law econ slides
Common Law 2
• Applied in English-language countries such as USA, England,
Canada, Australia and New Zealand.
• To a large degree, law is made and developed by judges
(“Richterrecht”) instead of legal code.
• Roots in medieval England, where courts of the English king tried to
find law, as it was already applied in the common practice of people.
• The finding of such rules resulted in precedents, which were
expected to be followed by courts throughout.
⇒ Gradual change of law over time
2The slides for this part are based on slides by Gerd Muelheusser and Berno Buchel. ¨
41
Introductory Concepts | Legal Background
Civil Law
• Except England, applied in most of Western Europe (e.g., France,
Germany, Switzerland, Spain, Italy, Netherlands) and other parts of
the world which were formerly colonized by these countries (e.g.,
Central and South America)
• Source is the Code Napoleon (1804), which itself builds on ´ Corpus
Juris Civilis (528-534), due to the Roman Emperor Justinian
(Roman Law).
• Spread throughout Europe in the course of Napoleon dominating
large parts of Western Europe in the beginning of the 19th century.
• Judges place more weight in (correctly) interpreting legal statues
rather than the more case-based approach in Common Law.
• However, differences between the two traditions in how law is
actually made should not be over-estimated...
42
Introductory Concepts | Legal Background
Further Differences Between the Two
Traditions
• The Role of the Judge in Trial:
• Adversarial process (Common Law): Arguments made and
evidence presented by either party’s lawyer. Judge rather
neutral, acting like a referee, ensuring that procedural rules are
followed
• Inquisitorial process (Civil Law): Court has a direct interest in
“finding the truth”. Judge takes more active role.
• Use of Juries:
• Much more common in Common Law tradition, especially in
the US.
43
Introductory Concepts | Positive & Normative Analysis
What is Law & Economics
• Studying the law from an economic viewpoint, focusing on the
incentives generated by the legal system.
• The economic approach to law assumes that rational individuals
view legal sanctions (monetary damages, prison) as implicit prices
for certain kinds of behavior.
• These prices can be set by legislators to guide these behaviors in a
socially desirable direction.
44
Introductory Concepts | Positive & Normative Analysis
Positive Analysis
• Explaining consequences of legal sanctions for behavior:
• Will longer prison sentences deter more crime?
• How will changes in tort rules affect the accident rate?
• Does the death penalty reduce the murder rate?
• Underlying assumption: people do respond to the incentive
structure generated by the law.
45
Introductory Concepts | Positive & Normative Analysis
Normative Analysis
• How can the law be improved to better achieve the goal of
efficiency?
• Economic point of view: efficiency is a goal that the law should
reflect. Therefore, legal rules should be changed when they fail to
achieve it.
• In some cases, efficiency serves as a good proxy for social welfare.
• Not uncontroversial. Alternative view: Efficiency not the primary
norm for the law. Rather it should do “Justice” (Fairness).
46
Introductory Concepts | Efficiency
Pareto Efficiency
• Recall that Pareto efficient allocations are “best” among all possible
allocations in the following sense:
1. Allocation A is said to be Pareto-superior or to constitute a
Pareto improvement compared to allocation B if all individuals
are at least as well off under A compared to B, and at least one
is strictly better off.
2. Allocation A is said to be Pareto efficient if there exists no other
allocation that is Pareto-superior to A.
47
Introductory Concepts | Efficiency
Pareto Efficiency: Advantages and
Weaknesses
• Advantage: Reallocations only if neither party is made worse off.
⇒ Pareto-superior changes can be expected to be consensual
(although not necessarily consistent with Nash-Equilibrium!).
• Weakness:
1. Set of Pareto efficient allocations typically not a singleton,
2. The different allocations within this set cannot be ranked
(non-comparability), but they might have different normative
appeal.
3. In reality, any regime change will typically harm at least one
group of individuals (i.e. regime change not a Pareto
improvement).
⇒ not a useful criterion in practice.
48
Introductory Concepts | Efficiency
Kaldor-Hicks Efficiency (Compensation)
• Addressing non-comparability problem by relaxing Pareto criterion
referred to as Kaldor-Hicks efficiency.
• Cost-benefit-analysis: When moving from allocation B to allocation
A, A is Kaldor-Hicks superior if winners gain more than losers would
lose, so that the former could (in principle) compensate the latter.
• Allocation A is said to be Kaldor-Hicks efficient if there exists no
other allocation that is Kaldor-Hicks superior to A.
• Requires intra-personal utility comparison.
• If compensations were actually carried out, then moving to an
allocation which is Kaldor-Hicks superior would in fact also
constitute a Pareto improvement.
• Without compensation, there are winners and losers so that
changes are less likely to be consensual.
• Applied in English-language countries such as USA, England,
Canada, Australia and New Zealand.
• To a large degree, law is made and developed by judges
(“Richterrecht”) instead of legal code.
• Roots in medieval England, where courts of the English king tried to
find law, as it was already applied in the common practice of people.
• The finding of such rules resulted in precedents, which were
expected to be followed by courts throughout.
⇒ Gradual change of law over time
2The slides for this part are based on slides by Gerd Muelheusser and Berno Buchel. ¨
41
Introductory Concepts | Legal Background
Civil Law
• Except England, applied in most of Western Europe (e.g., France,
Germany, Switzerland, Spain, Italy, Netherlands) and other parts of
the world which were formerly colonized by these countries (e.g.,
Central and South America)
• Source is the Code Napoleon (1804), which itself builds on ´ Corpus
Juris Civilis (528-534), due to the Roman Emperor Justinian
(Roman Law).
• Spread throughout Europe in the course of Napoleon dominating
large parts of Western Europe in the beginning of the 19th century.
• Judges place more weight in (correctly) interpreting legal statues
rather than the more case-based approach in Common Law.
• However, differences between the two traditions in how law is
actually made should not be over-estimated...
42
Introductory Concepts | Legal Background
Further Differences Between the Two
Traditions
• The Role of the Judge in Trial:
• Adversarial process (Common Law): Arguments made and
evidence presented by either party’s lawyer. Judge rather
neutral, acting like a referee, ensuring that procedural rules are
followed
• Inquisitorial process (Civil Law): Court has a direct interest in
“finding the truth”. Judge takes more active role.
• Use of Juries:
• Much more common in Common Law tradition, especially in
the US.
43
Introductory Concepts | Positive & Normative Analysis
What is Law & Economics
• Studying the law from an economic viewpoint, focusing on the
incentives generated by the legal system.
• The economic approach to law assumes that rational individuals
view legal sanctions (monetary damages, prison) as implicit prices
for certain kinds of behavior.
• These prices can be set by legislators to guide these behaviors in a
socially desirable direction.
44
Introductory Concepts | Positive & Normative Analysis
Positive Analysis
• Explaining consequences of legal sanctions for behavior:
• Will longer prison sentences deter more crime?
• How will changes in tort rules affect the accident rate?
• Does the death penalty reduce the murder rate?
• Underlying assumption: people do respond to the incentive
structure generated by the law.
45
Introductory Concepts | Positive & Normative Analysis
Normative Analysis
• How can the law be improved to better achieve the goal of
efficiency?
• Economic point of view: efficiency is a goal that the law should
reflect. Therefore, legal rules should be changed when they fail to
achieve it.
• In some cases, efficiency serves as a good proxy for social welfare.
• Not uncontroversial. Alternative view: Efficiency not the primary
norm for the law. Rather it should do “Justice” (Fairness).
46
Introductory Concepts | Efficiency
Pareto Efficiency
• Recall that Pareto efficient allocations are “best” among all possible
allocations in the following sense:
1. Allocation A is said to be Pareto-superior or to constitute a
Pareto improvement compared to allocation B if all individuals
are at least as well off under A compared to B, and at least one
is strictly better off.
2. Allocation A is said to be Pareto efficient if there exists no other
allocation that is Pareto-superior to A.
47
Introductory Concepts | Efficiency
Pareto Efficiency: Advantages and
Weaknesses
• Advantage: Reallocations only if neither party is made worse off.
⇒ Pareto-superior changes can be expected to be consensual
(although not necessarily consistent with Nash-Equilibrium!).
• Weakness:
1. Set of Pareto efficient allocations typically not a singleton,
2. The different allocations within this set cannot be ranked
(non-comparability), but they might have different normative
appeal.
3. In reality, any regime change will typically harm at least one
group of individuals (i.e. regime change not a Pareto
improvement).
⇒ not a useful criterion in practice.
48
Introductory Concepts | Efficiency
Kaldor-Hicks Efficiency (Compensation)
• Addressing non-comparability problem by relaxing Pareto criterion
referred to as Kaldor-Hicks efficiency.
• Cost-benefit-analysis: When moving from allocation B to allocation
A, A is Kaldor-Hicks superior if winners gain more than losers would
lose, so that the former could (in principle) compensate the latter.
• Allocation A is said to be Kaldor-Hicks efficient if there exists no
other allocation that is Kaldor-Hicks superior to A.
• Requires intra-personal utility comparison.
• If compensations were actually carried out, then moving to an
allocation which is Kaldor-Hicks superior would in fact also
constitute a Pareto improvement.
• Without compensation, there are winners and losers so that
changes are less likely to be consensual.
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