ECO 320 Standard Mid-term Exam
Questions and Accurate Answers
|verified answers! All Graded A+
Aspects of Transaction costs? - Answer Search, Bargaining, Enforcement
What is production efficiency? (2) - Answer - Cannot produce more with same inputs
- Cannot produce same with less inputs
Allocative Efficiency - Answer Not possible to make one person better without making others
worse
What are the two (2) main approaches economists use to define efficiency - Answer Pareto
Optimal and Cost Benefit
Pareto Optimal - Answer Similar/same as allocative efficiency
- Make A better without making B worse
Cost Benefit - Answer Making A better so that it outweighs the cost to B
For burglary, the victim's loss usually exceeds the injurer's gain, but the opposite is true for
breach of contract. Why? What are the implications for relative dollar values of compensation
and punishment? - Answer In breach of contract, damages are generally assessed on the basis of
compensation, not punishment. For breach of contract, perfect compensation is a sum of money
that leaves the victim indifferent between the breach of contract with compensation and no
breach of contract.
A rational agent would only breach the contract if they could gain more than would be necessary
to fully compensate the principal to the point of indifference between performance and breach.
Because we can reasonably expect sophisticated business actors to be rational, we would only
,expect breach to occur in such situations, necessarily making the injurer's gain greater than the
victim's loss.
In the case of burglary, the probability of being caught and punished lowers the expected payoff
to the injurer. Even if the person valued the object only at its resale value (i.e. attached no
personal significance to the item stolen and no damage was done to
In what ways do you think a "rent-a-judge" who seeks to maximize income might decide cases
differently from an independent public judge? - Answer The parties can agree to "rent" a retired
judge to decide their case. The resulting private trial is usually held in a mutually convenient
place, such as a hotel suite. The retired judge usually conducts the trial in an informal manner,
without the concern for procedure shown in public trials. The case is decided by application of
the relevant state law. The judge's final decision is, furthermore, registered with the state court
and has the full effect of a decision in a public court. Critics say that "rent-a-judge" is unfair to
the poor because only the rich can use it. People who rent judges benefit from a speedy trial, and
others benefit indirectly from relieving the congestion in the public courts. Notice that renting a
judge changes judicial motivation. Suppose you were a retired judge who decided to participate
in a rent-a-judge program. In your former role as a public judge, you were supposed to be
"independen
Suppose "loser pays all" is more efficient than "each pays his own." In a jurisdiction that follows
"each pays his own,'' the Cease Theorem would predict that the two parties would sign a contract
requiring the loser to reimburse the winner, thus adopting the more efficient rule by private
agreement. Give some economic reasons why this does not occur in fact. - Answer If the
jurisdiction allows for "each pays his own", rational parties would not want to engage in another
private agreement regarding costs which would increase both of the parties' transaction costs.
The transaction costs for the parties of bargaining around the default rule might inhibit this deal
from occurring. Recognize that for most parties litigation is not so common that they can develop
boilerplate to deal with this situation. For most parties, litigation is uncommon. (The average
American consults a lawyer only three times during a lifetime.) And many people may well be
overly optimistic about their abilities to prevail at trial, thus inclining them not to want to bargain
away from the default of "loser pays."
Suppose that the seller is very attached to her home and wishes to sell only to someone who will
maintain the property as a single family dwelling. A prospective buyer says that he, too, wants to
use the property as a single-family dwelling. The sale is completed, and the seller moves out.
,However, several days later, she learns that the buyer intended all along to demolish the house in
order to open a commercial establishment. Does efficiency commend enforcing the contract or
rescinding it? - Answer It would generally be efficient to enforce the contract since the house
was clearly more valuable to the purchaser than to the seller.
This is a case of fraud since a false assertion was made with the intention to deceive. Under the
traditional common law doctrine, the victim of fraud is entitled to damages for harm caused by
fraud.
The economic reason for not enforcing a promise elicited by fraud is straightforward: if parties to
a contract know that fraud is a ground for voiding the agreement, then they can rely on
truthfulness of the information developed in negotiations for the contract. This saves parties the
costs of verifying material statements. This in turn, lowers the costs of concluding cooperative
agreements.
As such, the law should be designed such that they aim to improve the exchange of information
in private contracts. Enforcing these regulations can be costly. Consequently, legislation directed
at a
"Default rules save transaction costs in direct proportion to their efficiency." Explain this
proposition. (TT1, Oct 2017) - Answer When a court rules to fill a gap in a contract, the rules
apply by default. If the parties opt out of the default rules by explicit terms, the court enforces the
explicit terms even though they contradict the default terms that the court would have used to fill
the gap.
When a default rule is inefficient, the parties can gain by replacing it with their own explicit
terms that are efficient. This is the Coase Theorem.
The parties have to bear the transactions costs relating to this negotiation of explicit terms.
If the court supply efficient default terms, then neither party can gain further from replacing them
with explicit terms. The fewer the terms requiring negotiation, the less transaction costs.
So in general, all parties to a contract can benefit when lawmakers replace inefficient default
terms with efficient default terms, and the size of the gain is proportional to the cost of
transacting around the defaul
Analyze caps and limitations on litigation awards using the analysis of rent control (rent control
is from chapter 2) - Answer Caps and limitations on litigation awards can be associated with the
principle of rent control in that a "price ceiling" can be used as protection against excessive
litigation fees taking from the losing party.
, -if the cap is set below market price there will be excess demand for houses and not enough
supply --> price floor
-similarly, if the cap is set too low there will be more demand for damages because more crimeis
committed if the cap on damages is lower than it should be. not enough supply of damage awards
and so plaintiffs will seek for alternative damage awards like punitive damages
"Excessive damages increase expected liability under a negligence rule, which results in excess
precaution." Explain the mistake in this proposition. - Answer When potential defendants know
they are subject to any of the negligence systems, including simple negligence, modest errors
increasing damages (compensation) for claimants, will not motivate rational defendants to
change their standard of care. (Text, p. 219)
When potential claimants know they are subject to any of the negligence systems, including
simple negligence, modest errors increasing damages motivate rational claimants to file more
claims. (Text, p. 266)
Theorem of Coase - Answer When transaction cost are zero, an efficient (socially optimal) use
of resources results from private bargaining, regardless of the legal assignment of property rights
Converse (High transaction cost) Theorem of Coase - Answer When transaction costs are high
enough to prevent bargaining, the efficient use of resources will depend on how property rights
are assigned
Normative Coase Theorem - Answer Structure the law as to remove the obstacles to private
agreements (lawyers, high transactions costs, etc)
Normative Hobbes Theorem - Answer Structure the law so as to minimize the harm caused by
failures in private agreements
Injunction - Answer Order to stop creating an externality
Questions and Accurate Answers
|verified answers! All Graded A+
Aspects of Transaction costs? - Answer Search, Bargaining, Enforcement
What is production efficiency? (2) - Answer - Cannot produce more with same inputs
- Cannot produce same with less inputs
Allocative Efficiency - Answer Not possible to make one person better without making others
worse
What are the two (2) main approaches economists use to define efficiency - Answer Pareto
Optimal and Cost Benefit
Pareto Optimal - Answer Similar/same as allocative efficiency
- Make A better without making B worse
Cost Benefit - Answer Making A better so that it outweighs the cost to B
For burglary, the victim's loss usually exceeds the injurer's gain, but the opposite is true for
breach of contract. Why? What are the implications for relative dollar values of compensation
and punishment? - Answer In breach of contract, damages are generally assessed on the basis of
compensation, not punishment. For breach of contract, perfect compensation is a sum of money
that leaves the victim indifferent between the breach of contract with compensation and no
breach of contract.
A rational agent would only breach the contract if they could gain more than would be necessary
to fully compensate the principal to the point of indifference between performance and breach.
Because we can reasonably expect sophisticated business actors to be rational, we would only
,expect breach to occur in such situations, necessarily making the injurer's gain greater than the
victim's loss.
In the case of burglary, the probability of being caught and punished lowers the expected payoff
to the injurer. Even if the person valued the object only at its resale value (i.e. attached no
personal significance to the item stolen and no damage was done to
In what ways do you think a "rent-a-judge" who seeks to maximize income might decide cases
differently from an independent public judge? - Answer The parties can agree to "rent" a retired
judge to decide their case. The resulting private trial is usually held in a mutually convenient
place, such as a hotel suite. The retired judge usually conducts the trial in an informal manner,
without the concern for procedure shown in public trials. The case is decided by application of
the relevant state law. The judge's final decision is, furthermore, registered with the state court
and has the full effect of a decision in a public court. Critics say that "rent-a-judge" is unfair to
the poor because only the rich can use it. People who rent judges benefit from a speedy trial, and
others benefit indirectly from relieving the congestion in the public courts. Notice that renting a
judge changes judicial motivation. Suppose you were a retired judge who decided to participate
in a rent-a-judge program. In your former role as a public judge, you were supposed to be
"independen
Suppose "loser pays all" is more efficient than "each pays his own." In a jurisdiction that follows
"each pays his own,'' the Cease Theorem would predict that the two parties would sign a contract
requiring the loser to reimburse the winner, thus adopting the more efficient rule by private
agreement. Give some economic reasons why this does not occur in fact. - Answer If the
jurisdiction allows for "each pays his own", rational parties would not want to engage in another
private agreement regarding costs which would increase both of the parties' transaction costs.
The transaction costs for the parties of bargaining around the default rule might inhibit this deal
from occurring. Recognize that for most parties litigation is not so common that they can develop
boilerplate to deal with this situation. For most parties, litigation is uncommon. (The average
American consults a lawyer only three times during a lifetime.) And many people may well be
overly optimistic about their abilities to prevail at trial, thus inclining them not to want to bargain
away from the default of "loser pays."
Suppose that the seller is very attached to her home and wishes to sell only to someone who will
maintain the property as a single family dwelling. A prospective buyer says that he, too, wants to
use the property as a single-family dwelling. The sale is completed, and the seller moves out.
,However, several days later, she learns that the buyer intended all along to demolish the house in
order to open a commercial establishment. Does efficiency commend enforcing the contract or
rescinding it? - Answer It would generally be efficient to enforce the contract since the house
was clearly more valuable to the purchaser than to the seller.
This is a case of fraud since a false assertion was made with the intention to deceive. Under the
traditional common law doctrine, the victim of fraud is entitled to damages for harm caused by
fraud.
The economic reason for not enforcing a promise elicited by fraud is straightforward: if parties to
a contract know that fraud is a ground for voiding the agreement, then they can rely on
truthfulness of the information developed in negotiations for the contract. This saves parties the
costs of verifying material statements. This in turn, lowers the costs of concluding cooperative
agreements.
As such, the law should be designed such that they aim to improve the exchange of information
in private contracts. Enforcing these regulations can be costly. Consequently, legislation directed
at a
"Default rules save transaction costs in direct proportion to their efficiency." Explain this
proposition. (TT1, Oct 2017) - Answer When a court rules to fill a gap in a contract, the rules
apply by default. If the parties opt out of the default rules by explicit terms, the court enforces the
explicit terms even though they contradict the default terms that the court would have used to fill
the gap.
When a default rule is inefficient, the parties can gain by replacing it with their own explicit
terms that are efficient. This is the Coase Theorem.
The parties have to bear the transactions costs relating to this negotiation of explicit terms.
If the court supply efficient default terms, then neither party can gain further from replacing them
with explicit terms. The fewer the terms requiring negotiation, the less transaction costs.
So in general, all parties to a contract can benefit when lawmakers replace inefficient default
terms with efficient default terms, and the size of the gain is proportional to the cost of
transacting around the defaul
Analyze caps and limitations on litigation awards using the analysis of rent control (rent control
is from chapter 2) - Answer Caps and limitations on litigation awards can be associated with the
principle of rent control in that a "price ceiling" can be used as protection against excessive
litigation fees taking from the losing party.
, -if the cap is set below market price there will be excess demand for houses and not enough
supply --> price floor
-similarly, if the cap is set too low there will be more demand for damages because more crimeis
committed if the cap on damages is lower than it should be. not enough supply of damage awards
and so plaintiffs will seek for alternative damage awards like punitive damages
"Excessive damages increase expected liability under a negligence rule, which results in excess
precaution." Explain the mistake in this proposition. - Answer When potential defendants know
they are subject to any of the negligence systems, including simple negligence, modest errors
increasing damages (compensation) for claimants, will not motivate rational defendants to
change their standard of care. (Text, p. 219)
When potential claimants know they are subject to any of the negligence systems, including
simple negligence, modest errors increasing damages motivate rational claimants to file more
claims. (Text, p. 266)
Theorem of Coase - Answer When transaction cost are zero, an efficient (socially optimal) use
of resources results from private bargaining, regardless of the legal assignment of property rights
Converse (High transaction cost) Theorem of Coase - Answer When transaction costs are high
enough to prevent bargaining, the efficient use of resources will depend on how property rights
are assigned
Normative Coase Theorem - Answer Structure the law as to remove the obstacles to private
agreements (lawyers, high transactions costs, etc)
Normative Hobbes Theorem - Answer Structure the law so as to minimize the harm caused by
failures in private agreements
Injunction - Answer Order to stop creating an externality
