Introduction To Law and Economics

Introduction to Law and Economics
 The initial scope of law and economics was limited to anti-trust laws,
taxation and determining monetary damages.
 Got a major break through in 1960s when Economist Ronald Coase

published his work titled ‘The Problem of Social Cost’ citing the case
of Struges v Bridgman
 Law and Economics scholars and jurists such as Richard Posner paved
way through their verdicts.
Economic Analysis of Law
 Largely related to behavioral economics and science,
 If law is an obligation backed by a state sanction, to economists these

sanctions are like prices which change the behavior of the people.
 Eg Higher fines for speeding , cost of imposing higher fines to the state
Efficiency or Distribution
 Distribution by private law such as contract law, property law, and tort
(private legal rights)
Eg If courts rule in favor of a consumer (likely to be the plaintiff) of a
particular good, then the ruling or the law tends to benefit all the consumers.
So is the case with investors, or people of certain occupations.
But, this may not be the efficient distribution as the consumers maybe the
consumers of high end goods,
Why Efficiency over distribution?
Tax and transfer system, progressive taxation and social welfare programs
can achieve redistribution more efficiently than reshuffling of private legal
rights
1. The progressive taxation targets inequality more precisely than
shuffling of private legal rights
2. The distributive effects of reshuffling legal rights are difficult to
measure. Eg. Passing the cost to consumer by increasing the price of
the good
3. Transaction cost of redistribution through private legal rights are high.
Eg cost of attorney of both parties
Positive and Normative Economic
Analysis of Law
 Positive Analysis is based on data, historical instances, tangible

evidences which can be measured. It cannot be approved or
disapproved.
 While normative analysis is a goal setter. It deals with “What should be”
or “what ought to be”
 Richard Posner’s positive claim in economic analysis of law would mean
two things. Either, common law induces efficient behaviour or the law is
efficient (thereby judging the contents of law by efficiency)
 While normative claim in economic analysis of law suggests that law is
ought to be efficient.
Economic Efficiency
 Usually measurable by the ratio of total output to total input

 Economic Efficiency means all the factors of production are allocated
such that they are being utilised to its optimum capacity.
This means that the utilisation of these resources is at the point where
Marginal Cost = Marginal Benefit (or near to it)
 This involves efficient production decisions by firms and industries,

rational consumption decision by consumers.
 It includes allocative efficiency, productive efficiency, distributive
efficiency and pareto efficiency
Output Total Margin Total Margin Total
Cost al Cost Revenu al Profit
e Revenu
e and
Averag
e
Revenu
e
1 15 15 30 30 15
2 25 10 60 30 35
3 40 15 90 30 50
4 60 20 120 30 60
5 85 25 150 30 65
6 115 30 180 30 65
7 155 40 210 30 55
Pareto Optimality
 The concept were developed by Italian Economist Vilfredo Pareto.

 Pareto Optimality or Pareto Efficiency means that a person cannot be
made better off without making someone else worse off
 Pareto Inefficient is a point wherein, a person can be made better off
without making someone else worse off.
 Pareto Improvement is a process where a person is being made better
off without making someone else worse off
 Pareto efficiency is silent of equal, equitable and justifiable allocation
Kaldor- Hicks Compensation Criterion
 If the reallocation of resources is such that the gainer is able to

compensate the lost utility to the one who losses.
 Change in output
 Change in allocation
 Income distribution
 Utility of Money
Ethics of Market
 Distortions?
 Superfluous?
 Harmful ?
 https://link.springer.com/chapter/10.1007/978-94-010-0956-0_8
 https://www.econlib.org/library/Enc/EthicsandEconomics.html
 https://austrian-institute.org/en/subjects/austrian-school-of-economics/
the-ethics-of-the-market-economy-a-critical-appraisal-of-ludwig-von-
mises-utilitarian-interpretation/
Cost Benefit Approach
 Considering the economic motives of any entity, a consumer tries to

maximise his/her utility and producer tries to maximise his/her profit.
Here the utility and the profits are the benefit sought by consumer and
producer respectively.
 The resources that are undertaken to achieve the above benefit and the
expenditure made on those resources is said to be the cost incurred by
an entity.
Private Cost and Social Cost
 Private cost is incurred by a firm while undertaking production. This

cost can be summarised into factor payments, that is, rent, wages,
interest. This would also include other expenditures which a firm may
incur while producing anything (Electricity, Internet, etc)
Likewise, a private cost to a consumer is incurred when expenditure is
made to purchase and utilise the goods that are being produced.
 Social Cost is cost borne by the society (a region, nation etc). This
includes the private cost which firm may incur to produce a product and
the external cost which individual or a community may face without
receiving any proportionate benefit
 To summarise Social Cost = Private cost + External Cost
 Examples of Air, water and noise pollution

Private Benefit and Social Benefit
 Private benefit is the profit or utility a firms and consumers seek to

maximise by making an effort towards it. It is specifically achieved by an
individual entity.
 Social benefit is the benefit which is realised by the society (a region,

nation etc). This includes private benefit and external benefit which may
be realised by individuals or firms without having to incur any
proportionate cost.
 Therefore, Social Benefit = Private Benefit + External Benefit
 Examples, Education, Health,
Subsidies? Loan Waiver?
Marginal Social Cost and Social
benefit
 Marginal Social Cost is the incremental cost that arises from the
production of an additional unit. It is not merely a private cost but
additional external cost caused to the society. It is upward sloping.
Why? (homework)
 Marginal Social Benefit is the incremental benefit that arises from the
consumption of an additional unit. It is not merely a private benefit but
additional external benefit caused to the society. It is downward
sloping. Why?
 Without externalities MPB=MSB & MPC=MSC
Shadow Price
 Shadow price is the price of non-marketed goods after adjusting for

externalities and distortions in the market
 They are considered to be more accurate form of cost benefit analysis.
 However, a lot of assumptions and guesswork goes behind its
calculation, therefore, they remain unsubstantiated at large
 SP are more likely to be employed for public goods since the welfare is
the main objevtive
Social Discount Rate (SDR)
 The gains for today and cost for tomorrow
 https://www.lse.ac.uk/granthaminstitute/explainers/what-are-social-
discount-rates/#:~:text=Social%20discount%20rates%20(SDRs)
%20are,climate%20change%20in%20the%20future.
Types of Externalities
1. Positive Production
2. Positive Consumption
3. Negative Production
4. Negative Consumption
Causes of Market Failure
1. Monopoly and Market Power

2. Externalities
3. Public Goods
a. Non-Rivalrous
b. Non-Excludability
4. Asymmetric Information

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Introduction to Law and Economics

 Got a major break through in 1960s when Economist Ronald Coase

 Largely related to behavioral economics and science,

 If law is an obligation backed by a state sanction, to economists these

 Positive Analysis is based on data, historical instances, tangible

 Usually measurable by the ratio of total output to total input

 This involves efficient production decisions by firms and industries,

 The concept were developed by Italian Economist Vilfredo Pareto.

 If the reallocation of resources is such that the gainer is able to

 Considering the economic motives of any entity, a consumer tries to

 Private cost is incurred by a firm while undertaking production. This

 Examples of Air, water and noise pollution

 Private benefit is the profit or utility a firms and consumers seek to

 Social benefit is the benefit which is realised by the society (a region,

 Shadow price is the price of non-marketed goods after adjusting for

 The gains for today and cost for tomorrow

1. Monopoly and Market Power

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