Economics and Law

Question 1

What is neoclassical economics?

Answer 1

A microeconomic school that focus is on how dynamics of supply and demand effect the output and distribution of material goods and services.

Question 2

What is neo-institutional economics

Answer 2

A theory that explores how various governmental structures contribute to national economic development.

Question 3

When is something Kaldor-Hicks efficient?

Answer 3

When production of social welfare is maximized – It is impossible to produce greater social welfare from a given set of resources.

Question 4

What is a Kaldor-Hicks improvement?

Answer 4

Any improvement in the amount of social welfare that is produced from a given finite set of resources.

Question 5

When is something Pareto efficient?

Answer 5

When the only way to make one person better off is to make another person worse off.

Question 6

What is a Pareto improvement?

Answer 6

Any change that makes someone better off without making anyone else worse off.

Question 7

What is a key difference between Pareto efficiency and Kaldor-Hicks efficiency?

Answer 7

Something can be Kaldor-Hicks efficient without becoming Pareto efficient.

For example, a person who can generate $1,000 of social welfare by depriving $100 of social welfare from another individual. Such a move would be Kaldor-Hick efficient but would not be Pareto efficient.

Question 8

What is regulatory capture?

Answer 8

When regulatory agency ends up advancing the interests of lobbying groups that dominate an industry or sector the agency is charged with regulating.

Question 9

What is the rationality assumption?

Answer 9

In seeking to maximize utility, people base their actions on rational and realistic understandings of cause and effect – as opposed to whim, fantasy, or unreflective impulse.

There are two kinds of ‘rationality assumptions: Perfect rationality and bounded rationality.

Question 10

What is perfect rationality?

Answer 10

An agent who has complete information about the options available for choice, perfect foresight of the consequences from choosing those options, and the cognitive ability to select the option that gives her the maximum utility.

Question 11

What is bounded rationality?

Answer 11

The more realistic, limited rationality of ordinary human beings

Question 12

What is the economic man?

Answer 12

The idea that human beings are driven to maximise utility, do so based on rational understandings of cause and effect, and are also the best judge of how much utility a particular decision will bring to themselves.

Question 13

What are the 3 basic ‘laws’ of human behavior within law and economics?

Answer 13

The utility function: Human beings are driven to maximise utility

The rationality assumption: In seeking to maximize utility, people base their actions on rational and realistic understandings of cause and effect – as opposed to whim, fantasy, or unreflective impulse.

Voluntariness: An individual is the best judge of how much utility a particular thing will bring to him or her

Question 14

What does it mean to maximise utility?

Answer 14

To get the greatest aggregate utility from a finite set of resources

Question 15

What is a perfect market?

Answer 15

A market whose behavioural practices correspond to the 3 behavioural rules of law and economics.

Question 16

What are some 5 common causes of market failure, and how does the law deal with them?

Answer 16

Transaction costs; The costs of coming into an agreement with another individual for the exchange of goods.
-> Contract law

Information deficiency; Contracting parties may miscalculate the utility of an exchange due to information imbalances.

• > Strict liability places the burden on the defendant who has the means of correcting any imbalances
• > Res ipsa loquitur shifts the burden of proof to the person with more knowledge/information

Negative externalities; The agreement can create expenses for third-parties and reduce social welfare.
-> Class action law suits, carbon taxes

Dysfunctional incentive structures; Excessive regulation of a market can create excessive compliance costs.
-> Deregulation

Inability to enforce relevant laws

Question 17

What is utility?

Answer 17

The capacity of a thing to satisfy an individual’s wants.

Question 18

What is social welfare?

Answer 18

The aggregate utility found in a collective (i.e the summing up of the utility of all individual members)

Often equated with wealth.

Question 19

How are the three laws of human behaviour in laws and economics different from Hart’s rule of recognition?

Answer 19

While Hart’s RoR is a social construction, the rules of laws and economics are objectively scientific (psychological) phenomena.

Question 20

What is the purpose of law, according to law and economics?

Answer 20

The purpose of law is to construct markets that maximise social welfare through legal devices such as property rights and contract law.

Also prevent instances of market failure through legal devices.

Question 21

What are examples of legal devices that help to construct markets?

Answer 21

Property rights, contract law

Question 22

What is an example of a dysfunctional incentive structure?

Answer 22

Prisoners’ dilemma in rating services

Question 23

What is another term for market failure?

Answer 23

Market imperfection

Question 24

What is the endowment effect?

Answer 24

We values things that we own more than identical things that we don’t own

Question 25

What is the overconfidence effect?

Answer 25

We tend to overestimate our own capacities

Question 26

What is the altruism effect?

Answer 26

We tend to value our own self-interest

Question 27

What is the pattern recognition bias?

Answer 27

We tend to perceive patterns, for example in a series of numbers, even when there isn’t any.

Question 28

What is the projection bias?

Answer 28

We tend to assume that our tastes or preferences will remain the same over time. This leads to impulse purchases.

Question 29

What is the action bias?

Answer 29

We tend to have an impulse to act - simply to feel like we have control of a particular situation

Question 30

What is the ambiguity aversion bias?

Answer 30

We prefer the devil we know to the devil we don’t, even if the latter is less risky

Question 31

What is the intertemporal choice bias?

Answer 31

We value immediate gratification more than delayed gratification of the same type and intensity

Question 32

What is utility satisficing?

Answer 32

We tend to accumulate utility until an acceptable threshold level is met. We don’t feel the need to maximise utility beyond that.

Question 33

What is the advantage of replacing liberalism with economic analysis as a basis of understanding law?

Answer 33

As a science, economics formulates precise hypotheses which can be empirically tested.

This allows economics to be more precise and objective than liberalism.

It also allows economics to determine the extent to which law actually affects society.

Question 34

A policy greatly increases the social welfare of only the wealthiest individuals without benefiting anyone else. Is this Pareto efficient, Kaldor-Hicks efficient, or both?

Answer 34

It is both a Pareto and Kaldor-Hicks improvement.

Pareto improvement because a group of people have been made better off, without making anyone worse off.

Kaldor-Hicks improvement because social welfare has increased from a given, finite set of resources.