem. In fact, the railroad is no more the cause of the fires than the crops are. Ex: Shi-da night market in Taiwan
49. Sources of Transactions Costs Principal-agent problem Miners vs mining company taking the liability for workers being injured. CT implies that it does not matter if there is no transactions costs. However, moral hazard problems may occur as miners are likely to be less careful if the liability for injuries belongs to the company. The P-A problem occurs b/c the miners’ behaviors cannot be fully monitored.
50. Sources of Transactions Costs (con’t) AIDS blood test Blood test cannot be 100% precise. CT implies that the liability rule does not matter if there is no transactions costs. In this case, monitoring difficulty could happen both ways.
51. Sources of Transactions Costs (con’t) Incomplete property rights In the Sturgesvs Bridgeman case, the quiet environment is owned by only Bridgeman or by all potential confectioners? Free Riders If victims of a pollution case are large in number, it’s likely that some are willing to be free riders.
52. Law and Economics British and U.S. courts Common law vscivil law Liability rules and property rights Promote economic efficiency Solve problem using least expensive method Reduce transactions costs
53. Law of Torts Acts that cause damages to others
54. Law of Torts The law of torts is relevant here because according to which the court can redistribute income, but it cannot change the size of the social pie. That is, CT might apply. However, stories are sometimes more complicated than what CT can predict. A main concern is that this view fails to consider how the court’s decision affects the future acts of others.
55. Law of Torts There are different standards of liability.
56. Law of Torts Standards of liability (1) Negligence: A defendant’s failure to take precautions whose cost is less than the damage caused an accident multiplied by the probability that the accident will occur. This standard can lead to inefficient outcomes. Eg: the victim can prevent the accident at low cost.
57. Law of Torts Standards of liability (2) Contributory negligence: A plaintiff’s failure to take precautions whose cost is less than the damage caused by an accident multiplied by the probability that the accident will occur. But this might also lead to inefficient outcomes.
58. Law of Torts Standards of liability (3) Strict liability: Liability that exists regardless of whether the defendant has been negligent. Efficient on the defendant’s side, but the victim has no incentive to take any precautionary measures.
59. Law of Torts Standards of liability (3) Strict liability: Liability that exists regardless of whether the defendant has been negligent. Efficient on the defendant’s side, but the victim has no incentive to take any precautionary measures.
60. Law of Torts Bottomline: incentive is the key.
61. Example: heartbreak hotels A defibrillator is a $2,000 device that can restart a human’s heart following a cardiac arrest.
62. Example: heartbreak hotels Why Hotels Resist Having Defibrillators, WSJ 2009/02/24 Because they worry that they will be sued for not using them properly.
63. Example: heartbreak hotels This is a problem of negligence standard. Under strict liability, hotels would keep more on hand.
64. Criminal penalty and punitive damages In 1989, the Exxon oil tanker went aground off Alaska. Exxon spent $2-3B settling lawsuits and cleaning up the mess. Is this enough? Judge RusselHoland said: No, arguing for criminal charge and heavy fine. What do you think?
65. Positive Theory Posner argues that the common law has tended to embody standards the encourage economic efficiency. This maintains to the contrary to the principle of “Whose ox is being gored?” (that is, who wins and who loses), because Posner’s argument implies that law’s main concern is to minimized gored oxen, regardless of who owns them.
66. Positive Theory Example: general average: the rule of law that dictates the division of losses when cargo is jettisoned to prevent a disaster at sea. Losses should be proportionally divided according to each person’s share in the venue. If the ship is worth $25k and the cargo $75k. If 3k belongs to you, you pay for 3% of the losses despite who owns it. This is efficient how?
67. Positive Theory Example: Respondeat superior: the liability of an employer for torts committed by his employees. But this responsibility does not apply when the victim is a coworker of the employee.
68. Normative Theories Contrary to Coase and Posner, some argue that goals other than economic efficiency should be given great weight. Good Samaritan rule stating that a bystander has no duty to rescue a stranger in peril is not efficient. Why? This rule is good because the bystander is not the cause of the danger.