Introduction to the economics of Law

Economics of Law

Law and economy are two subjects that move together as a unit. It is also called the economic analysis of Law, and it is different from other forms of analysis in the legal industry. There are several factors that make it unique, with two main ones. First, because the theoretical aspect focuses on efficiency, in other words, a situation that is legal is said to efficient where a right is given to the party with more willingness to pay. Legal efficiency is based on two clear theories, whose arguments are supported by Law and economic scholars. On one side is the positive model of legal efficiency, which says the common Law is efficient, while on the other hand, it is the normative Law that states that Law should be efficient. These two theories have been at the center of understanding Law and economics for a long time, and they are both accepted by a large percentage of economics.

Also, the main subject of concern in Law and economics is that markets are more efficient than courts. Economics is the backbone of modern development, and it is through it that real development can be seen. When moving on the positive line, the positive theory states that the legal system will compel a market transaction. Where it is not possible, the legal system tries to ‘mimic a market, by guessing what different participants would have wanted if the markets were any different, say feasible.

The other aspect that defines Law and economics is that it emphasizes incentives and how people respond to incentives. For instance, when someone gets involved in an accident, they are paid for the damage. This is called tort law, and it is not aimed at compensating the injured parties, but rather to provide a caution/incentive for the one who caused the injury not to repeat such a mistake. It is one way of letting them learn the importance of taking more precautions not to cause another accident. As if that is not enough, there are many other economic share branches by Law and economies. Consider, for instance, the assumption that individuals are rational, and they respond to incentives. When there is an increase in the penalties of action, people are more likely to take less action. Law and economics have more likely than other legal analysis branches to use empirical and statistical methods when measuring responses to incentives.

Three functions are important to the legal system and must be performed, all of which are related to property and property rights. In other words, Law looks at economics in terms of what individuals and companies own, and uses that to establish different measures for it to work correctly. Among the three functions, the first one is that the system must develop a clear definition of property rights. This is a task the Law itself must perform. Second, the system needs to allow for property transfer, which is where contract law comes into place. And in the third role, the system must protect property rights; here, we have tort law and criminal law. 

Law and economics, or otherwise the economics of law, is now a major subject of study in both fields. The aspects mentioned above are the main issues studies under this subject. Scholars in this field and anyone else interested also apply economics tools like the game theory in analyzing and answering legal questions. We can, therefore, say that these are crucial aspects of Law and economics. However, they are more helpful to legal scholars than students in the economy. Nevertheless, students of economic studies can still find some incentives in studying these aspects.

Importance of Law and Economics

The modern study of Law and economic dates back to the 1960s. This was when Ronald Coase published his work titled, “The Problem of Social Cost.” Gordon Tullock and Friedrick reviewed the same area. The expansion of the field started with Gary Becker in 1968 when he wrote on crime. In 1972, another economics scholar, Richard Posner, who was also a major advocate of the positive theory of efficiency, published the first edition of Economic Analysis of Law. He was also the founder of the Journal of Legal Studies. These events have formed a very crucial foundation and the path followed by modern scholars in the discipline. Posner later became a federal judge while holding his position as a prolific scholar. One important factor that encouraged the spread of Law and economics in the 70s was a series on seminars and courses related to Law that become a crucial part of the industry. Henry Manne founded most of these seminars, which were in part funded by the Liberty of Fund.

Today, the discipline has been well established with eight associations, among them the American, Canadian, and European Law and economics associations. There are also several associations that make the industry even more viable to the modern economy and law student. The appearance of law and economics journals have become more popular, with the same approach witnessed in law review articles. In many law schools, there are faculty trained economists focused on dealing with economics and law courses. Besides, many departments in economics also teach the field as the main course. Students completing their studies in Law and related subjects must be ready to learn Law and economics because this is one area that makes a lot of sense to them.

Components of Economics law

When companies and individuals have issues with either product or properties that require legal assistance, it is important to first establish the substance and types of Law right for the current issue. It takes a lot to understand dealing with specific economic issues using Law. This is why everyone involved has to be very careful with what they will be doing. And since we have seen that economy and Law is a crucial field in modern Law and economics, understanding different aspects that define these fields is also very important.

Property Law

A legal system should always provide a clear definition of property rights and what they mean to the holder and the state. In other words, every party should determine who owns that asset and what rights they have towards the asset they own. Details are very important in this Law. There have been very many situations where people fight over property ownership, taking each other to court just to establish who has more rights over the said property. The idea of efficiency holds that when there is a dispute about the ownership of a right, the right should be given to the party who finds more value in the property. It all comes down to who will be using the property more, and what substance they gain from this use. If there is no evidence that the property helps the other party, then they should be ready to leave it for one who wants more. However, chances of exchange of rights may be allowed, in which case, the efficiency of the initial allocation is not of primary importance. Coase Theorem is used as the most fundamental result of economics and Law, which states that where rights can be transferred and transfer costs are small, the real definition of property rights is not of primary concern since parties can exchange rights moves to most valuable users.

In many cases, the right owner is not of any importance since there are never zero transactions. And if the rights are not allocated in the right manner, correcting the error will be very costly. Where transaction costs are higher than the increase in the value from when the property is moved to the next owner, a different mechanism is necessary, and their corrective mechanism may not be possible. Any type of economy can witness such a case. The most serious example is Russia, where the courts lack a clear definition of property rights, and those who control the properties are not necessarily the owner. In other words, those who control companies have not right to sell and keep the proceeds. In such a case, incentives are created for inefficiency use of the said assets. This coarse Theorem fails to operate in this scenario, whereas defining property rights becomes crucial.

Contract law

Contracts bound many transactions in the world of business and other aspects of life. In economics, the Law governing exchange critical in a market economy. Most aspects and principals of contract law seem consistent with efficiency, where economies are involved. The study of contract law in economics and Law has revealed that it is generally more efficient for parties to be free to draft their own contracts, and normally, courts should only be used in enforcing the terms agreed upon, and the costs incurred in the contract, the courts may not enforce the contracts, where performance is deemed inefficient, but, rather, it will allow for payment of damages. For instance, if one person agrees to construct a property that may cost them $50000, but the costs increase along the way to $150000, it is inefficient to continue with the property. Courts can allow the contract to compensate the property owner with a monetary payment, which is efficient.

The issue opportunism is eminent where two players may agree on something, and one makes irreversible investment for his side. In this case, contracts and contract laws become very crucial. If, for instance, one company may agree to build a railway spur for a coal mine, and use a contract in advance to ship the coal at a specified price. At the end of it all, the coal miner may refuse to honor their end of the contract and hold out lower shipping costs. If he is tempted to accept rates that exceed the railroad's excess costs, they will miss out on the full return of the spur line. Doctrines like the ones on the duty of mitigating can be easily seen as efficient. However, some doctrine is inefficient.

Law of Tort and Criminal law

Understanding, or owning property rights alone is not enough. These rights have to be protected, and this is where tort law and criminal laws come into play – to protect property rights from intentional and unintentional harm. These laws are specifically designed to induce potential tortfeasors or criminal to take account of their actions' costs. Tort laws are a crucial part of private law, and it is enforced through private actions. Issues like the distinction between negligence and strict liability have been highlighted under the economic analysis of tort laws that are basic to understanding the subjects. They also follow the fact that most accidents are caused by joint action of the injurer and the injured, and hence, efficiency rules, create incentives for involved parties to take care. A good example is the negligent rules, which create these exact incentives (a driver may be going too fast, but the pedestrian they hit may have failed to look carefully. Taught laws are used widely in dealing with automobile accidents, but liability issues extend far beyond companies. There are other issues that make it hard to apply tort and criminal laws. For instance, where a firm has committed a serious crime, some lawyers may argue that a company cannot be arrested, making it hard for them to assume liability.

Criminal Law is best enforced by state governments rather than by the victim. The main reason for this concerns efficient enforcement, which calls for only a fraction of criminals to be arrested, and every punishment be multiplied to echo the Law of probability detention and conviction. For instance, where four criminals were to be arrested, but only one was caught, punishment must be four-time the cost of the crime. But then, criminals lack sufficient wealth to pay for these fines; therefore, the Law calls for incarceration or other forms of punishment. Sometimes wealth and payment are transferred to the affected party, which calls for different laws' intervention. Economic theory, which suggests that criminals, just like anyone else, respond to incentives, is used to determine the best punishment. And thereforeEconomics of Law, economic analysis of Law becomes an interesting and important subject of study. 

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Oct 16, 2020

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