Solution Manual for Law and Economics, 6th Edition, Robert D Cooter Thomas Ulen Solution Manual by TBtutors

Type:

Solution Manual

Resource:

Law and Economics

Edition:

6th Edition

Author(s):

Robert D. Cooter Thomas Ulen

Instructor’s Manual to accompany

Law and Economics Sixth Edition

Robert Cooter University of California, Berkeley

Thomas Ulen University of Illinois, Urbana-Champaign

Authored by Thomas Ulen University of Illinois, Urbana-Champaign

Acquisitions Editor: Noel Kamm Seibert Editorial Assistant: Melissa Pellerano Production Editor: Alison Eusden Manufacturing Buyer: Carol Melville Copyright © 2012 Pearson Education, Inc., 75 Arlington Street, Boston, MA 02116. Pearson Addison-Wesley. All rights reserved. Printed in the United States of America. This publication is protected by copyright and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise. For information regarding permission(s), write to: Rights and Permissions Department. This work is protected by United States copyright laws and is provided solely for the use of instructors in teaching their courses and assessing student learning. Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted. The work and materials from it should never be made available to students except by instructors using the accompanying text in their classes. All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials.

Pearson Addison-Wesley™ is a trademark of Pearson Education, Inc.

ISBN-13: ISBN-10:

978-0-132-54070-4 0-132-54070-3

Contents Chapter 1

An Introduction to Law and Economics......................................................................

Chapter 2

A Brief Review of Microeconomic Theory ................................................................

Chapter 3

A Brief Introduction to Law and Legal Institutions ....................................................

Chapter 4

An Economic Theory of Property ...............................................................................

Chapter 5

Topics in the Economics of Property Law ..................................................................

Chapter 6

An Economic Theory of Tort Law ..............................................................................

Chapter 7

Topics in the Economics of Tort Liability ..................................................................

Chapter 8

An Economic Theory of Contract Law .......................................................................

Chapter 9

Topics in the Economics of Contract Law ..................................................................

Chapter 10

An Economic Theory of the Legal Process .................................................................

Chapter 11

Topics in the Economics of the Legal Process ............................................................

Chapter 12

An Economic Theory of Crime and Punishment ........................................................

Chapter 13

Topics in the Economics of Crime and Punishment ...................................................

Introduction Sixth Edition, Law & Economics, Cooter & Ulen This is the Instructor’s Manual for the sixth edition of Law and Economics. We have continued to maintain—and, we hope, improve—the website that we first put up several years ago in conjunction with the third edition. Indeed, we have undertaken a complete overhaul of the website to coincide with the publication of this edition. In this introduction we seek to explain what the manual tries to do and how the Website—www.pearsonhighered.com/cooter_ulen—might work with the book during a semester-long course. What roles do we perceive for the Companion website and for this manual? The Manual is meant for instructors only. It contains information on teaching techniques, extensions of the course material, emphases that you might want to place on the topics covered, and some ideas for making the material exciting, for helping the students learn the material better, and for enlivening class discussions. The Instructor’s Resource Center will also contain some additional material—sample examinations, PowerPoint presentations, sample syllabi, and more. The Companion Website, by contrast, is meant for both students and instructors as a means of updating the material that is in the text, bringing new and important topics to the attention of those studying the material, offering additional practice questions, dealing with material that is more current than that in the text, extending some of the discussions in the text, and so on. As in previous editions, we have inserted what we call “Web Notes” in the text of this edition. These refer readers to entries on the Companion website where we elaborate on the textual material. For an example, consider Web Note 1.1. That is at the end of the section in Chapter 1 in which we discuss the relationship between economic efficiency and equity. In 2001 Louis Kaplow and Steve Shavell of the Harvard Law School published a very important book entitled Fairness Versus Welfare. The book’s central contention is so important to law and economics that we considered discussing it in the text. But in the end we opted for textual brevity and left it out. The device of the Web Note allows us, however, to have our cake and eat it, too. So, returning to Web Note 1.1 we discuss Fairness Versus Welfare and several important reviews of that work, including work by Chris Sanchirico, Dan Farber, and Richard Fallon. Your students who are most eager to expand their understanding of the course material will probably have read the Web Notes. (We return to Kaplow and Shavell in Web Note 12.1.) Finally, Ulen has used PowerPoint presentations for his law students for several years. Those presentations are posted on the Instructor’s Resource Center.

◼

A Guide for the Use of the Text and of This Manual

One of the issues with which we have wrestled in putting together this Manual is how best to deal with the wide-ranging audience of instructors and students. Law and economics is taught principally in economics departments and law schools. We can testify from personal experience that those are two very different venues and two very different audiences. For example, a class of upper-level economics undergraduates may know microeconomic theory, mathematics, game theory, and some econometrics but has very little knowledge and understanding of the legal system. A class of second- or third-year law students has precisely the reverse set of talents: They are very comfortable with legal reasoning and the institutions of the legal system but have little understanding (and often a great fear) of economic theory and mathematics. Add the additional audiences of business school, public policy programs, other parts of the academy, and, importantly, other countries, and one realizes that law and economics is being taught to a very broad range of students and by a diverse range of instructors. This presents special challenges for us in putting together this Manual.

Introduction v

Our guiding principle here has been to include material that would be of interest to the broadest range of instructors and students. As should or will be evident, we find law and economics to be an extremely exciting field. That makes the material, we believe, easy to teach. Just as importantly, most students find the subject matter inherently interesting. Class discussions about issues in law and economics are usually vigorous and illuminating. Part of what we include here are examples of the issues that we have found to be most stimulating for the students, particularly in class discussion. This text is too long to march through in a semester, although we both try to do so. We almost invariably find that our best intentions to the contrary notwithstanding (to use a time-honored legal phrase), we get through the first nine chapters but do not get through all of Chapters 10, 11, 12, and 13. (Previous editions had only 12 chapters. We have now split Chapter 10 into two chapters, a theoretical and an applications chapter.) Of course, each instructor will change the coverage as he or she thinks best. But you should be prepared to cut and paste and rearrange and supplement the material to suit your own and your students’ purposes. Here are our suggestions concerning what to include and exclude in your class. You will notice that the recommendations stress the theoretical chapters and generally call for selected coverage of the more applied chapters. There will be differences in taste on these matters, but we believe that if sacrifices have to be made, they should be made with respect to the applications. If our experience is a guide, you will find that you get many, many opportunities in class discussion to apply this material to pressing issues. Recommended chapters

◼

Type of class

Prerequisite

Cover in full

Cover selectively

Omit

Undergrad. economics

Microeconomics

1, 3, 4, 6, 8, 10, 12

5, 7, 9, 11, 13

Undergrad. legal studies

Legal studies

1, 2, 3, 4, 6, 8, 10, 12

5, 7, 9, 11, 13

Undergrad., general

None

1, 2, 3, 4, 6, 7, 10

Grad. policy or business Grad. policy or business

Microeconomics None

1, 3, 4, 6, 8, 9, 13 1, 2, 3, 4, 6, 8, 9, 12

5, 7, 10, 12 5, 7, 10, 11, 13

Law class

Microeconomics

1, 4, 6, 8, 10, 12

applications

2, 3

Law class

None

1, 2, 4, 6, 8, 10, 12

5, 7, 9, 11, 13

Law seminar

None

1, 4, 6, 8, 10, 12

5, 7, 9, 11, 13

2, 3

5, 7

Additional Course Materials

We each use additional course materials beyond the text, the Web material, and the materials posted on the Instructor’s Resource Center. These additional materials include excerpts from journal articles, clippings from newspapers, court opinions, and the like. If you are interested in seeing what things we use, please don’t hesitate to contact us and ask. We’d be happy to send you copies of the materials that we use. You have some great ideas, too. As you’ll see in the next section, we’d love to hear from you about how you teach the course, what materials you use, and so on.

Cooter/Ulen • Law & Economics, Sixth Edition

◼

A Note to Previous Users

Please note that the order of the chapters in this edition has changed and that a new chapter has been added. We explain these changes in the preface to the new edition. Our hope is that this reordering will help the exposition without significantly disrupting previous lesson plans, and that the addition of a second applications chapter on the legal process will also help the book’s balance between theory and applications.

◼ Feedback We are eager to learn from you about your own experiences in teaching this material and any suggestions that you would like to share with us and with other users of this text about teaching techniques. You would be surprised to learn how much we have changed in the various editions of this book in response to communication with students and faculty. We have made provision on the Companion website for students and others to communicate with us. But we also invite you to let us hear from you directly. The best way to communicate with us is by means of e-mail. Cooter is available at rcooter@law.berkeley.edu. Ulen is available at tulen@law.illinois.edu; his phone number is (217) 333-4953. If you would prefer to write to us by U.S. mail, here are our addresses: Professor Robert D. Cooter Herman Selvin Professor of Law School of Law (Boalt Hall) University of California Berkeley, CA 94720 Professor Thomas S. Ulen Swanlund Chair Emeritus and Professor Emeritus of Law University of Illinois College of Law 504 E. Pennsylvania Ave. Champaign, IL 61820

◼

Acknowledgments

In the preparation of this manual and of the Web Notes that accompany the text we have had the great research help of Brian Doxey of the University of Illinois College of Law. Sally Cook has provided her usual superb help with all manner of things.

Chapter 1 An Introduction to Law and Economics The introductory material in this chapter is very similar to that in previous editions. Most law students will find it either off-putting or suspicious that economists pay so much attention to efficiency and not much to fairness or justice. So, it’s worth saying whatever one can early in the semester about this topic. The section on the efficiency aspects of achieving an equitable distribution of resources makes what seems to us to be an uncontroversial point—namely, that in seeking an equitable outcome, one ought to pay attention to efficiency considerations—but it is a point about which there has been much sturm und drang in the professional literature. There is more on this issue on our website.

◼

Efficiency; Positive and Normative; Ex Ante; and Empirical

Over the years we have found that although law students are becoming increasingly familiar with economic (and other social scientific) concepts, there is, nonetheless, some deep and persistent misunderstandings about economics among noneconomists. One that seems nearly impervious to reasoned refutation is that economics is a handmaiden to a very conservative political philosophy. It may be that there is a sensible explanation for why this view is so widespread, but if so, neither of us has expressed it or heard it. We have also found that there are some emphases that you might want to make in discussing the material in this chapter. First, be sure to stress the difference between positive and normative analyses. Economic analysis is insightful in both tasks. Even those who are skeptical of efficiency as a legal norm must recognize the value of economic analysis in performing positive analysis. Second, we have found that stressing the ex ante analysis of the effects of legal rules is crucial. This is especially so with regard to law students. Legal education tends to focus on the resolution of disputes. Indeed, in the United States the principal method of teaching any substantive area of the law is to read the opinions of appellate justices. There’s no denying the value of this method of teaching the law. But it also has costs. One is that law students tend to focus on how best to resolve disputes than on how best to avoid disputes. Law and economics clearly puts a much stronger emphasis on the prospective effect of law—that is, on a law’s likely effect on future human behavior—than does traditional doctrinal analysis. Third, we believe that one of the most significant developments in law and economics since the publication of the early editions of this book has been the rapid rise of empirical legal studies. Indeed, there is now a first-rate scholarly journal entitled the Journal of Empirical Legal Studies. You might want to alert your students to the fact that this edition of the book, unlike previous editions, now contains, as an integral part of each subject, an extensive discussion of the empirical literature in this area. Preparing the students to think about the empirical aspects of the subject—does the patent system really encourage innovative and inventive activity, and how would we know?—is an important innovative element of law and economics in the legal curriculum.

Cooter/Ulen • Law & Economics, Sixth Edition

◼ Introduction to Law and Economics Part of the delight of this course is the reading and discussion of written opinions of courts in some real disputes. The founding article of law and economics—Ronald Coase’s, “The Problem of Social Cost,” 3 J. Law & Econ. 1 (1960)—contained this wonderful case. We’ll describe it in some detail because it serves as a wonderful introduction to the subject. Or you might use these facts in an examination or in a later class discussion. The case of Sturges v. Bridgman involves a dispute about the use of property in London in the 1870s. The plaintiff (the person who files a complaint) was a Dr. Sturges. He felt that his neighbor, Mr. Bridgman, had interfered with his legitimate use of his property. Dr. Sturges had built a consulting room at the end of the garden behind his home. As was the custom for doctors then, he held examinations of his patients in that room. Apparently to save money in building the room and to preserve as much of his garden as possible, Dr. Sturges had built the wall of his consulting room hard against the back wall of his neighbor, Mr. Bridgman. Thus, the neighbors shared a wall, which was called a “party wall.” The Bridgmans operated a confectionery-manufacturing operation in their kitchen, and their kitchen wall was also the back wall of Dr. Sturges’ consulting room. When the confectionery-manufacturing machines were going, they made such a racket that Dr. Sturges could not properly examine his patients. He brought an action against the Bridgmans to ask the court to order them to stop making so much noise during his office hours. The Bridgmans answered this complaint by saying that they were using their property in a perfectly legitimate manner, and, moreover, they had been doing so for over 60 years without anyone’s complaining of noise and vibration. They suggested that the doctor could not fairly claim that he had been surprised by their manufacturing activity. He knew or should have known that they were using noisy machinery when he decided to build his consulting room hard against their kitchen wall. Here is what the court said about the matter and how they tried to resolve this dispute: Sturges v. Bridgman 11 Ch.D. 852 (1879)1 The Plaintiff in this case was a physician. In the year 1865 he purchased the lease of a house in Wimpole Street, London, which he occupied as his professional residence. Wimpole Street runs north and south, and is crossed at right angles by Wigmore Street. The Plaintiff’s house was on the west side of Wimpole Street, and was the second house from the north side of Wigmore Street. Behind the house was a garden, and in 1873 the Plaintiff erected a consulting-room at the end of his garden. The Defendant was a confectioner in large business in Wigmore Street. His house was on the north side of Wigmore Street and his kitchen was at the back of his house, and stood on ground which was formerly a garden and abutted on the portion of the Plaintiff’s consulting-room and the Defendant’s kitchen [abutted] the party-wall. The Defendant had in his kitchen two large marble mortars set in brickwork built up to and against the party-wall which separated his kitchen from the Plaintiff’s consulting-room, and worked by two large wooden pestles held in an upright position by horizontal bearers fixed into the party-wall. Those mortars were used for breaking up and pounding loaf-sugar and other hard substances, and for pounding meat.

Recall what this citation means. The report of this case may be found in volume 11 of the Chancery Division, one of the major courts in England, beginning on page 852. The opinion was published in 1879.

Chapter 1

An Introduction to Law and Economics

The Plaintiff alleged that when the Defendant’s pestles and mortars were being used the noise and vibration thereby caused were very great, and were heard and felt in the Plaintiff’s consulting-room, and such noise and vibration seriously annoyed and disturbed the Plaintiff, and materially interfered with him in the practice of his profession. In particular the Plaintiff stated that the noise prevented him from examining his patients by auscultation for diseases of the chest. He also found it impossible to engage with effect in any occupation which required thought and attention. The use of the pestles and mortars varied with the pressure of the Defendant’s business, but they were generally used between the hours of 10 a.m. and 1 p.m. The Plaintiff made several complaints of the annoyance, and ultimately brought this action, in which he claimed an injunction to restrain the Defendant from using the pestles and mortars in such manner as to cause him annoyance.2 The Defendant stated in his defense that he and his father had used one of the pestles and mortars in the same place and to the same extent as now for more than sixty years, and that he had used the second pestle and mortar in the same place and to the same extent as now for more than twenty-six years. He alleges that if the Plaintiff had built his consulting-room with a separate wall, and not against the wall of the Defendant’s kitchen, he would not have experienced any noise or vibration. [The trial court focused on a single issue: whether the Bridgmans had acquired a right to create noise and vibration against their neighbors by virtue of having done so continually for 60 years with one mortar and pestle and for 26 years with two. The trial court held that no one can acquire a right to create a nuisance and that, therefore, Dr. Sturges was entitled to an injunction against the Bridgmans. The Bridgmans appealed this judgment to a higher court.] 1879, July 1. THESIGER, L.J., delivered the judgment of the Court (James, Baggallay, and Thesiger, L.JJ.)3 as follows: [If the general rule was that the Plaintiff had a right to be free from the noise and vibration being generated from the Defendant’s property, this rule] would result in the most serious practical inconveniences, for a man might go—say into the midst of the tanneries of Bermondsey, or into any other locality devoted to a particular trade or manufacture of a noisy or unsavory character, and, by building a private residence upon a vacant piece of land, put a stop to such trade or manufacture altogether. The case also is put of a blacksmith’s forge built away from all habitations, but to which, in course of time, habitations approach. We do not think that either of these hypothetical cases presents any real difficulty. As regards the first, it may be answered that whether anything is a nuisance or not is a question to be determined, not merely by an abstract consideration of the thing itself, but in reference to its circumstances … where a locality is devoted to a particular trade or manufacture carried on by the traders or manufacturers in a particular and established manner not constituting a public nuisance, Judges and juries would be justified in finding, and may be trusted to find, that the trade or manufacture so carried on in that locality is not a private or actionable wrong. … It would be on the one hand a very high degree unreasonable and undesirable that there should be a right of action for acts which are not in the present condition of the adjoining land, and possibly never will be any annoyance or inconvenience to either its owner or occupier; and it would be on the other hand in an equally degree unjust, and, from a public point of view, inexpedient that the use and value of the adjoining land should, for all time and under all circumstances, be restricted and diminished by reason of the continuance of acts incapable of physical interruption, and which the law gives no power 2

An injunction is an order from the court to the defendant requiring him or her to do something or, as here, to refrain from doing something. We shall discuss injunctions at more length in Chapter 5.

The abbreviations mean “Lord Justice” and “Lords Justice.”

Cooter/Ulen • Law & Economics, Sixth Edition

to prevent. The smith in the case supposed might protect himself by taking a sufficient curtilage4 to ensure what he does from being at any time an annoyance to his neighbor, but the neighbor himself would be powerless in the matter. Individual cases of hardship may occur in the strict carrying out of the principle upon which we found our judgment, but the negation of the principle would lead even more to individual hardship, and would at the same time produce a prejudicial effect upon the development of land for residential purposes. The Master of the Rolls in the Court below took substantially the same view of the matter as ourselves and granted the relief which the Plaintiff prayed for, and we are of opinion that his order is right and should be affirmed, and that this appeal should be dismissed with costs. What legal rule did the court propound? What is the implicit price placed on different types of behavior affected by that rule? And is that rule (and its implicit price) efficient? The court in Sturges found for the plaintiff and in so doing said that noise and vibration produced on one person’s private property is a nuisance if it causes harm to some other person’s use of her private property. Moreover, the nuisance-creator (in this case, the Bridgmans) did not acquire a right to create noise and vibration by having done so without complaint over a long period of time. As to the implicit price on different types of behavior affected by this rule, note that the court speculated on this matter. It asked whether this rule might induce someone to build a private residence in an area previously devoted to the very smelly operation of tanneries and then to seek an injunction against the continued operation of those tanneries on the ground that they were disturbing the new residents. Or the court suggested that its rule might induce potential nuisance-creators, such as a blacksmith, to purchase large tracts of land around their operations to serve as buffers against harming others. These are valid points, but notice that the court dodges the issue of whether these results, these types of behavior induced by its rules, are desirable. Instead, the court said—as courts frequently do—that it would not speculate on these hypotheticals. Rather, it would prefer to let future courts resolve these issues as future parties brought new circumstances before those courts. (This strategy is frequently referred to as dealing with issues “on a case-by-case basis,” rather than by the application of a blanket rule. You might ask the students about the differences between the institutional competencies of legislatures and courts to deal with these broad questions. The general feeling is that legislatures can tackle broader issues than can courts, which must, by and large, confine themselves to the facts before them.) What about the efficiency of the legal rule in Sturges? From an economic standpoint, we are eager to have the legal rule in situations of conflicting uses of property or of nuisance encourage the most productive use of all of the resources involved. In the case of Sturges v. Bridgman it is fairly certain that the two conflicting uses—the manufacture of confectionery and the examination of patients—are simply incompatible. One of them will have to cease at its present site and re-locate. The question is which one ought to do this. Presumably the use that should cease is the one that is, all things considered, less valuable. If, for instance, confectionery manufacture is more valuable than the doctor’s provision of medical services, the Bridgmans should remain, and Dr. Sturges should go. If the doctor’s services are more valuable, then Dr. Sturges should remain, and the Bridgmans should go. (Be sure to contrast this with the way in which the court—typically any court—would deal with this matter. It would try to find out who had the prior right or who was inflicting unwarranted harm on whom. Having answered those questions, the court will have resolved the matter legally.) One way to use this case is to anticipate the discussion of the Coase Theorem in Chapter 4. The discussion that follows shows how this might be done.

“Curtilage” is the land around a house and within an enclosure.

Chapter 1

An Introduction to Law and Economics

Assuming this to be the economic way to look at issues of conflicting property rights, we are led to ask if the legal rule enunciated in 1879 is efficient. However, as we’ve seen, the legal rule is not entirely clear. On the one hand, the court may have said that the nuisance-creator should never prevail. If that were the rule, we could say that it is not necessarily efficient because it does not allow for the possibility that the nuisance-creator’s actions are more valuable than those of the plaintiff. On the other hand, the court may have said that in this case only the nuisance-creator (Bridgman) should lose but that in different circumstances he or she might win, depending on the facts. This interpretation is more compatible with our efficient rule that the more valuable use should prevail (and, implicitly, that the more valuable use might sometimes be the plaintiff and sometimes the defendant). There is a third possibility—that the legal rule in situations like that in Sturges does not matter to the efficient use of resources by the confectioner and the doctor. That is, it could be that the more valuable use will prevail regardless of which rule the court adopts. This would be the case if the costs to the nuisancecreator and the complainant of concluding a private agreement to limit the nuisance are very low. In those circumstances the amount of the nuisance and the amounts of production by both parties will be efficient, whatever the legal rule. Thus, when the costs of concluding a private agreement are low, whether the law states that the Bridgmans are entitled to create noise and vibration or that Dr. Sturges is entitled to be free from noise and vibration, there will be an efficient amount of the nuisance and an efficient amount of confectionery and of doctor’s services. This remarkable conclusion—which we shall explore in much more detail in Chapter 4—is, of course, the Coase Theorem, named after its author, Professor Ronald Coase, in this very article from which Sturges v. Bridgman is taken—“The Problem of Social Cost.” To see why this conclusion follows, let us imagine an unlikely but dramatic solution to this nuisance problem in Sturges: Dr. Sturges marries the owner of the confectionery factory. As a result, the cost of coordinating the activities of the factory and the doctor become very low. We would confidently expect the couple to coordinate their activities so as to maximize the total profits of the two enterprises—that is, to maximize their combined income, regardless of whether the law would protect the doctor’s practice from the noise and vibration from the confectionery. Rational bargainers facing low bargaining costs will do just as well as a married couple, because they will bargain until they exhaust the possibilities for mutual gain, which occurs when the total profits of the two enterprises are maximized. For example, suppose that the damage suffered by the doctor because of the disruption is $5,000 in lost income and that the cost to the factory of installing less noisy equipment, moving the existing equipment, or adjusting its production schedule so as to eliminate the nuisance to the doctor is $10,000. Assume, furthermore, that the two parties can bargain between themselves at low cost. How will different rules of law affect this situation? If the rule of law entitles the factory to make as much noise and vibration as it likes, then the factory can create its nuisance with impunity. So, it will go on polluting. The doctor will simply have to suffer $5,000 in losses. But what if the law gives a right to the doctor to be free from the factory’s noise and vibration? One might think that the result of this different assignment of rights would force the factory to spend $10,000 to eliminate its nuisance entirely. But under our assumption of low bargaining costs, that result is unlikely. A mutually beneficial transaction is possible that allows the factory to continue its production and nuisance and also allows the doctor to be compensated for the loss of $5,000 that the noise and vibration inflict. If the factory stops its noise and vibration entirely, then it loses $10,000, and the doctor benefits $5,000. Both will benefit if some alternative can be found that pays the doctor more than his $5,000 in losses but costs the factory less than $10,000. Suppose, for example, that the Bridgmans pay Dr. Sturges $7,500 in exchange for the doctor’s waiving his right to be free from the nuisance and allowing the factory to continue to create the noise and vibration. Under this alternative, the doctor is paid $7,500 for putting up with $5,000 ©2012 Pearson Education, Inc. Publishing as Addison Wesley

Cooter/Ulen • Law & Economics, Sixth Edition

in damages, thus enjoying a net profit of $2,500. Similarly, the factory is better off paying $7,500 to the doctor instead of incurring the expense of $10,000 to reduce the noise and vibration. Both parties are better off. So, under the assumption of low bargaining costs, the factory will continue its method and location of production whether the law gives the doctor the right to be free from the nuisance or gives the nuisancecreator the right to emit noise and vibration.

Chapter 1

An Introduction to Law and Economics

There is a useful, general way to describe these facts: if someone values an asset—whether it be automobiles, wheat, labor, or legal rights—more than its owner, then there is scope for mutual gain by exchange. We may think of the agreement between the doctor and the factory as an exchange of legal rights. The potential gains from exchange are not exhausted unless the total profits from the two enterprises are maximized.

◼ Impact of Law and Economics One of the exciting things to tell the students is that law and economics is having a real impact on how courts decide cases. In a recent article by Professor Carol Rose of the Yale Law School—“Canons of Property Talk, or, Blackstone’s Authority,” 108 Yale L.J. 601 (1998)—these two cases are cited as examples of how law and economics is becoming part of the general language of judges: Westfarm Assocs. v. Washington Suburban Sanitary Comm’n., 66 F.3d 669, 679 (4th Cir. 1995) (discussing “externalities”); and Gail v. United States, 58 F.3d 580, 585 n.7 (10th Cir. 1995) (discussing “transaction costs”). The bigger impact of law and economics is clearly on legal scholarship, particularly, but not exclusively, in the United States. Every law student today learns a lot of law and economics in the study of the traditional law school courses. Indeed, one can hardly go through the first semester of an American law school education without hearing about the Coase Theorem in property law, efficient breach of contract in contract law, and the least-cost-avoider in tort law. And the impact of law and economics continues in almost every other course taught in the modern curriculum. Most law professors today in the United States use law and economics in their research. In fact, some of them are so adept at economic reasoning and the techniques of game theory and econometrics that you would think that they have had formal training in economics—even though most have not. One could argue—one of us has—that this is revolutionizing legal scholarship and legal education. But those contentions are not, perhaps, as important as assuring the students that a knowledge of law and economics is vital to the well-trained lawyer today and essential for those who wish to pursue a scholarly career in the law.

◼

Efficiency and Equity

The most startling aspect of law and economics, especially to law students, is the normative contention that law should be efficient. It is good to say something about this matter early on because it is going to be a constant source of discussion throughout the semester or term. There are two general methods of dealing with this matter. One is to take a temporizing position and say something like this, “Efficiency is important but not necessarily the most important quality of a legal command. Distributional or equitable concerns are, without a doubt, extremely important, and many people feel that, as important as efficiency is, it must play second fiddle to distributional concerns. Presumably even if one believes this, one is also willing to concede that legal decisionmakers should consider efficiency. For example, if we could agree on a distributional goal, we would presumably want to reach it in the most efficient method possible.” The other method is to take a more aggressive position. One might say that the private law adjudication process ought to focus on efficiency and not on distribution. Distribution, one might argue, is the province of the democratic process, of the legislature, but not of the judges who resolve private law disputes. This second method of dealing with the matter takes strength from the article by Steven Shavell and Louis Kaplow referenced in a footnote and from their recent book, Fairness Versus Welfare, and in the Second Fundamental Theorem of Welfare Economics, which holds that issues of efficiency and equity are, in principle, separable. ©2012 Pearson Education, Inc. Publishing as Addison Wesley

Cooter/Ulen • Law & Economics, Sixth Edition

◼ Law and Economics Moot Court One of the devices that we have found to be fun and instructive in teaching undergraduates law and economics is to hold a law-and-economics moot court. Typically, we hold the court toward the end of the semester, when the students have a better understanding of the full range of private law and, perhaps, of criminal law. If you are interested in trying this, we urge you to begin thinking about it early because the organization of the exercise takes some effort. The organizational aspects are three. First, you have to choose and edit suitable cases. You will find some edited cases that we have used on our webpage. Second, you must divide the students into small law firms of three or four, enough so that there are an even number of firms, and pair the firms. We frequently ask each firm to designate one of their members to act as the managing partner so that we can funnel all our paperwork and messages through that one person. Then give each firm a copy of the case and instruct the firm, not each individual, to write a short brief by a certain date and to be prepared for oral argument about one week later. The instructions usually instruct the students that the “Supreme Court of Coseana,” which will hear their oral argument, only entertains economic arguments, although they expect all those who appear before them to understand and to be sensitive to the legal constraints. Third, you will need to ask local attorneys, law school faculty colleagues, local judges, and third-year law students to serve in panels of three judges to hear the oral argument. In addition, you will have to prepare for these judges a “bench brief,” which summarizes the facts in the case, suggests the economic reasoning that you hope the students will pursue in arguing the cases, and even proposes questions that the judges might want to ask. The judges will almost certainly get into the spirit of the moot court on their own, but you can help direct them toward the economic reasoning you hope that the students will pursue by means of this bench brief. Our experience has been that the students take this exercise very seriously. Indeed, many of them spend more time on this than on other requirements of the course. Interestingly, the rigors of oral argument and of the brief seem to reveal the student abilities that might not be evident through the usual methods of evaluating student performance.

Chapter 2 A Brief Review of Microeconomic Theory This chapter reviews microeconomics theory. As the suggested guide for teachers in the Introduction to this manual has indicated, not every class using this text will find that they need to cover this material. Some instructors tell us that even if their students do not know microeconomic theory, they do not take time early in the semester to review this chapter. Rather, they tell the students to read through the chapter on their own. No one should expect students who have never studied economics to emerge from their reading of Chapter 2 a full-blown economist. Perhaps the better message to give to students who have not heretofore studied economics is to read through the chapter solely to familiarize themselves with where in this chapter they can later find treatment of various economic topics. For example, a student may not want to labor over the material on game theory now. Rather, she may want to know where this treatment is in Chapter 2 so that when she meets game theory in Chapters 4 and 8 she can return to this point in Chapter 2 for a refresher. Other teachers tell us that they spend up to three weeks of a fifteen-week semester reviewing microeconomic theory before they get to the legal material. Still others take three or four lectures at the beginning of the semester or term to go over selected parts of Chapter 2. For example, in teaching law students (some of whom were economics majors as undergraduates, but many of whom have never studied economics) one might focus on the sections in Chapter 2 on market failure and decisionmaking under uncertainty. Our experience has been that because a great deal of the economic analysis of law consists of demonstrating that legal commands and institutions can correct for such market imperfections as external costs and benefits, public goods, information asymmetries, and collective action and group coordination problems, students need to be thoroughly familiar with those concepts before launching into Chapter 4 and the subsequent material. Ulen frequently uses the first week of the semester to stress only limited aspects of micro theory for the law students he teaches. For example, he discusses welfare economics much more extensively than is the case in the text, stressing the sources of market failure and their correctives, spending time on the Arrow Impossibility Theorem, and introducing some intriguing uses of economics to discuss important public policy issues, which we describe in more detail below and in the PowerPoint presentations that are available on the Instructor’s Resource website.

◼ Notions of Efficiency Be certain to distinguish between Pareto and Kaldor-Hicks efficiency. Pareto efficiency requires consent— that is, the gainers from a reallocation must receive the explicit consent of the losers. Presumably, they will only be able to do so when their gains are greater than the total of all losses. (In Chapter 4 we refer to this difference as “cooperative surplus.”) In contrast, Kaldor-Hicks efficiency is a species of cost-benefit analysis in which a change is deemed efficient if the total gains exceed the total losses but without the requirement

Chapter 2

A Brief Review of Microeconomic Theory

that the gainers compensate the losers.