butler 3e 00 fmt 7/24/14 11:38 AM Page i Economic Analysis for Lawyers butler 3e 00 fmt 7/24/14 11:38 AM Page ii Carolina Academic Press Law Advisory Board ❦ Gary J. Simson, Chairman Dean, Mercer University School of Law Raj Bhala University of Kansas School of Law Davison M. Douglas Dean, William and Mary Law School Paul Finkelman Albany Law School Robert M. Jarvis Shepard Broad Law Center Nova Southeastern University Vincent R. Johnson St. Mary’s University School of Law Peter Nicolas University of Washington School of Law Michael A. Olivas University of Houston Law Center Kenneth L. Port William Mitchell College of Law H. Jefferson Powell Duke University School of Law Michael P. Scharf Case Western Reserve University School of Law Michael Hunter Schwartz Dean, William H. Bowen School of Law University of Arkansas at Little Rock Peter M. Shane Michael E. Moritz College of Law The Ohio State University butler 3e 00 fmt 7/24/14 11:38 AM Page iii Economic Analysis for Lawyers third edition Henry N. Butler George Mason University Foundation Professor of Law and Executive Director, Law & Economics Center, George Mason University School of Law Christopher R. Drahozal John M. Rounds Professor of Law, University of Kansas School of Law Joanna Shepherd Professor of Law, Emory University School of Law Carolina Academic Press Durham, North Carolina butler 3e 00 fmt 7/24/14 11:38 AM Page iv Copyright © 1998, 2006, 2014 Henry N. Butler, Christopher R. Drahozal, and Joanna Shepherd All Rights Reserved ISBN: 978-1-59460-997-8 LCCN: 2014943567 Carolina Academic Press 700 Kent Street Durham, NC 27701 Telephone (919) 489-7486 Fax (919) 493-5668 www.cap-press.com Printed in the United States of America butler 3e 00 fmt 7/24/14 11:38 AM Page v To Paige –H.N.B. To Julia –C.R.D. To Ted and Sophie –J.S. butler 3e 00 fmt 7/24/14 11:38 AM Page vi butler 3e 00 fmt 7/24/14 11:38 AM Page vii Contents Table of Cases xvii Preface to the Third Edition xxi Preface to the Second Edition xxiii Preface to the First Edition xxv Chapter I · The Economics Perspective: Incentives Matter 3 Austan Goolsbee, Where the Buses Run on Time 3 A. Economic Behavior 5 1. Opportunity Costs, Economic Choices, and the Margin 5 2. Assumptions About Human Behavior 6 Michael C. Jensen and William H. Meckling,The Nature of Man 6 Notes and Questions 10 3. Assumptions about Firm Behavior 12 Matsushita Elec. Indus. Co. v. Zenith Radio Corp. 12 Notes and Questions 15 B. Property Rights and Exchange in a Free Market Economy 17 1. An Overview of the Efficient Property Rights System 18 2. Enforcement of Property Rights 19 Guido Calabresi & A. Douglas Melamed, Property Rules, Liability Rules, and Inalienability: One View of the Cathedral 20 Notes and Questions 21 3. Poorly Defined Property Rights 21 Garrett Hardin, The Tragedy of the Commons 21 Notes and Questions 22 Wronski v. Sun Oil Co. 22 Notes and Questions 24 4. Public Goods 26 5. Externalities, Property Rights, and the Coase Theorem 27 Miller v. Schoene 29 Fontainebleau Hotel Corp. v. Forty-Five Twenty-Five, Inc. 30 Notes and Questions 31 C. Legal Analysis and the Art of Economics 33 Eldred v. Ashcroft 33 Notes and Questions 37 D. Game Theory 39 Page v. United States 41 Notes and Questions 43 vii butler 3e 00 fmt 7/24/14 11:38 AM Page viii viii CONTENTS E. Positive versus Normative Economic Analysis 45 1. Positive Economic Analysis and Scientific Methodology 45 In Re Aluminum Phosphide Antitrust Litigation 46 Notes and Questions 50 2. Efficiency and Other Normative Goals 51 Chapter II · Markets and the Price System 55 A. The Law of Demand 56 1. Consumer Choice 56 2. Market Demand 57 B. The Law of Supply 58 1. The Opportunity Costs of Supply 58 2. Supply and Costs of Production 61 C. Equilibrium: Market Price and Quantity 62 1. Market Price and Quantity 63 Sedmak v. Charlie’s Chevrolet, Inc. 63 Notes and Questions 65 2. Market Prices and Subjective Value 67 Peevyhouse v. Garland Coal & Mining Co. 69 Notes and Questions 72 D. Gains From Trade: Consumer Surplus and Producer Surplus 73 1. Mutually Beneficial Exchange 74 2. Individual Self-Interest, Free Markets, and Social Welfare: The Invisible Hand 75 Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations 76 Leonard E. Read, I, Pencil: My Family Tree as Told to Leonard E. Read 76 Notes and Questions 78 3. Unequal Bargaining Power and the Limits of Mutually Beneficial Exchange 80 a. Unconscionability 80 Williams v. Walker Thomas Furniture Co. 80 Williams v. Walker Thomas Furniture Co. II 81 Notes and Questions 83 b. Modification and the Pre-Existing Duty Rule 86 Alaska Packers’ Association v. Domenico 86 Notes and Questions 87 E. Changes in Demand and Supply 89 1. Changes in Demand 89 2. Changes in Supply 91 Competitive Enterprise Institute v. National Highway Traffic Safety Admin. 93 Notes and Questions 96 F. Price Controls 98 1. Price Ceilings 98 M. Kraus & Bros., Inc. v. United States 99 Notes and Questions 102 Jones v. Star Credit Corp. 104 Notes and Questions 106 2. Price Floors 106 butler 3e 00 fmt 7/24/14 11:38 AM Page ix CONTENTS ix 3. The Quality of Products and Services in a Price-Controlled Market 108 G. Elasticity: The Responsiveness of Supply and Demand to a Price Change 109 1. Elasticity of Demand 109 2. Elasticity of Supply 114 3. Time and Elasticity 116 4. Tax Incidence 117 H. The Role of Prices 120 Friedreich von Hayek, The Use of Knowledge in Society 120 Notes and Questions 122 Chapter III · The Legislative Process and the Courts 125 A. Normative Grounds for Government Intervention 125 1. Market Failures 126 a. Information Problems 126 b. Externalities 127 c. Monopoly 128 d. Public Goods 129 2. Distributional Issues 129 B. Public Choice Economics 130 Fred S. McChesney, Money for Nothing: Politicians, Rent Extraction, and Political Extortion 131 Notes and Questions 134 City of Columbia v. Omni Outdoor Advertising, Inc. 137 Notes and Questions 140 West Lynn Creamery, Inc. v. Healy 142 Notes and Questions 146 C. The Economics of the Court System 147 1. Public Choice and the Courts 147 Republican Party of Minnesota v. White 148 Notes and Questions 155 2. Suit and Settlement 158 Kohls v. Duthie 159 Notes and Questions 162 3. The Economics of Court Procedures 167 a. Discovery 167 Hagemeyer North America, Inc. v. Gateway Data Sciences Corp. 168 Notes and Questions 171 b. Class Actions 172 In re: Bridgestone/Firestone, Inc. 173 Notes and Questions 175 Lane v. Facebook, Inc. 176 Notes and Questions 181 4. Arbitration 182 Carbajal v. H&R Block Tax Services, Inc. 182 Notes and Questions 183 Chapter IV · Externalities 185 A. Externalities 185 1. Negative Externalities 187 Orchard View Farms, Inc. v. Martin Marietta Aluminum, Inc. 189 butler 3e 00 fmt 7/24/14 11:38 AM Page x x CONTENTS Notes and Questions 194 2. Positive Externalities 195 B. Dealing with Externalities 196 1. The Assignment and Enforcement of Property Rights 197 a. Bargaining and the Coase Theorem 198 Prah v. Maretti 198 Notes and Questions 205 b. Transaction Costs 205 Boomer v. Atlantic Cement Co., Inc. 207 Notes and Questions 211 Spur Industries, Inc. v. Del E. Webb Development Co. 213 Notes and Questions 217 2. Corrective Taxes and Subsidies 217 3. Government Regulation 219 a. Direct Regulation Versus Corrective Taxes 220 b. Selling Rights to Pollute 220 C. Market Failures and Government Failures 222 Terry L. Anderson, Markets and the Environment: Friends or Foes? 223 Notes and Questions 229 Chapter V · Information Costs and Transaction Costs 231 A. Asymmetric Information and Market Responses 233 1. The Market for “Lemons” 233 2. Adverse Selection and Insurance Contracts 234 3. Reputational Bonds and Other Market Mechanisms for Disclosing Information About Quality 234 Benjamin Klein & Keith Leffler, The Role of Market Forces in Assuring Contractual Performance 235 Notes and Questions 239 B. Monitoring Contractual Performance: Agent-Principal Contracting 241 C. Opportunism: Market and Contractual Solutions 244 1. Firm-Specific Investments and the Appropriation of Quasi-Rents 246 Lake River Corp. v. Carborundum Co. 247 Notes and Questions 250 2. Franchising 254 Corenswet, Inc. v. Amana Refrigeration, Inc. 255 Benjamin Klein, Transaction Cost Determinants of “Unfair” Contractual Arrangements 259 Notes and Questions 263 D. Corporate Governance 266 1. Shareholder Voting and Rationally Ignorant Shareholders 267 2. Agency Costs and Owner/Manager Conflicts 268 3. The Contractual Theory of the Corporation 269 a. The Market for Corporate Control 270 Notes on the Market for Corporate Control 271 b. Product Market Competition 272 c. Capital Market Competition and Capital Structure 272 d. Corporate Performance and Executive Compensation 273 Kamin v. American Express Co. 274