econ 522 economics of law dan quint spring 2011 lecture 23
TRANSCRIPT
Econ 522Economics of Law
Dan Quint
Spring 2011
Lecture 23
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Remaining lectures Today: some interesting digressions Monday: efficiency, recap Next Wednesday: practice problems (me)
Homework 4 due tomorrow, 5 p.m.
Final: Thursday May 12 12:25-2:25, 6210 Social Science Cumulative, more weight on second half of semester
Logistics
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Models inEconomics
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Imagine you’re a physicist
(Not drawn to scale)
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The world is too complicated to study “as is”
So we make a simple model
Try to leave in the “important parts” for studying a particular question
Realize that our results follow from the assumptions that we made, and may or may not be relevant to the real world
Economists (at least theorists) work the same way
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“Are people risk averse?” Ask a sociologist, you get an answer Ask an economist, he’ll say, “It depends on what type of problem you’re
studying”
For some questions, risk aversion is important How people choose investment portfolios How people save for retirement if they don’t know how long they’ll live
For other questions, risk aversion plays no role Including risk aversion complicates model, without adding insight So we assume agents are risk neutral – not because they are, but
because we’re focusing on something else
Many assumptions get made differently in different situations
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What does it take to do economic theory?
Solvethe
model
Reduce asituation toa tractable
model
Interpretthe
model
Technical ability Judgment
(Which assumptions to make)
Judgment
(How much to “trust” results, given the model/ assumptions behind them)
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“All models are wrong, but some are useful.”– George Box (Statistician)
Another way to think about this:
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We said: some assumptions (risk neutrality) get made differently in different settings
Other assumptions get made so consistently that they become a part of the “standard way” that economists look at the world… …almost become a part of conventional wisdom
And then we start to forget that they were assumptions in the first place
The idea of a “standard” model
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People have preferences Allowed to like whatever they like… …but assumed to understand all their options, and how they rank
them
And people optimize People pick whichever option they like most… …subject to what they can afford
To put it another way, people are rational
Basically all mainstream microeconomics is based on two premises
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“People respond to incentives according to what they correctly perceive to be their own rational best interest”
Property/nuisance law each knows own threat point, can bargain with each other to transfer
ownership of entitlements to whoever values them most
Contract law can negotiate efficient contracts, courts can enforce them correctly
Tort law people react rationally to incentives courts can assign liability and assess damages correctly
Criminal law even criminals react rationally to incentives, commit crimes when benefit
outweighs expected cost
We’ve been assuming this throughout the semester
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Very useful assumption Led to lots of predictions about how laws affect behavior… …and therefore what types of laws would lead to efficient outcomes
But conclusions are only as valid as the assumptions
Today: How these assumptions sometimes fail in real life… …and therefore why we may be skeptical about some of the
semester’s conclusions But, you’re still being tested on those conclusions! Think of today as a digression
But rationality is a strong assumption
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Behavioral Lawand Economics
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How peoples’ actual behavior differs from predictions of “standard model”
Started out ad-hoc Take a prediction of the standard model, e.g., expected utility
maximization Do an experiment – put a bunch of undergrads in a room and make
them play a game Or look for instances in real world where prediction was violated
Over time, generated some fairly robust conclusions Systematic ways behavior differs from perfect rationality in a number of
different situations
Behavioral economics
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What’s important is that deviations from standard predictions of economics are not random Not random errors But consistent, systematic biases
At its best, behavioral economics holds itself to a “higher standard” than traditional economics Traditional economics: makes assumptions (rationality and
optimization), derives predictions Asks whether predictions seem right, but doesn’t spend much time
questioning the assumptions Behavioral economics looks to justify the assumptions as well
Behavioral economics
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Two recent “pop economics” books that are supposed to be pretty good:
Behavioral economics – sources
Effect of behavioral economics on law and econ:
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Positive “An increase in expected punishment will lead to a decrease in crime” Or an explanation for the laws that do exist, as outcomes of some
process (evolutionary, legislative, etc.)
Prescriptive “To achieve efficiency, the law should specify injunctive relief when
transaction costs are low, and damages when TC are high”
Normative What should be the goal of the legal system? (For this class, we’ve assumed it’s efficiency)
Jolls/Sunstein/Thaler on three different “uses” for economics
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Positive Goal of any positive model is to mirror actual behavior
Prescriptive If people respond differently to laws than the standard model would
predict… …then the law should be designed differently to account for this
Normative If people seem to make “incorrect” choices, should we force them to
choose “correctly”? If people do not optimize based on stable preferences, even the definition
of efficiency becomes unclear
Behavioral economics has implications for all three “uses” for economics
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One observation of behavioral economics: people value things more once they have them My office doesn’t have a lake view, I don’t think it’s that big a deal, I’d only
pay $100 to switch offices with someone If I were given an office with a lake view, I’d come to love it – I wouldn’t be
willing to sell it for less than $500 My colleague has a lake view, which he values at $300
Coase breaks down If I start with the lake view, I keep it If he starts with the lake view, he keeps it So initial allocation matters, even without transaction costs
Which of us is the efficient owner?
(An example of how behavioral economics makes meaning of “efficiency” unclear…)
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To give a more accurate model of how people actually behave…
…and use that model to reconsider the positive, prescriptive, and normative conclusions of law and economics
The goal of behavioral law and economics
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Bounded rationality We make mistakes… …and use simple heuristics or “rules of thumb” to make choices
Bounded willpower Even when we know what we “should” do, don’t always do it Means commitment devices can have value
Bounded self-interest People aren’t totally selfish, even in anonymous situations with
strangers
So, how does behavior typically differ from the standard model?
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Examples ofbounded rationality
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Similar to the first experiment we did in this class 44 students in an advanced undergrad Law and Econ class Half were given tokens Each was given a number – how much they could exchange a token for
at the end of the experiment Given an opportunity to trade As you’d expect, people with high token values bought them from
people with low token values This was with tokens – which had objective, artificial value
Reran experiment with coffee mugs Half the students were given Cornell mugs Then they were given opportunity to trade
Trading experiment from Cornell
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Since the mugs were given out randomly… If each person knew exactly what a mug was worth to them… …we’d expect half the mugs to change hands Since half the mug owners would have above-average values, and
half would have below-average values Instead, only 15% of the mugs were traded On average, people who got a mug asked more than twice as
much money for them as people who didn’t get a mug were willing to pay
And the effect remained if the experiment was repeated
Trading experiment from Cornell
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Conclusion from the Cornell experiment: having something makes you value it more If you have a mug, you value mugs more than if you don’t
“Endowment effect”
Existence of this bias seems robust One of the chapters in Sunstein book shows 12 studies where
Willingness To Pay for something is compared to Willingness To Accept an offer for something people already have
Every time, people who have something value it more than people who don’t – typically by 3X or more!
Endowment effect
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Seems to contradict Coase Coase: without transaction costs, initial allocation shouldn’t affect final
allocation, since whoever starts with something, it will get traded to whoever values it most
But endowment effects mean initial allocation does matter in predicting final allocation
And, if preferences change depending on who starts with the object, it’s not even clear how to define efficiency!
Recall why we argued for injunctive relief for private nuisances When TC are small, injunctions clarify two sides’ threat points and
allow them to bargain to efficient outcome Endowment effect: initial allocation effects preferences, outcome
Endowment effect – so what?
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What about calculating damages? Ask someone beforehand how much money they’d accept to lose
an arm – huge number After someone loses an arm, ask how much money it would take to
make them as well-off as before – much smaller number Suppose someone with two arms thinks losing one would be a
catastrophe, like a $10,000,000 loss Someone with one arm realizes he’s OK that way, thinks damage
done was $500,000 How much damages should a construction company owe if a
worker lost an arm? And should they take precautions that cost $3,000,000 per lost arm
saved?
Endowment effect – so what?
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“Second-cheapest wine” effect
Context dependence
Price
Quality/features
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Once something happens, people overestimate what its likelihood was Think back to one year before last election, guess what probability was
at the time that Obama would be elected In November 2007, Intrade had Obama at 7%
So what? Determining negligence (Hand Rule) requires figuring out the probability
something would happen, after it happens Example: risk of factory fire is 1 in 1,000, harm is $1,000,000, company
chooses not to install $10,000 sprinkler system Fire occurs, jury thinks risk was 1 in 50, finds company negligent Publicly-owned companies must disclose “material risks” to investors
Hindsight bias
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Effect of hindsight bias Judges/juries will find negligence more often than they “should”
Jolls/Sunstein/Thaler ideas for dealing with this all seem flawed Keep jury in the dark about what happened Raise standard of proof for finding negligence
Hindsight bias
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People overestimate probability of a certain type of accident if they’ve recently observed a similar accident “Availability” – memory of a recent accident is available in your
mind, colors your judgment “Salience” – how vivid the memory is
Explains environmental/safety regulations covering “hot topic” without regard for cost-benefit
Made worse because some people may deliberately keep the accident available for private gain “Availability entrepreneurs” – think of U.S. politicians after 9/11/01
Similar bias – perception of probability based on availability and salience
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Relative optimism when both sides have same information
Students randomly assigned to roles of plaintiff and defendant, would be asked to negotiate a settlement
Asked to write down a guess as to actual damages awarded in the case, and what a “fair” settlement would be These answers would not be used during negotiations
Students chosen to be plaintiffs guessed $14,500 higher for actual damages, $17,700 higher for “fair” settlement
Suggests pre-trial settlement may be rare, sharing information may not solve problem
“Self-serving bias”
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Boundedwillpower
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Peoples’ choices do reflect discounting of future events…
…but not in the way standard model predicts Standard model: if discount factor is 11%, $100 today = $90 in a year = $81 in two years = $73 in three = …
Actually, dropoff between “now” and “later” is more severe than between two future times Example: $100 today versus $150 in six months… …or $100 in six months versus $150 in a year
How people discount the future
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Boundedself-interest
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Player 1 proposes a way to divide up $10 Player 2 says yes or no
Yes: they each get the proposed share No: they both get nothing
Backward induction: only equilibrium is for 1 to keep almost everything, 2 to say yes
Experiments: offers less than $3-4 are often rejected, many people offer fairly even split
Shocking to economists, obvious to everyone else: People sacrifice their own well-being to help those who are being
kind to them And sacrifice their own well-being to punish those who are unkind
“Ultimatum game”
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People care not only about their own payoff, but also about “fairness” But fairness is not objective – not all offers < $5 rejected
Preference for fairness could explain lots of rules we see: Rules against scalping tickets Rules against predatory pricing during emergencies Rules against usury (very high interest rates) Any voluntary transaction should be a Pareto-improvement… …but prices which are too “unfair” are sometimes illegal
One interpretation of bounded self-interest
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Jolls/Sunstein/Thaler prescriptive and normative
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Lots of interesting stuff on positive aspects
Less on prescriptive and normative
Jolls/Sunstein/Thaler
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How people respond to information depends on how it’s presented Example: choosing between safe and risky retirement investments
So if government is putting out information, should think about how “framing” changes its effect Safe driving ads used to be, “Drive carefully, or you’ll kill someone” But everyone believes they’re a good driver When ads changed to, “Drive carefully, there are other BAD
DRIVERS out there you have to watch out for!” They started having more of an effect
One prescriptive suggestion
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Antipaternalism Government shouldn’t tell people what to do
J/S/T stop short of advocating paternalism If behavioral bias leads individuals to make mistakes, could also
lead government bureaucrats to make mistakes in telling people what to do!
“Anti-antipaternalism” We shouldn’t automatically reject paternalism, since it may have a
role sometimes
Jolls/Sunstein/Thaler’s conclusion: the case for “anti-antipaternalism”
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Unenforcedlaws
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Optimal criminal system will not detect/punish every crime, for two reasons Some crimes may be efficient (rare) When cost of deterrence is positive, it’s not worth paying enough to
deter every crime
But we still assumed most crimes are inefficient, and main reason not to punish them all is cost
We saw last week…
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There are a lot of old laws in many states that seem inefficient Massachusetts: can’t buy alcohol on Sundays Many states still have laws passed a long time ago
In some cases, law is enforced
Tim Wu, “American Lawbreaking” – many laws that we, as a society, have basically decided not to enforce at all
However…
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Begins with New York prosecutors sitting around office, choosing celebrities (John Lennon, Mother Theresa) and coming up with obscure crimes they could be charged with “obstructing the mails,” “false pretenses on the high seas”
“Full enforcement of every last law on the books would put all of us in prison for crimes such as “injuring a mail bag.” No enforcement of our laws, on the other hand, would mean anarchy. Somehow, officials must choose what laws really matter.”
“Tolerated lawbreaking is almost always a response to a political failure – the inability of our political institutions to adapt to social change or reach a rational compromise that reflects the interests of the nation and all concerned parties. That’s why the American statutes are full of laws that no one wants to see fully enforced – or even enforced at all.”
Tim Wu, “American Lawbreaking” (Slate)http://www.slate.com/id/2175730/entry/2175733/
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“Over the last two decades, the pharmaceutical industry has developed a full set of substitutes for just about every illegal narcotic we have.” Rather than legalizing street drugs… …society has developed Ritalin, vicodin, oxycontin, clonazepam, etc… …which may serve legitimate medical purposes in some instances, but
also mimic highs of cocaine and other drugs
Marijuana: several cities where police chiefs or DAs have announced they won’t prosecute possession Philadelphia law will treat possession as a ticketable offense Medical marijuana in California and elsewhere
First example doesn’t perfectly fit premise, but interesting
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Apparently, there’s porn online
And it’s basically all illegal
Federal law prohibits using a “computer service” to transport over state lines “any obscene, lewd, lascivious, or filthy book, pamphlet, picture, motion-picture film, paper, letter, writing, print, or other matter or indecent character.”
Wu’s second example: pornography
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In 1968, Congress set up a commission to investigate Commission recommended we repeal all obscenity laws, replace them
with laws to protect children and control public display Nixon and other politicians condemned report as “morally bankrupt”,
insisted they would continue war on pornography
A few well-publicized prosecutions in 70s and 80s, halted in 90s
2005: Attorney General Alberto Gonzalez tried to pressure local prosecutors to crack down, but nothing happened One Miami attorney: “compared to terrorism, public corruption, and
narcotics, [pornography] is no worse than dropping gum on the sidewalk.”
Wu’s second example: pornography
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So pornography is technically illegal, rarely prosecuted
What’s developed is unofficial zoning system – rather than prohibiting behavior, it’s regulated Prosecuted when it crosses certain lines Ignored otherwise Super Bowl wardrobe malfunction – when something gets on prime-time
network TV, people freak out Child pornography still prosecuted But “mainstream” porn left alone, so functionally legal
So as a society, we’ve functionally legalized porn… Not through legislation or courts… …but through general concensus among prosecutors, FCC, FBI, local
police, etc., to do nothing about it
Wu’s second example: pornography
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Amish refuse to pay Social Security taxes, do not accept benefits, do not educate children past eighth grade
Mormons to some degree still practice polygamy
Wu discusses history of legal treatment
Again, what’s emerged is de facto zoning Mormon polygamist went on Sally Jessy and Springer to discuss his
lifestyle, he was tried and convicted But when it’s done quietly, in scattered communities outside of big
cities, polygamy still goes on and is basically tolerated Amish are open about how they live, but keep to themselves, and
nobody worries about it
Wu’s other examples: copyright law, illegal immigration, Amish and Mormons
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You’d think crimes are crimes because society wants them to be crimes
But in some cases, society doesn’t care whether something is a crime, but doesn’t care enough to make it legal either
Or, political system is “broken” enough that some things can’t be fixed, we adapt by ignoring certain laws
More obvious example: speeding
This all doesn’t really fit into our framework of criminal law
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Throughout the semester, we’ve been assuming rationality Of individuals, of businesses, etc.
This has led to a number of conclusions
Today: like with all economics, our conclusions are only as strong as our faith in our assumptions When we apply these conclusions to the real world, need to be
aware of how they depend on assumptions, how robust they are when assumptions are violated
So what’s my point for today?