[You may omit any complete question or questions for 20%. This does not apply to individual sections within a question]



I.             Answer one of the following two questions:                                              (10 points)


When governments take land under the power of eminent domain, they are required to compensate the owner for the land's value. What is the economic argument in favor of that requirement? Against?


The argument in favor is that it gives governmental actors an incentive to take into account the cost they are imposing in deciding what land to use for their projects.


The argument against is that it reduces the incentive of a land owner deciding whether to make expensive improvements—build a house, for instance—to take into account the chance that the land will end up being used in a way that makes those improvements worthless—for instance by having a freeway built over it.


B. What is the argument for the "coming to the nuisance" defense? What is the argument against?


The argument for is that it is cheaper to move a project, whether pig farm or housing development, before it is built than after, hence the second mover is likely to be the lower cost avoider of problems due to the conflict between the two uses.


The argument against is that while the housing development can be moved away from the existing pig farm by building it somewhere else, the land near the pig farm cannot be. So if the best use of that land is for a housing development, the pig farm is imposing a cost on the land’s owner. If the situation was predictable, the existence of the defense means that the builder of the pig farm could ignore that cost in deciding where to build it.


II.         Pick one of the following and briefly explain it:                                          (10 points)

A. The argument discussed in class for why increasing the penalty for crimes of passion, such as killing someone in a blind rage, might result in fewer such crimes.


See Law’s Order, chapter 8 p. 89


B. Why permitting plea bargains might result, on average, in more severe punishments.


See Law’s Order, chapter 8 pp. 91-2

III.       If I tortiously kill you I owe damages to your heirs. The amount owed is both what your heirs receive, which can be thought of as a sort of insurance, and what I pay, which can be thought of as a penalty for my act. Is there any reason to expect the optimal amount for the two purposes to be the same? Explain.            (10 points)


There is not. The optimal amount of insurance depends on the usefulness of the money to my survivors. The optimal amount for deterrence depends on the value of my life—to me as well as to other people. I might value my life a great deal, making the appropriate penalty large, but have no dependents, making the appropriate amount of insurance zero. See chapter 9.


IV.       Ownership of a piece of land is really ownership of a bundle of rights related to that land. Answer both:    (10 pts)


1. Give examples of several of the rights included in the bundle.


The right to walk on the land. The right to grow things on the land. The right to build on the land. The right to exclude other people from going on the land.



2. Give an example of a right that might plausibly belong in either of two bundles—the one associated with my property or with my neighbor’s. What sort of considerations should determine which bundle it goes in?


The right to make loud noises on my land—loud enough to disturb my neighbor.


Other examples: The right to pump oil from under my land—from a pool that also extends under my neighbor’s land. The right to dig a hole on my land near the border, into which my neighbor’s house might slide.


Relevant considerations include the question of whether the right is more valuable in a bundle that includes the rest of my rights or in a bundle that includes the rest of his, and how easily, given either starting situation, the right could be transferred to another party who valued it more if that turned out to be its highest valued use.


V.         Answer one of the following:                                                                      (10 points)

  1. Should contracts made under duress be enforceable under all, some, or no circumstances? Explain.


Some. If the gains from reducing the costs when the duress happens are larger than the losses from encouraging people to create duress. See Law’s Order, chapter 12, pp. 152-153



  1. Discuss why freedom of contract might not be appropriate for transactions between tug boats and sinking ships. Is there an efficient price for the ship to pay the tug to rescue it? Explain.


The price that gives the tug the right incentive to be there to do the rescue is the benefit from the rescue, which is the value of the ship. The price that gives the ship the right incentive to risk needing rescue is the cost of the rescue to the tug. So no single price will give both actors the right incentive, and there is no reason to expect bargaining to lead to the optimal compromise between the two.


Bargaining is, however, likely to be expensive, as the water rises around the ship captain’s ankles, with a very large bargaining range and some risk of bargaining breakdown and a sunken ship.


C. You are arranging with a contractor to build a house for you. One possibility is to agree on a fixed price that you will pay, in exchange for his building the house as described in the contract. An alternative is for you to pay his costs, plus an additional sum for himself. What problems will arise with each alternative? How might they be dealt with?


The fixed price gives the contractor an incentive to keep costs down, which is sometimes desirable—but might be done by lowering quality below what you would be willing to pay for. You might control that by specifying measures of quality, requiring your  architect to approve building materials, and similar precautions.


The cost plus contract reduces the contractor’s incentive to keep costs down when that can be done without lowering quality below what you want to pay for—in particular it gives him an incentive to reduce his own cost in time at the expense of increasing your cost in money. One solution is to use a contractor who will be building many other houses, and make it clear that the final cost of yours will be public information, available to future customers. You might also try to find such information for the contractor’s previous houses. You might include a term in the contract, allowing you to reduce your payments if you could show that some of his costs were unnecessary—that the same materials could have been purchased at a lower cost.


A related problem is that the builder might deliberately pay inflated prices to his suppliers at your expense, in exchange for their giving him a discount on purchases for other projects—perhaps ones done on a fixed cost basis. The same precautions would be relevant.


VI.       Answer one of the following:                                                                      (10 points)

A. Summarize Margaret Brinig’s explanation for why the custom of giving engagement rings became common when it did.


Men and women who were not yet married wanted to have sex, but if a woman was known to have had sex—most obviously if she became pregnant—that would reduce her value on the marriage market to other men. One solution was sex between engaged couples with a commitment to future marriage. That commitment used to be legally enforceable, via a suit for breach of contract to marry. In the course of the 20th century, legal changes eliminated legal enforcement and the custom of giving an expensive engagement ring became common as a replacement—essentially as a bond for fulfillment of the promise to marry.


Note that a good answer should include not only the function of the custom but why it arose when it did—as a result of legal change.


B. Suppose we shift from divorce by mutual consent to unilateral divorce—either party can walk out of the marriage without penalty.  In the short run, who is worse off or better off as a result of the change? Explain. In the longer run, how do people adjust their behavior in response to the change? Explain.


The woman in a traditional marriage performs her part of the implied contract earlier than the man, since producing and rearing children is done in the early years and is very costly in time and effort. Furthermore, women’s value on the marriage market tends to decline more rapidly than men’s value on that market. So when the contract becomes unenforceable, there is an opportunity for the man to dump his now aging wife, who has already done most of her part of the bargain, and find a younger replacement.


In the longer run women adapt to that risk in part by making fewer investments specific to that marriage—having a career on the market instead of being a full time housewife, and hiring people to do some of what a housewife would do—and in part by altering the timing of performance of her part of the contract, for instance by having children later or spacing them out more.


VII.       Answer all parts          (15 points)

1. What does “negligence” mean in tort law as interpreted by economists? 


Failure to take all cost justified precautions.


2. Briefly explain Posner’s argument for why strict liability is efficient for ultrahazardous activities and relate it to the issue of what courts do or do not know.


Ultrahazardous activities are activities for which the most important precaution may be choosing not to take them—i.e. reducing the activity level. But it is difficult for a court to know whether engaging in such activities—removing tree stumps with dynamite, say, instead of with shovels—is worth its cost, including the cost to third parties. So negligence rules do a poor job of giving people an incentive to take all cost justified precautions with regard to such activities, including the precaution of not taking them. Strict liability puts the total cost on the person engaging in the activity, giving him an incentive to take account of that cost in deciding both whether and how to engage in it.


3. Briefly explain how, with a perfectly informed court, negligence liability solves the problem of giving both parties the correct incentive to take precautions.


The driver (or other potential tortfeasor), who will be held liable if negligent, takes all cost-justified precautions because if he doesn’t he will be found negligent, if negligent will be liable, and if he is liable it is in his interest to take all cost-justified precautions.


The pedestrian (or other potential tort victim) knows that the driver will take all cost-justified precautions for the reason just given, hence will not be found negligent hence will not be liable, so the pedestrian will have to bear his own costs, so it is in his interest to take all cost-justified precautions.


This depends on all relevant precautions by the driver being observable by the court, so that it can find him negligent if he doesn’t take all of them that are cost-justified.



VIII.   What is the "optimal number of traffic accidents.” Of murders? Is either number zero? Explain.       (10 points)


The optimal number of traffic accidents is the number such that reducing it further would cost more in precautions then it would be worth.


The optimal number of murders (answer 1) is the number such that all the murders that occur are ones for which the gain to the murderer is larger than the cost to the victim.


A different, and arguably more sophisticated, answer (answer 2) is the number such that the increased enforcement and punishment costs needed to reduce it further would be larger than the net gain (net to murderer+victim) of the reduction.


Note that one could legitimately apply a version of answer 2 to the traffic accident case, but I don’t expect that, since we didn’t discuss it in that context.


IX.         IX. Do A or B                                                                                                   (15 points)


A. What is an “efficient crime”? How can criminal law be set up to deter inefficient crimes and permit efficient ones?


An efficient crime is one for which the gain to the criminal is greater than the loss to the victim (more precisely, for which total gain is greater than total loss—we have been discussing these issues with the implicit assumption that the criminal is the only gainer and the victim the only loser).


Criminal law can be set up to deter inefficient and only inefficient crimes in two ways. One is by special casing the efficient crimes, in cases where the legal system can identify them—the defense of necessity for the lost hunter, for example. The other is by imposing an expected punishment on crimes equal to the damage done, so that only criminals whose benefit is larger than that will commit them.


B. A crime might be deterred by a high probability of a low punishment, a low probability of a high punishment, or something in between. How, in principle, do we choose the best combination of probability and punishment to impose any given level of deterrence?


Increasing the probability requires more cops and prosecutors, more trials, possibly a lower standard of proof resulting in more false convictions—all increases in enforcement costs. Increasing the punishment requires a shift from fines to jail sentences, lengthening jail sentences, increases in punishment cost.


Consider alternative combinations of probability and punishment with the same deterrent effect—loosely speaking, the same expected cost to the criminal. For each, calculate the sum of the enforcement and punishment costs it implies. Pick the combination for which the sum is lowest.


X.          Discuss any one of the following questions:   (5 points)


A. Why did victims of crime in 18th century England prosecute offenses?


Either to get an out of court settlement that would give them something of value—an (illegal) private plea bargain—or to deter crimes against themselves. The latter could be done either by a repeat player, a firm that was a likely crime victim, prosecuting to get a reputation as a bad target to commit crimes against, or by ordinary people who joined a prosecution association in order to publicly precommit to prosecute.


B. How did the legal system of saga period Iceland deal with the problem of judgment proof defendants? Note that the problem is not only how to punish them but how to make it in someone's interest to prosecute them.


A defendant who didn’t pay his fine could be outlawed and, if he remained in Iceland, legally killed. That gave convicted defendants a strong incentive to find some way of paying. That might mean having friends and relatives pay for him, with the expectation of being repaid in some form by him in the future. It might mean debt-thralldom, working his fine off as a temporary slave.


C. Residents of Shasta County punish neighbors who violate local norms in a way which is costly for both the person inflicting the punishment and the person receiving it. Is there a reason why doing things this way is more important in that system than in an ordinary legal system?


Yes. Since the victim is functioning as judge and jury, if punishing benefits him he has an incentive to punish even innocent parties or minor infractions. Other people know that, so would distrust his judgment. By restricting punishments to ones that are costly to the person punishing, the system of norms gives victims an incentive only to punish serious infractions and gives other people a reason to trust them to do so.


XI.        What is the Posner Conjecture? Offer one example of a legal rule that is evidence in favor of it and one that is evidence against it, explaining briefly. Use the back of the previous page if necessary. (10 points)


The Posner conjecture is that Anglo-American common law can best be understood as a system of legal rules designed to maximize economic efficiency (what Posner calls “wealth maximization”).


Strict liability for ultrahazardous activities is evidence in favor, for reasons explained in the answer to an earlier question. The failure of common law to award tort damages for tortuous loss of life based on the value of the life to the person who lost it is evidence against, since that value ought to be included in the calculation of when to take actions that might result in someone else dying.