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Law and Economics Exam Questions-Answers


1) An airplane crashes as the result of a non-negligent defect in an instrument supplied by A. The airplane was manufactured by B from various components, including the instrument from A, and is operated by C, an airline. What economic difference does it make, if any, whether A is liable for the damages resulting from the crash, or B or C? [Posner, page 212, #4]

If the supplier A is liable for the damages, he/she would raise the price to cover the additional costs. In effect, the manufacturer, B, would search for an alternative supplier and this would reduce the accidents only if the cause was the supplied component. The benefit would be great and reduced cost once A is imposed. A would incur fewer costs in an examination of the part to determine its effectiveness and reduce the overall activity. When the cost is imposed on the manufacturer, the cost would be huge since a supplier may serve several manufacturers. If the liability is imposed on B (the manufacturer), he/she would raise the price to cover the added cost. The operator (C), as the customer, would switch to another manufacturer. If the problem was in the manufacturing part, then crushes would reduce. The manufacturer is strategically positioned to examine the faults in the manufacturing process cheaply as opposed to the airline. It would be uneconomical for every airline to examine every plane since they are a number of airlines served by the same manufacturer. Lastly, if C is poised with the liability, he/she would raise the airfare to reduce costs and additional measures to reduce faults. Customers would shift to alternative airlines reducing the flights and consequently the probability of accidents. Taxing the airline to take greater measures has high social benefits. The airline would not pay the customers to determine the safety of the flight and would not cause accidents as this would be costly to every traveler in an attempt to examine the flights, which is economically inefficient.

2) Is it arguable that there is greater economic justification for strict products liability to bystanders than for strict liability to purchasers of the product?[Posner, page 213, #8]

A purchaser should take precautions. It is economical and efficient to take strict liability to the purchaser as opposed to a bystander. Purchasers are people who interact with sellers and buy products for use. Bystanders, on the other hand, are people, who neither buy nor use the good, but are affected by it. Therefore, to reduce any incurred economic costs, the purchaser should take precautions.

3) If the tort system were deemed a method of social insurance rather than one of deterrence of uneconomical accidents, would awards in tort cases be on average higher or lower than under the deterrence rationale? [Posner, page 213, #8]

Under the deterrence rationale, the damages are high as well as the rewards since the cost of enforcement is high. In social insurance, the claims would be significantly low based on the goal which is to compensate the victim for losses incurred. With a deterrence rationale, the aim is to make it expensive so that the injurer does not take precautions and, therefore, the damages associated count for victim compensation, ensuring future occurrences are deterred.

4) Discuss the economic pros and cons of making social hosts liable for accidents caused by guests who have drunk too much liquor at the host’s party.

[Posner, page 213, #11]

If hosts were to be held liable to the behavior depicted by guests at their party and any consequent accidents or actions, they would be accountable. The hosts would take precautions to ensure accidents do not happen. As a result, they may serve less alcohol and this might reduce external costs such as drunk driving as the host will monitor his/her guests. However, constant monitoring at a party is not feasible and this does not give the host the ability to determine the condition and capacity of the guests. Therefore, drunk driving will be slightly reduced. It is also hard to determine whether the guests came already drunk or got drunk in the house. It further poses a moral hazard as the guests might misbehave knowing they are not accountable for their actions. If hosts are held accountable, then guests have no incentive to control their actions.

5) Suppose that a person who is burned in an accident suffers intense pain for one week and then fully recovers. What does “perfect compensation” mean in principle to the burn? Why do you expect actual compensation to be imperfect? [Cooter and Ulen, page 328, #8.2]

According to the ruling of the court, the amount of money that perfectly compensates the victim’s injuries and pain should be determined. One would expect that the perfect compensation covers more than the medical bills. For a just cause, the compensation would cover the physical and emotional pain and bring back the person in the condition prior to the accident. However, such a scenario is not possible because the damage has already occurred. Therefore, it is imperfect since pain suffered for one week cannot be quantified. There are immeasurable prevalent factors such as emotional pain, stress, and duress among others. In regard to the burn, perfect compensation refers to damage coverage that leaves the person rewarded in a similar manner as prior to the accident. Both emotional hurt and physical pain are inculcated together. Actual compensation is not perfect as there is no amount of compensation that can bring back the lost comfort and time, the stress and the pain suffered.

6) Offer an economic explanation for why the owner of a dog is liable for the harm it causes due to negligence, whereas the owner of a tiger is strictly liable for any harm that it causes?[Cooter and Ulen, page 334, #8.6]

Dogs, unlike tigers, are domesticated and docile. People are more conversant with how to react around dogs and it is easy to deter dogs from harming people like muzzling them. Tigers, on the other hand, are not a common occurrence and a majority of people have not seen one let alone know how to act around them. Tigers are primarily wild animals with unpredictable behaviors. Therefore, tiger owners are strictly liable for their actions since they are expected to keep them contained, thus, making it impossible for tigers to hurt people. A dog is not considered inherently dangerous compared to a tiger. Economically, a dog can only cause a bite while a tiger can kill a person. The economic differences and expectations are also grounds for the differences in liability.

7) The rungs of ladders must be constructed to support the weight of the people who climb them. Compare the relative efficiency of a precise government standard for ladders concerning their weight that the rungs must support, as opposed to the rule that the strength of the rungs should be determined as suits arise in a case-by-case basis using the Hand rule.[Cooter and Ulen, page 361, #8.23]

The relative efficiency of any governmental premise is not varied in case there are changes in construction standards. For example, if a change in technology occurs, that makes ardent the precaution for cheaper, effective and stronger ladders, the adjudication method of case-by-case can alter the standard through an incentive of care. A question of whether the regulators have the same flexibility arises.

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Crime and Punishment

1) It is commonly said that people who occupy positions of trust should be well paid to reduce the temptation to betray their trust. Can you think of an economic basis for this view? [Posner, page 247, #2]

The temptation is a desire to perform an action. The marginal cost is directly equivalent to the marginal benefit, which translates to the more a person is paid, the greater the cost of committing a breach of trust. The assumption is that dismissal will be among the sanctions, and often the principal sanction as retaliation for the breach. If one is highly paid, then the marginal cost of any betrayal increases. The main reason behind the payment is maintaining trust and as such the economic basis is that the individual strives to be trustworthy.

2) If mental incapacity is self-induced, as when a person kills in a drunken fit, should the law excuse the crime? If not, should it be punished less severely? [Posner, page 247, #7]

Through the concept of diminished responsibility, the law reduces the severity of the crime but does not excuse the crime. The threat posed by the punishment for any acts committed while drunk mitigates and reduces the incentive to be drunk in the first place. The punishment is only lightened through the recognition that a person, who is drunk, is less likely to succeed in the attempt to do harm, as opposed to when he/she is sober. The apprehension and consequent conviction of a drunk are more likely than that of a sober individual.

3) From an economic standpoint, should the criminal law use the same principle of causation as tort law or different principles?[Posner, page 247, #12]

Torts are civil wrongs recognized by the law as grounds for a lawsuit. Criminal law, on the other hand, involves prosecution by the government of an individual for an act categorized as a crime. Strict liability is assigned to cultivate an incentive to reduce social cost. Criminal law aims at deterring bad or criminal behavior. Since society is opposed to bad behavior, criminal offenses are costly. Criminal law should not adopt the same causation as tort law since the additional value of criminal law is to reduce and eliminate crime. Compared to torts, criminal offenses are worse as they may include injury and murder.

4) For burglary, the victim’s loss usually exceeds the injurer’s gain, but the opposite is true for breach of contract. Why? What are the implications for relative dollar values of compensation and punishment?[Cooter and Ulen, page 460, #12.6]

A contract is only breached with expectations of a higher value. An efficient breach of contract leaves neither of the parties worse off, although one party benefits. In the case of burglary, one party is left worse off since the loss of the victim exceeds the injurer`s gain. The breach of contract involves parties that know each other as opposed to a burglary. A contract may involve a bargain to reach a consensus as opposed to a burglary. To deter the probability of a burglary happening, a high punishment is induced bringing the differences in dollar values of compensation and punishment respectively.

5) Why should the law punish a person more severely for committing the same crime deliberately rather than spontaneously?[Cooter and Ulen, page 470, #12.13]

Spontaneous crime occurs from irrationality and an individual is not aware of what he/she is doing. As a result, the act cares less towards the actions associated with the crime. Deliberate crime, on the other hand, is rational, well cultivated and planned. When a person commits a deliberate crime, he/she should be severely punished to indicate that the law does not tolerate deliberate breakage of the law. The punishment for a spontaneous crime should not be severe as a perpetrator didn’t weigh the costs and consequences of he/her actions. On the other hand, in case of a deliberate crime, a person had weighed the consequences of he/her actions and further continued with the actions. It is assumed that the individual considered the benefits of committing a crime to be higher than the consequences and, therefore, deserves punishment.

6) Explain in words when efficiency requires severe punishments with low probability, and when efficiency requires mild punishments with high probability.[Cooter and Ulen, page 479, #12.19]

Offenses and crimes with a low detection probability, arrest, and consequent conviction and a high social cost should be severely punished. The punishment should be that the expected cost will exceed the benefits accrued or expected. When the cost of compensating the benefit of an action is extremely high, a person will probably not commit a crime. The fact that it is hard to detect certain actions should be compensated. On the contrary, if the social cost incurred due to a certain crime is modest but continuous, adoption of mild punishment with a high level of certainty will deter the occurrence of the crime.

Past Questions

1) Consider the right to smoke or to be free from smoke in the following situations:

a. Smoking in a public area.

b. Smoking in hotel rooms.

c. Smoking in a private residence.

d. Smoking on commercial airline flights.

In which situations do you think the transaction costs are so high that they preclude private bargaining? In what cases are they low enough to allow private bargains to occur? Explain your answer.

In this scenario, ranking the circumstances based on the transaction cost, the actions presented in the list should be ranked from lowest to highest results: smoking in a private residence, smoking in hotel rooms, and smoking on commercial airline flights and lastly smoking in a public area. The key differences of transaction costs arise from the parties involved in the scenario. Private cost has the least transaction cost as there are few people, specifically one, to allow you to smoke. On a flight, there are more parties involved in the bargain, which increases the transaction cost. Due to the closure of an airplane, it is arguable that the smoke will be harsher in this condition. In a public area, one must bargain with a vast number of parties making the transaction cost unfeasible and astronomical. Private bargaining can only occur in a private residence as the cost of transactions is relatively low. In this case, also, only one party has the monopoly of deciding whether one is allowed to smoke or not. The result is that the resource may be misused.

2) If everyone had free access to a public beach, who, if anyone, has the power to control the use of this resource?

A public beach is categorized as a public good. The essence is that it is a product that an individual can consume without inherently reducing its availability to others. It is also notable that no individual is excluded from the use of this resource. Power, from the definition, refers to the ability to coerce. In essence, the government is the only party that can coerce individuals. Since everyone has free and unrestricted access to the beach, there is no discretion in the use of the beach. Being a public beach, there is no party with the power to control the beach, which means that the beach has no owner and people can use it as they please. Therefore, without restriction, various activities may be conducted on the beach without accountability. Different rationing devices for a public property do not apply in this scenario.

3) Why is it efficient to limit the duration of patents and copyrights, whereas real property rights endure almost forever?[Cooter and Ulen, page 143, #5.11]

A patent is issued by the government as a right to an individual, who owns a product, in an attempt of excluding others from owing and selling the product. On the other hand, copyright covers the rights of a creator of artistic works to print and publish them. Patents are incentives for people to create new and better products. It is beneficial to society. However, the cost of tracking all patents is extremely high calling for the need to regulate the period of issue. Furthermore, patents give the holders the monopoly as no one can reproduce the same good. The result is an increased cost to consumers. With regulation, the market is open for other producers and this reduces the overall cost of the product due to the competition. Real property rights are meant to indicate ownership of a property such as land and buildings. Since these properties are not transferable on the market as goods and services, their rights endure almost forever. Real property rights guarantee regulated the transfer of ownership of property creating stability.

4) To what extent can the private law of property solve the problem of pollution?[Cooter and Ulen, page 180, #5.36]

A law can only solve a problem to the extent of its definition. Therefore, the private law of property can solve the problem of pollution to the extent of its definition. If the law is explicitly defined with a zero transaction cost, an efficient outcome is achieved and it poses no problem. In addition to this, when an efficient outcome is achieved, households with the right to pollute can do nothing about the outcome. In the event of conflicting laws of property, like the right to pollute and the right to clean air, a high transaction cost to solve the dilemma is incurred. Therefore, private law can only help in mitigating the problem when it is explicitly defined and an efficient outcome is achieved.

5) The Federal Government provides disaster insurance that helps people to build vacation homes in places subject to flooding, such as sand dunes. Assume the government wants to protect the environment by preventing the construction of homes on a specific sand dune near the ocean. If the government takes private property on the sand dune, either by condemning it or by imposing regulations that forbid any construction, should compensation include or exclude the increase in the value of land caused by government flood insurance? [Cooter and Ulen, page 192, #5.44]

In this case, the compensation is dependent on what the government wants to do. Since the government wants to regulate and protect the environment, the acquisition of the private sand dune reduces the amount of land available for construction. Therefore, if the land is on high demand, the price escalates. Due to the incentive from the government and the increased price of the land, the area becomes lucrative for investment in beach houses. To ensure that this condition is maintained, the compensation should include the full incentive as stipulated in the insurance cover. Failure to this, people will be incentivized to build beach homes since they will not be compensated for the construction. The offset is a detriment to the success of the disaster insurance previously provided by the federal government to cover individuals.

6) Ashley pays $100 for a ticket to a Super Bowl game. Through some mix-up by the ticket broker, the ticket is never delivered to Ashley, and she misses the game. She would have paid $10,000 for the ticket. Assume that the mix-up was not avoidable at a reasonable cost by the broker but he has broken the contract. What should Ashley’s damages be?

[Posner, page 141, #6]

Restitution is the restoration of the victim party injured by a breach of contract to the position that the party occupied before e/she entered the contract. Reliance, on the other hand, is costs incurred in the assumption that the other party will hold its end of the bargain. It is a middle alternative while the expectations are the full benefits of the bargain. In this case, assuming that Ashley made no extra reliance costs, the damages incurred are $100 she spent on ordering the ticket. The fee is payable as restitution. If she valued the ticket at $10,000 she would have gone the extra mile to ensure she got the ticket and even ensured an insurance cover. In addition, if the value placed on the ticket had been that high, she would have flown to the broker. In this case, the restitution is $100. Reliance includes all the costs she incurred with the thought of attending the Super Bowl. The reliance may include any phone calls made, hotel reservations and transportation costs incurred. The full amount of expectation damages amounts to the real value of the ticket which is $10,000. Therefore, the damages payable may be anything between $100 and $10,000 depending on the amount she incurred. In settling the case, the court may determine the damages payable based on evidence provided by Ashley regarding the cost incurred and preparations made in advance.

7) “Default rules save transaction costs in direct proportion to their efficiency.” Explain this proposition. [Cooter and Ulen, page 223, #6.11]

Default rules are rules mandated by the government that takes part in every contract. In the context of this question, efficiency may refer to transaction costs that are saved through default rules. Efficient default rules save a large number of transaction costs to the parties involved. The costs are saved since there are fewer stipulations to be explicitly made in the contract since they are already available in the contract rule. However, the proposition only works if both parties are in agreement with this law whenever they sign a contract. Therefore, transaction costs are lowered since certainty is increased. Due to the precedent, there are fewer disputes if any. The best approach to inculcating default rules in choosing rules applicable to both parties if they were always present. Default rules adopted should also be reasonable, and agreeable by everyone, which eliminates the need for writing them down. As a result, transaction costs are drastically reduced.

8) Doctors who form a partnership may say nothing in the partnership agreement concerning its future dissolution. The parties may deliberately avoid discussing dissolution for fear of breeding distrust. Provide some other examples of gaps left in contracts for strategic reasons. [Cooter and Ulen, page 224, #6.13]

Some partnerships such as those of different professions, such as doctors and engineers, are based on mandatory rules. The rules deter the participants from engaging in discussions for fear of breeding distrust to the fraternity which they hold dear. Due to the confidential information handled by doctors, strategic reasons are not disclosed in the event that the partnership is dissolved. Other examples where there are gaps in the contract for strategic reasons are engineering contracts and building and construction contracts. In the case of a construction contract, the gaps are regulation for not providing essential information regarding the blueprints of a building.

9) Restitution is usually inadequate to compensate the victim. What practical reasons do courts have for using restitution as a remedy?[Cooter and Ulen, page 261, #7.7]

Compared to expectations, restitutions are cost-effective and properly stipulated in the given contract. As a result, restitutions are easy to measure and quantify. It is for this reason that the court system uses restitution as a remedy. The party breaching a contract is ordered by the court to return the innocent party the benefits conferred. Expectations are not primarily defined and may be hard to measure. The reason is they may include personal attachments, emotions, and intangible value, which are hard to measure. Despite this, restitution also has flaws since perfect compensation cannot be achieved. However, the ability to achieve a fairly just compensation makes the adoption of the approach practical in courts.

10) Suppose that excessive drinking causes temporary incompetence, and suppose someone who has drunk too much alcohol seeks to enter into a contract with someone who is sober. Contrast the incentive effects of enforcing and not enforcing such contracts. [Cooter and Ulen, page 281, #7.21]

A contract is considered mutually binding if the parties involved are in consent on a common ground of understanding. In this case, the contract cannot be signed since it is evident that excessive drinking causes temporary incompetence. Therefore, the contract is not valid since one party is not aware of what is happening. When one person is drunk, he/she is not knowledgeable of what he/she is allowing and the rights he is granting. On the other hand, if a contract is enforced between drunk people, some of them will aim at taking advantage of others and the deal made would be biased. Therefore, contracts between drunk people are not enforced since it is easier to prove that an individual was drunk when signing a contract as opposed to proving someone took advantage of the other while he/she was drunk.

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