Economic Analysis of Law

This entry for the forthcoming The New Palgrave Dictionary of Economics (Second Edition) surveys the economic analysis of five primary fields of law: property law; liability for accidents; contract law; litigation; and public enforcement and criminal law. It also briefly considers some criticisms of the economic analysis of law.law and economics, property law, liability for accidents, contract law, litigation, public enforcement, criminal law

Public Enforcement of Law

This entry for the forthcoming The New Palgrave Dictionary of Economics (Second Edition) surveys the economic analysis of public enforcement of law — the use of public agents (inspectors, tax auditors, police, prosecutors) to detect and to sanction violators of legal rules. We first discuss the basic elements of the theory: the probability of imposition of sanctions, the magnitude and form of sanctions (fines, imprisonment), and the rule of liability. We then examine a variety of extensions, including the costs of imposing fines, mistake, marginal deterrence, settlement, self-reporting, repeat offenses, and incapacitation.fines, imprisonment, probability of detection, sanctions, crime, enforcement, strict liability, fault-based liability, mistake, marginal deterrence, settlement, self-reporting, repeat offenses, incapacitation

Enforcement Costs and the Optimal Magnitude and Probability of Fines

Some of the costs of enforcing laws are fixed" - - in the sense that they do not depend on the number of individuals who commit harmful acts- -while other costs are "variable"- - they rise with the number of such individuals. This article analyzes the effects of fixed and variable enforcement costs on the optimal fine and the optimal probability of detection. It is shown that the optimal fine rises to reflect variable enforcement costs; that the optimal fine is not directly affected by fixed enforcement costs; and that the optimal probability depends on both types of enforcement costs.

Should Liability be Based on the Harm to the Victim or the Gain to the Injurer?

Should the level of liability imposed on an injurer be based on the harm he caused or instead on the gain he obtained from engaging in the harmful act? The main point of this article is that there is a strong reason to favor liability based on harm rather than gain when account is taken of the possibility of legal error. Notably, even a small underestimate of gain can lead an injurer to commit a harmful act when the harm greatly exceeds his gain, causing a large social loss. In contrast, a comparable error in the estimate of harm will not lead an injurer to engage in the harmful act when the harm significantly exceeds his gain. The general superiority of harm-based liability is shown to hold under the rules of negligence and strict liability and regardless of whether potential injurers know the error that will be made.

The Theory of Public Enforcement of Law

This chapter of the forthcoming Handbook of Law and Economics surveys the theory of the public enforcement of law — the use of governmental agents (regulators, inspectors, tax auditors, police, prosecutors) to detect and to sanction violators of legal rules. The theoretical core of our analysis addresses the following basic questions: Should the form of the sanction imposed on a liable party be a fine, an imprisonment term, or a combination of the two? Should the rule of liability be strict or fault-based? If violators are caught only with a probability, how should the level of the sanction be adjusted? How much of society’s resources should be devoted to apprehending violators? We then examine a variety of extensions of the central theory, including: activity level; errors; the costs of imposing fines; general enforcement; marginal deterrence; the principal-agent relationship; settlements; self-reporting; repeat offenders; imperfect knowledge about the probability and magnitude of sanctions; corruption; incapacitation; costly observation of wealth; social norms; and the fairness of sanctions.public enforcement of law, fines, imprisonment, strict liability, fault-based liability, probability of detection, errors, general enforcement, marginal deterrence, settlements, self-reporting, repeat offenders, fairness of sanctions, norms

Pigouvian Taxation with Administrative Costs

This paper examines how the optimal Pigouvian tax should be adjusted to reflect administrative costs. Several cases are examined, depending on whether the administrative costs are fixed per firm taxed or are a function of the amount of tax collected, and on whether such costs are borne by the government or by the taxed firm. In some cases, the presence of administrative costs increases the optimal tax above the external cost, while in other cases it leads to a decrease in the tax.

Mandatory Versus Voluntary Disclosure of Product Risks

We analyze a model in which firms are able to acquire information about product risks and may or may not be required to disclose this information. We initially study the effect of disclosure rules assuming that firms are not liable for the harm caused by their products. Although mandatory disclosure obviously is superior to voluntary disclosure given the information about product risks that firms possess -- since such information has value to consumers -- voluntary disclosure induces firms to acquire more information about product risks because they can keep silent if the information is unfavorable. The latter effect could lead to higher social welfare under voluntary disclosure. The same results hold if firms are liable for harm under the negligence standard of liability. Under strict liability, however, firms are indifferent about revealing information concerning product risk, and mandatory and voluntary disclosure rules are equivalent.

The Uneasy Case for Product Liability

In this Article we compare the benefits of product liability to its costs and conclude that the case for product liability is weak for a wide range of products. One benefit of product liability is that it can induce firms to improve product safety. Even in the absence of product liability, however, firms are often motivated by market forces to enhance product safety because their sales may fall if their products harm consumers. Moreover, products must frequently conform to safety regulations. Consequently, product liability might not be expected to exert a significant additional influence on product safety — and empirical studies of several widely sold products fail to find an effect of product liability on the frequency of product accidents. A second benefit of product liability is that it can improve consumer purchase decisions by causing product prices to increase to reflect product risks. But because of litigation costs and other factors, product liability may raise prices excessively and undesirably chill purchases. A third benefit of product liability is that it compensates victims of product-related accidents for their losses. Yet this benefit is only partial, for accident victims are frequently compensated by insurers for some or all of their losses. Furthermore, the payment of compensation for pain and suffering actually reduces the welfare of individuals because it effectively forces them to purchase insurance for a type of loss for which they ordinarily do not wish to be covered. Offsetting the potential benefits of product liability are its costs, which are great. Notably, the transfer of a dollar to a victim of a product accident via the liability system requires more than a dollar on average in legal expenses. Given the limited benefits and the high costs of product liability, we come to the judgment that its use is often unwarranted. This is especially likely for products for which market forces and regulation are relatively strong, which includes many widely sold products. On the other hand, the use of product liability may be desirable for products for which these factors are weak. Our generally skeptical assessment of product liability for products for which market forces and regulation are strong is in tension with the broad social endorsement of such liability

A Skeptical Attitude About Product Liability is Justified: A Reply to Professors Goldberg and Zipursky

In The Uneasy Case for Product Liability, we maintained that the benefits of product liability are likely to be less than its costs for many products, especially widely sold ones. Our article was intended to alter the dominant view held by the judiciary and commentators that product liability has a clear justification on grounds of public policy. We argued instead that a skeptical attitude toward product liability should be adopted. Professors John Goldberg and Benjamin Zipursky strongly criticize our article in The Easy Case for Products Liability Law: A Response to Professors Polinsky and Shavell. To a significant extent, however, they attack a straw man, for they impute to us a radical thesis – that product liability should be eliminated for all widely sold products – that we manifestly did not advance. In fact, we argued that whether product liability is undesirable depends on the particular product. Goldberg and Zipursky also ascribe to us other opinions that exaggerate what we said in our article – notably, they state that we believe that product liability has no beneficial effect on product safety for widely sold products. It is not surprising, therefore, that they are unable to support these mischaracterizations with citations to statements in our article. The major claim that Goldberg and Zipursky develop is that our benefit-cost analysis fails to demonstrate that the case for product liability is uneasy. In our view, their critique is deficient on multiple accounts, including that it contains numerous distortions and errors, and hence does not alter our original conclusion

A Note on Optimal Fines When Wealth Varies Among Individuals

An important result in the economic theory of enforcement is that, under certain circumstances, it is optimal for a fine to be as high as possible - to equal the entire wealth of individuals. Such a fine allows the probability of detection to be as low as possible, thereby saving enforcement costs. This note shows that when the level of wealth varies among individuals, the optimal fine generally is less than the wealth of the highest wealth individuals, and may well be less than the wealth of most individuals.