Normative Analysis

Question 1

4 similarities between law and econimics

Answer 1

1. Human interaction is object of study
2. Strongly influenced by (moral) philosophy
3. Method of deduction (general principles yield specific conclusions)
4. Storytelling is used to persuade the audience

Question 2

What is the definition of law?

Answer 2

The system of rules which a particular country or community recognizes as regulating the actions of its members and which it may enforce by the imposition of penalties

E.g., defining the rules of the game

Question 3

Why do we have law?

Answer 3

The law protects people by constraining the state

Question 4

Law versus economics: ex-post vs. ex-ante and top-down vs. bottom-up

Answer 4

Most laywers are in the ex-post (facts happened; studying the law that already exists) and bottom-up (specific cases to general rules) box

Most economists are in the ex-ante (behavior can change in the future; context is not given) and top-down box

Question 5

What is consequentialism?

Answer 5

Something is good when its effect is good

E.g., when a tax policy has been changed and its effect was desirable, this change in policy is desirable

Question 6

What is efficiency?

Answer 6

A change in the allocation of outcomes in the economy that potentially makes at least one individual better off without making anyone worse off

Question 7

Exchange efficiency

Answer 7

A market with no production, only preferences

Example: Angela and Bruno both owns apples and bread -> where their indifference curve meets each other, they trade so that Angela gets a few more apples and Bruno a bit more bread

This makes one of them better off without making the other worse off -> parto-efficient point

Question 8

What is Pareto-improvement?

Answer 8

A change that makes at least one individual better off without making any other individual worse off

Question 9

What is pareto-efficiency?

Answer 9

A situation where the welfare of an individual cannot be improved without reducing the welfare of others (e.g., no pareto improvement is possible anymore)

Question 10

2 assumptions behind pareto-criterion

Answer 10

1. Welfare consists out of individual utility only
2. Individuals are the best judge of their own utility

Question 11

Is there only one pareto-efficient outcome?

Answer 11

No, there are several depending on negotiation power, and some are more desirable for society than others

Question 12

What is production efficiency?

Answer 12

The “cheapest” way to achieve a certain combination of produced goods -> the least amount of money or material being wasted

Question 13

First welfare theorem

Answer 13

Every competitive economy is pareto-efficient (all resources are being used efficiently)

Question 14

What is a Hicks-Kaldor improvement?

Answer 14

A change where gainers are able to compensate losers (a potential pareto improvement)

Question 15

What is Hicks-Kaldor efficiency?

Answer 15

A situation where no adjustment can be made that benefits some individuals more than costs to other - the loss of the others cannot be compensated fully

Question 16

Name 5 market failures

Answer 16

1. Public goods with no market (free-riding)
2. Externalities: consumption of a good hurts others
3. Information asymmetry
4. Market power: firms or consumers determine the price, so it does not reflect the production costs
5. Business cycles

Question 17

What is utilitarianism?

Answer 17

Creating the greatest happiness to the greatest number of individuals -> welfare is the sum of individual utility

Question 18

Reactive vs. proactive economist strategies

Answer 18

Reactive: let society define specific policy goals with reveal true welfare objective of society

Proactive: explicitly formulating a social welfare function that reveals a demand for a desired good that is insufficiently supplied by the market

Question 19

What do lawyers almost never do?

Answer 19

Explain the way a social objective can be achieved in the most efficient way

Question 20

Why is the total burden of a tax larger than the tax payment?

Answer 20

It also includes the social cost of taxation - people work less, buy less, firms relocate etc. This causes an excess burden/welfare loss

Question 21

Which market should be taxed?

Answer 21

The one with the steepest demand curve -> less change in the quantity bought so less welfare loss

Question 22

What is a surplus technically?

Answer 22

For consumers, the difference between what they pay for the product and how they value it

For suppliers, the difference between the price they get and what they are willing to produce it for

Question 23

What is the transfer-effect?

Answer 23

When introducing a tax, the part of the consumer surplus that goes to the tax revenue is not welfare loss, because it is assumed that the government spends the money in a socially desired way that benefits people

Question 24

What is deadweight loss/welfare burden on a graph?

Answer 24

Red triangle that describes the number of transactions that would have happened without the tax but does not happen now

Question 25

What is the income effect of a tax?

Answer 25

The tax reduces net income -> consumers buy less of all products/services

Question 26

What is the substitution effect of a tax?

Answer 26

The taxed product becomes more expensive -> buy different product/services instead

Question 27

Does income effect or substitution effect create a welfare loss?

Answer 27

Substitution effect -> a change in behavior that is not the purpose of the tax

Question 28

What is a lump-sum tax?

Answer 28

Taxes that are independent of behavior and only have an income effect

Question 29

How to measure income and substitution effect on a graph?

Answer 29

Parallel line from budget constraint that just touches on the indifference curve after tax.

Income effect is the move from the original equilibrium to equilibrium on parallel budget constraint -> less of both goods

Substitution effect is the move from the equilibrium on the parallel budget constraint to the new equilibrium with the tax -> one good substituted for the other

Question 30

The distance between the budget constraint and the parallel budget constraint that reflects income effect is…

Answer 30

Potential revenues from a lump-sum tax

Question 31

The difference between the potential revenues from a lump-sum tax and the actual revenues from the tax is…

Answer 31

The welfare loss due to substitution

Question 32

Is it desirable to choose the highest possible tax on the upward slope of the Laffer Curve?

Answer 32

Political choice -> it maximizes revenues but also creates large welfare loss

Question 33

The larger the tax base elasticity…

Answer 33

The larger the welfare loss of taxation

Question 34

What is the most elastic vs. inelastic tax bases?

Answer 34

Wealth, interest, and dividends are vert elastic

Property is practically immobile

Question 35

What are 4 direct benefits of tax?

Answer 35

1. Equitable taxation helps equlize after-tax income
2. Correcting market failures
3. Stabilization (macro-economic)
4. Paternalism

Question 36

Strengths and weaknesses of an economist

Answer 36

Strenghts: developing objective models, alternative policies, and evaluating efficiency

Weaknesses: narrow focus on rationality, oversimplification, failure to explain assumptions behind models,

Question 37

Strengths and weaknesses of a lawyer/policymaker

Answer 37

Strengths: understanding legal doctrine, understanding transactions, flexibility, normative ordering

Weaknesses: fondness for anecdote, inability to understand economic models, tendency to consider statistics and models the truth

Question 38

Does a reduction in the excess burden of taxation (deadweight loss) relate most to a Pareto Improvement or an Hicks-Kaldor improvement?

Answer 38

It is a Hicks-Kaldor improvement: it is not guaranteed that nobody is not worse off - there is no way to be sure; on average, we expect that the gains from those who gain is bigger than those who might have a loss.