Contract Law, remedies for breach: p. 280 Q 8.1 ?p. 343 Qs 9.20, 9.21 ?p. 347 Q 9.23 ?p. 354 Q 9.31 ?p. 359 Qs 9.32, 9.33 ?p. 361 Q 9.35Cooter_Ulen6e.pdf

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Law and Economics, 6th edition Robert Cooter Berkeley Law

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Authors’ Note

LAW AND ECONOMICS (pdf 6th edition)

by Robert Cooter and Thomas Ulen

This is a pdf version of the latest version (6th edition) of Law and Economics

by Cooter and Ulen. The ownership of this book has reverted from the publisher to

its authors, so we are posting it online for everyone freely to read or use as a

textbook. After more than thirty years as the field’s leading textbook, it continues to

cover the latest developments in the economic analysis of property, torts, contracts,

legal process, and crimes. Each new edition refines the analytical core, incorporates

new applications, and expands previous discussions of empirical legal studies and

behavioral law and economics. We hope that you enjoy reading this book as much as

we enjoyed writing it.

Looking forward to next year, this duet will become an internet symphony

that takes full advantage of the internet revolution in publishing. Improvements

will be posted to the internet continuously in small amounts (7.1, 7.2, 7.3, etc.), until

a new edition appears with large changes (8.0). Not just a textbook, the 7th edition

will have supporting materials, including translations. For updates, join the email

list found by googling “Cooter and Ulen Berkeley Law Repository”. Perhaps you will

have something to contribute to the website. For the best feast, the host supplies the

main course each guest contributes a dish.

Law&Economics

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T H E P E A R S O N S E R I E S I N E C O N O M I C S

Abel/Bernanke/Croushore Macroeconomics*

Bade/Parkin Foundations of Economics*

Berck/Helfand The Economics of the Environment

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Blau/Ferber/Winkler The Economics of Women, Men and Work

Boardman/Greenberg/Vining/ Weimer

Cost-Benefit Analysis

Boyer Principles of Transportation Economics

Branson Macroeconomic Theory and Policy

Brock/Adams The Structure of American Industry

Bruce Public Finance and the American Economy

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Case/Fair/Oster Principles of Economics*

Caves/Frankel/Jones World Trade and Payments: An Introduction

Chapman Environmental Economics: Theory, Application, and Policy

Cooter/Ulen Law & Economics

Downs An Economic Theory of Democracy

Ehrenberg/Smith Modern Labor Economics

Ekelund/Ressler/Tollison Economics*

Farnham Economics for Managers

Folland/Goodman/Stano The Economics of Health and Health Care

Fort Sports Economics

Froyen Macroeconomics

Fusfeld The Age of the Economist

Gerber International Economics*

Gordon Macroeconomics*

Greene Econometric Analysis

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Hartwick/Olewiler The Economics of Natural Resource Use

Heilbroner/Milberg The Making of the Economic Society

Heyne/Boettke/Prychitko The Economic Way of Thinking

Hoffman/Averett Women and the Economy: Family, Work, and Pay

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Hubbard/O’Brien Economics*

Money, Banking, and the Financial System*

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Husted/Melvin International Economics

Jehle/Reny Advanced Microeconomic Theory

Johnson-Lans A Health Economics Primer

Keat/Young Managerial Economics

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Miller Economics Today*

Understanding Modern Economics

Miller/Benjamin The Economics of Macro Issues

Miller/Benjamin/North The Economics of Public Issues

Mills/Hamilton Urban Economics

Mishkin The Economics of Money, Banking, and Financial Markets*

The Economics of Money, Banking, and Financial Markets, Business School Edition*

Macroeconomics: Policy and Practice*

Murray Econometrics: A Modern Introduction

Nafziger The Economics of Developing Countries

O’Sullivan/Sheffrin/Perez Economics: Principles, Applications, and Tools*

Parkin Economics*

Perloff Microeconomics*

Microeconomics: Theory and Applications with Calculus*

Perman/Common/McGilvray/Ma Natural Resources and Environmental Economics

Phelps Health Economics

Pindyck/Rubinfeld Microeconomics*

Riddell/Shackelford/Stamos/ Schneider

Economics: A Tool for Critically Understanding Society

Ritter/Silber/Udell Principles of Money, Banking & Financial Markets*

Roberts The Choice: A Fable of Free Trade and Protection

Rohlf Introduction to Economic Reasoning

Ruffin/Gregory Principles of Economics

Sargent Rational Expectations and Inflation

Sawyer/Sprinkle International Economics

Scherer Industry Structure, Strategy, and Public Policy

Schiller The Economics of Poverty and Discrimination

Sherman Market Regulation

Silberberg Principles of Microeconomics

Stock/Watson Introduction to Econometrics

Introduction to Econometrics, Brief Edition

Studenmund Using Econometrics: A Practical Guide

Tietenberg/Lewis Environmental and Natural Resource Economics

Environmental Economics and Policy

Todaro/Smith Economic Development

Waldman Microeconomics

Waldman/Jensen Industrial Organization: Theory and Practice

Weil Economic Growth

Williamson Macroeconomics

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S I X T H E D I T I O N

Law& Economics

ROBERT COOTER University of California, Berkeley

THOMAS ULEN University of Illinois, Urbana-Champaign

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Copyright © 2012, 2008, 2004, 2000 Pearson Education, Inc. All rights reserved. Manufactured in the United States of America. This publication is protected by Copyright, and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise. To obtain permission(s) to use material from this work, please submit a written request to Pearson Education, Inc., Rights and Contracts Department, 501 Boylston Street, Suite 900, Boston, MA 02116, fax your request to 617 671-3447, or e-mail at http://www.pearsoned.com/legal/permission.htm.

Many of the designations by manufacturers and sellers to distinguish their products are claimed as trademarks. Where those designations appear in this book, and the publisher was aware of a trademark claim, the designations have been printed in initial caps or all caps.

Library of Congress Cataloging-in-Publication Data Cooter, Robert.

Law and economics / Robert Cooter, Thomas Ulen.—6th ed. p. cm.

Rev. ed. of: Law & economics / Robert Cooter, Thomas Ulen. Includes index. ISBN 978-0-13-254065-0 1. Law and economics. I. Ulen, Thomas. II. Cooter, Robert. Law & economics. III. Title. K487.E3C665 2011 340’.11—dc22

2010049060 10 9 8 7 6 5 4 3 2 1

ISBN-10: 0-13-254065-7 ISBN-13: 978-0-13-254065-0

vii

Preface x

1. An Introduction to Law and Economics 1

I. What Is the Economic Analysis of Law? 3

II. Some Examples 4

III. The Primacy of Efficiency Over Distribution in Analyzing Private Law 7

IV. Why Should Lawyers Study Economics? Why Should Economists Study Law? 9

V. The Plan of This Book 10

2. A Brief Review of Microeconomic Theory 11

I. Overview: The Structure of Microeconomic Theory 11

II. Some Fundamental Concepts: Maximization, Equilibrium, and Efficiency 12

III. Mathematical Tools 14

IV. The Theory of Consumer Choice and Demand 18

V. The Theory of Supply 26

VI. Market Equilibrium 28

VII. Game Theory 33

VIII. The Theory of Asset Pricing 37

IX. General Equilibrium and Welfare Economics 37

X. Decision Making Under Uncertainty: Risk and Insurance 43

XI. Profits and Growth 49

XII. Behavioral Economics 50

3. A Brief Introduction to Law and Legal Institutions 55

I. The Civil Law and the Common Law Traditions 56

II. The Institutions of the Federal and the State Court Systems in the United States 59

III. The Nature of a Legal Dispute 62

IV. How Legal Rules Evolve 64

Contents

4. An Economic Theory of Property 70

I. The Legal Concept of Property 73

II. Bargaining Theory 74

III. The Origins of the Institution of Property: A Thought Experiment 76

IV. An Economic Theory of Property 81

V. How are Property Rights Protected? 94

VI. What Can be Privately Owned?—Public and Private Goods 102

VII. What May Owners Do with Their Property? 105

VIII. On Distribution 106

Appendix: The Philosophical Concept of Property 109

5. Topics in the Economics of Property Law 112

I. What can be Privately Owned? 112

II. How are Property Rights Established and Verified? 143

III. What May Owners Do with Their Property? 156

IV. What are the Remedies for the Violation of Property Rights? 166

6. An Economic Theory of Tort Law 187

I. Defining Tort Law 189

II. An Economic Theory of Tort Liability 199

Appendix: Liability and Symmetry 228

7. Topics in the Economics of Tort Liability 230

I. Extending the Economic Model 230

II. Computing Damages 253

III. An Empirical Assessment of the U.S. Tort Liability System 261

8. An Economic Theory of Contract Law 276

I. Bargain Theory: An Introduction to Contracts 277

II. An Economic Theory of Contract Enforcement 283

III. An Economic Theory of Contract Remedies 287

IV. Economic Interpretation of Contracts 291

V. Relational Contracts: The Economics of the Long-Run 299

viii Contents

9. Topics in the Economics of Contract Law 307

I. Remedies as Incentives 307

II. Formation Defenses and Performance Excuses 341

Appendix: Mathematical Appendix 373

10. An Economic Theory of the Legal Process 382

I. The Goal of the Legal Process: Minimizing Social Costs 384

II. Why Sue? 386

III. Exchange of Information 391

IV. Settlement Bargaining 399

V. Trial 403

VI. Appeals 410

11. Topics in the Economics of the Legal Process 419

I. Complaints, Lawyers, Nuisances, and Other Issues in the Legal Process 419

II. An Empirical Assessment of the Legal Process 442

12. An Economic Theory of Crime and Punishment 454

I. The Traditional Theory of Criminal Law 455

II. An Economic Theory of Crime and Punishment 460

13. Topics in the Economics of Crime and Punishment 485

I. Crime and Punishment in the United States 485

II. Does Punishment Deter Crime? 491

III. Efficient Punishment 501

IV. The Death Penalty 510

V. The Economics of Addictive Drugs and Crime 518

VI. The Economics of Handgun Control 522

VII. Explaining the Decline in Crime in the United States 526

Case Index 533

Name Index 535

Subject Index 539

Contents ix

x

Preface

This sixth edition of Law and Economics arrives as the field celebrates its (roughly) 30th birthday. What began as a scholarly niche has grown into one of the most widely used tools of legal analysis. The subject has spread from the

United States to many other countries. As scholarship deepens, the concepts in the core of law and economics become clearer and more stable, and new applications develop from the core like biological species evolving through specialization. With each new edition, we continue to refine the explanation of the analytical core and to incorporate new applications selectively as space permits. This edition expands previous discus- sions of empirical legal studies and behavioral law and economics. As we incorporate new material and respond to the suggestions that so many people have sent us, the book feels more like a symphony and less like a duet. We hope that you enjoy reading this book as much as we enjoyed writing it.

The book continues to cover the economic analysis of the law of property, torts, contracts, the legal process and crimes. Instructors and students who have used previ- ous editions will notice that we have reversed the order in which we treat torts and con- tracts, and we have divided the material on legal process into two chapters—one on theory and one on topics—in parallel with our treatment of all the other substantive ar- eas of the law. Below we describe what is new in this edition, followed by an account of the book’s website.

New to This Edition The Sixth Edition has been revised and updated to reflect the latest developments in law and economics. Major changes to the text are as follows:

• Tables and graphs have been updated. • New boxes and suggested readings have been added throughout the text. • Web Notes have been updated and added. • Chapter 6 contains additional information on liability and customs in trade. • Chapter 8 improves the explanation of contractual commitments through a better

representation of the principal-agent problem.

• Chapter 9 now includes new material on lapses, vicarious liability, incomprehensi- ble harms, punitive damages, mass torts, medical malpractice, and some behav- ioral aspects of contract remedies.

• Chapter 10 contains a new treatment of decision making by potential litigants and their lawyers, and new figures and decision trees.

• Chapter 11, a new chapter, combines new material on the legal process and an updated empirical assessment of various aspects of legal disputes.

• Chapter 12 now contains the theoretical material on crime and punishment, updated and clarified.

• Chapter 13 applies the theoretical insights of the previous chapter to wide-ranging policy issues in criminal justice and updates data and information from previous editions.

Online Resources The Companion Website presents a wealth of supplementary materials to help in teaching and learning law and economics. “Web Notes” throughout the book indi- cate the points at which there is additional material on the Companion Website at www.pearsonhighered.com/cooter_ulen. These notes extend the text presentations, provide guides and links to new articles and books, and contain excerpts from cases. We also include some examples of examinations and problem sets.

An updated Instructor’s Manual, reflective of changes to the new edition, will be available for instructors’ reference. The Instructor’s Manual is available for download on the Instructor's Resource center at www.pearsonhighered.com/irc.

Acknowledgments We continue to be extremely grateful to our colleagues at Boalt Hall of the University of California, Berkeley, and at the University of Illinois College of Law for the superb scholarly environments in which we work. Our colleagues have been extremely generous with their time in helping us to understand the law better. And in one of the great, ongoing miracles of the academic enterprise, we continue to learn much from the students whom we have the pleasure to teach at Berkeley, Illinois, and elsewhere.

We should also thank the many colleagues and students at other universities who have used our book in their classes and sent us many helpful suggestions about how to improve the book. We particularly thank Joe Kennedy of Georgetown, who has given us remarkably thorough and singularly helpful comments on improvements in the text.

We’d like to thank the following reviewers for their thoughtful commentary on the fifth edition: Howard Bodenhorn, J. Lon Carlson, Joseph M. Jadlow, and Mark E. McBride.

We would also like to thank those who have provided research assistance for this sixth edition: Theodore Ulen, Timothy Ulen, and Brian Doxey. And, also, for their long-time support and help: Jan Crouter, Dhammika Dharmapala, Lee Ann Fennell,

Preface xi

Nuno Garoupa, John Lopatka, Richard McAdams, Andy Morriss, Tom Nonnenmacher, Noel Netusil, Dan Vander Ploeg, and David Wishart.

Finally, we owe particular thanks to our assistants, Ida Ng at Boalt Hall and Sally Cook at the University of Illinois College of Law. They do many big things to help us get our work done, as well as many little things without which much of our work would be impossible to do. Thanks so much.

ROBERT D. COOTER Berkeley, CA

THOMAS S. ULEN Champaign, IL

November, 2010

xii Preface

For the rational study of the law the black-letter man may be the man of the present, but the man of the future is the man of statistics and the master of economics. . . . We learn that for everything we have to give up something else, and we are taught to set the advantage we gain against the other advantage we lose, and to know what we are doing when we elect.

Oliver Wendell Holmes. THE PATH OF THE LAW, 10 HARV. L. REV. 457, 469, 474 (1897)1

To me the most interesting aspect of the law and economics movement has been its as- piration to place the study of law on a scientific basis, with coherent theory, precise hypotheses deduced from the theory, and empirical tests of the hypotheses. Law is a social institution of enormous antiquity and importance, and I can see no reason why it should not be amenable to scientific study. Economics is the most advanced of the social sciences, and the legal system contains many parallels to and overlaps with the systems that economists have studied successfully.

Judge Richard A. Posner, in MICHAEL FAURE & ROGER VAN DEN BERGH, EDS., ESSAYS IN LAW AND ECONOMICS (1989)

UNTIL RECENTLY, LAW confined the use of economics to antitrust law, regulated in- dustries, tax, and some special topics like determining monetary damages. In these areas, law needed economics to answer such questions as “What is the de-

fendant’s share of the market?”; “Will price controls on automobile insurance reduce its availability?”; “Who really bears the burden of the capital gains tax?”; and “How much future income did the children lose because of their mother’s death?”

Beginning in the early 1960s, this limited interaction changed dramatically when the economic analysis of law expanded into the more traditional areas of the law, such as property, contracts, torts, criminal law and procedure, and constitutional law.2 This

1

1 An Introduction to Law and Economics

1 Our citation style is a variant of the legal citation style most commonly used in the United States. Here is what the citation means: the author of the article from which the quotation was taken is Oliver Wendell Holmes; the title of the article is “The Path of the Law”; and the article may be found in volume 10 of the Harvard Law Review, which was published in 1897, beginning on page 457. The quoted material comes from pages 469 and 474 of that article.

2 The modern field is said to have begun with the publication of two landmark articles—Ronald H. Coase, The Problem of Social Cost, 3 J. L. & ECON. 1 (1960) and Guido Calabresi, Some Thoughts on Risk Distribution and the Law of Torts, 70 YALE L.J. 499 (1961).

2 C H A P T E R 1 An Introduction to Law and Economics

new use of economics in the law asked such questions as, “Will private ownership of the electromagnetic spectrum encourage its efficient use?”; “What remedy for breach of contract will cause efficient reliance on promises?”; “Do businesses take too much or too little precaution when the law holds them strictly liable for injuries to con- sumers?”; and “Will harsher punishments deter violent crime?”

Economics has changed the nature of legal scholarship, the common understanding of legal rules and institutions, and even the practice of law. As proof, consider these in- dicators of the impact of economics on law. By 1990 at least one economist was on the faculty of each of the top law schools in North America and some in Western Europe. Joint degree programs (a Ph.D. in economics and a J.D. in law) exist at many prominent universities. Law reviews publish many articles using the economic approach, and there are several journals devoted exclusively to the field.3 An exhaustive study found that ar- ticles using the economic approach are cited in the major American law journals more than articles using any other approach.4 Many law school courses in America now in- clude at least a brief summary of the economic analysis of law in question. Many sub- stantive law areas, such as corporation law, are often taught from a law-and-economics perspective.5 By the late 1990s, there were professional organizations in law and eco- nomics in Asia, Europe, Canada, the United States, Latin America, Australia, and else- where. The field received the highest level of recognition in 1991 and 1992 when consecutive Nobel Prizes in Economics6 were awarded to economists who helped to found the economic analysis of law—Ronald Coase and Gary Becker. Summing this up, Professor Bruce Ackerman of the Yale Law School described the economic approach to law as “the most important development in legal scholarship of the twentieth century.”

The new field’s impact extends beyond the universities to the practice of law and the implementation of public policy. Economics provided the intellectual foundations for the deregulation movement in the 1970s, which resulted in such dramatic changes in America as the dissolution of regulatory bodies that set prices and routes for airlines, trucks, and railroads. Economics also served as the intellectual force behind the revolu- tion in antitrust law in the United States in the 1970s and 1980s. In another policy area, a commission created by Congress in 1984 to reform criminal sentencing in the federal courts explicitly used the findings of

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