Midterm

(You may leave any complete question or questions blank for 20% credit)

I. A. Briefly explain what it means to say that a change in a legal rule--or anything else--increases economic efficiency.

B. What roles does economic efficiency play in the economic analysis of law?

(10 points)

II. A. Briefly explain and distinguish real externalities (such as pollution), pecuniary externalities, and rent seeking.

B. Pick one of the above and briefly explain why it does or does not lead to inefficient outcomes. (10 points)

III. According to Coase, a Pigouvian tax will sometimes make the situation more efficient, sometimes less. Explain. (5 points)

IV. A railroad runs through farming country; there is one railroad company and a hundred farmers. The railroad's locomotives throw sparks which sometimes start fires, doing $100,000 worth of damage each year. The railroad company could prevent the fires by installing spark arresters on its locomotives at a cost of $50,000/year. The farmers could prevent the fires by switching from wheat to clover, costing them $70,000/year in lost income. (15 points)

A. What is the efficient outcome? (you may answer by circling the correct alternative in each pair—or giving it if you are taking the exam on a computer)

Sparks or spark arrester? Wheat or clover? Resulting in fires or no fires?

B. No transactions are possible between farmers and railroad. What happens if:

The railroad is free to throw sparks.

Sparks or spark arrester? Wheat or clover? Resulting in fires or no fires?

The railroad must pay the farmers damages for the fires caused by its sparks.

Sparks or spark arrester? Wheat or clover? Resulting in fires or no fires?

The railroad must pay a fine to the government for the damage due to the fires caused by its sparks.

Sparks or spark arrester? Wheat or clover? Resulting in fires or no fires?

In each case, is the result efficient?

C. Answer the same questions, assuming that transactions are possible and costless.

1. Sparks or spark arrester? Wheat or clover? Resulting in fires or no fires?

2. Sparks or spark arrester? Wheat or clover? Resulting in fires or no fires?

3. Sparks or spark arrester? Wheat or clover? Resulting in fires or no fires?

D. Transactions are possible but not costless. What transactional problems, if any, might prevent the parties from getting to the efficient outcome in each case?

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

A. We might try to prevent highway accidents with an ex ante rule, such as a speed limit, or with an ex post rule, such as making the driver responsible for the accident liable for the resulting costs. What are the advantages of each approach?

My neighbor sues me because noise from my factory makes it hard for him to sleep. The court agrees that my factory is a nuisance and must decide whether to award damages or grant injunctive relief. Discuss the advantages of each. What circumstances might be relevant to deciding which is preferable?