Solution Unsatisfactory: The Economics of Market and Political Failure


Economic theory suggests that there are certain sorts of problems, such as public goods and externalities, which a market cannot deal with perfectly and might deal with very badly. Public Choice theory--economic theory applied to political institutions--suggests that there are many problems which political institutions can be expected to do a bad job of dealing with. This course deals with the intersection of the two sets--problems for which neither private markets nor political institutions seem to provide a satisfactory solution. Examples range from natural monopoly to the effects of human activities on global climate.


Demsetz: JLE 1969 Information and Efficiency



0. Intro.

A. Orwell Review of Hayek, Ziliakus. Both may be right!

B. Heinlein. At every step the right choice. Consequence--imminent catastrophe.


I. Framework:

A. Efficiency and catastrophic failure.

B. Efficiency of perfect market (or 0 transaction cost)

C. Market Failure

1. Public goods

2. Externalities. Pigouvian solution. Coasian critique.

D. Political Failure

1. Absence of efficiency theorem

2. Becker interest group model

3. Niskanen Bureau

4. Downs democracy


II. natural monopoly--a simple case.


III. Product safety.

A. Market solutions

1. Perfect info--for purchaser but not 3rd party. (auto? smoke? asbestos?)

2. Perfect guarantee market. (find articles on problems with)

B. Liability solutions (Huber, Viscuzi)

1. Litigation cost--estimates. Economic implications of ... .

2. Error costs. Private plane industry?

3. Market evasion--kits. judgement proof?

4. Market solution of freedom of contract barred. See above.

C. Regulatory solution: Stigler articles? Peltzman on drugs, seatbelts.


IV. Welfare:

A. In what sense is inequality inefficient? Catastrophic?

1. Utilitarian/veil of ignorance sense.

2. Altruistic externalities

3. Physical externalities

a. Unpleasant environment.

b. crime. evidence?

c. political problems. evidence? Buckley Essay? Committee to rule Buckley? (Danny?)

B. Market problems.

1. Public good problem, but ...

2. Depends on nature of altruism ...

3. We observe some solutions.

a. Insurance, private or social? Social as solution to moral hazard etc.?

b. Charity.

C. Political problems.

1. moral hazard. illegitimacy rates. problem.

2. getting the right policies--expenditure per poor person estimates.

3. general rent seeking argument--agriculture program etc.


V. Global climate.

A. market problem--public good

B. Political problem--public good. Whaling/fishing as a small case.

C. Political problem--complicated issue+large information costs:

1. Random outcomes

2. Excuse for rent seeking.

VI. Organ market


VII. Encryption


VIII. Divorce

Atlantic Monthly Article

Lloyd Cohen article



Safety: Unsafe at Any Speed


Pollution: Silent Spring?


The Silent Revolution, Herbert Jacob


Moral Basis of a backward society and Robert Frank? and Smith?


Regulation magazine

Public Interest magazine

Calabresi: Tragic Choices No

Bob Crandall JLE on Auto safety and fuel limits

MIT author on global warming?

Jesse Dukeminier, N.E. Journal of Medicine, something on Body Parts, early 80's


Facts re Orwell: Paris late fall 1929, London 1927 and 1930. 120F=1[[sterling]] .


U.K. 1929 [[sterling]] : in 1930: 4.1 billion/46 million=[[sterling]] 89/capita x4.86$/[[sterling]] =$433/capita

U.S.1975: 325billion/214 million=$1500


Prices: 1929/1975: 3.46; 1975-1987: 1.86/.88

so price change USA 1929/1987: 7.3

1d U.K. 1929=486/240 cents us =2.025cents 1929 = $.15 1987

1 F 1929=486/120 cents 1929=4cents 1929=$.30 1987


Autobiography of a Super Tramp by Davis


Police brutality (ask Norvall)



Solution Unsatisfactory: Preliminary Syllabus


[...]: Optional readings.


3/30/93 Introduction [Orwell Review of Hayek & Ziliacus, Heinlein]

4/1/93 Efficiency and Perfect markets Friedman 1986 (ch 14,15->p. 374) or 1990 (ch 15, 16->p. 465)

4/6/93 Market Failure Friedman 1986(ch 17) or 1990 (ch 18)

4/8/93 Political Failure Friedman 1986(ch 18) or 1990 (ch 19) [Becker 1983 or 1985]

[Niskanen 1971]

4/13/93 Natural Monopoly Friedman 1986 (pp. 374-389) or 1990 (pp. 465-477)

4/15/93 Product Safety Viscuzi 1991 (pp. 62-70), [Huber 1988]

4/20/93 Product Safety Peltzman 1973

4/22/93 Poverty and Homelessness Orwell 1933, [Tucker 1991]

4/27/93 Poverty Murray 1990, [Murray 1984, Popenoe 1991, Stigler 1970]

4/29/93 Poverty O'Neill 1988, [Friedman 1986 (404-409) or 1990 (pp. 496-502)]

5/4/93 Divorce Friedman 1986( pp. 484-488) or 1990 (pp. 595-597)

5/6/93 Divorce Cohen 1987, Whitehead 1993

5/11/93 Allocating Organs for Transplant Cohen 1989, Niven 1971, [Thorne 1990]

5/13/93 Encryption Package of readings on reserve

5/18/93 Global Climate etc. Danny Boggs talk, Two books.

5/20/93 Global Climate etc.

5/25/93 ... Allocating Public Lands?? Hill and Anderson (1983) [Did not get to]


Friedman 1986 is on reserve in Harper; Friedman 1990 is on reserve in the Law School library. They are different editions of the same book and contain essentially the same material with different pagination and chapter numbering. All other readings are or will be on reserve in Harper.


My office is Rm 608 in the law school (1111 E. 60th St.). Temporary office hours (for the first week of class) are T, Th 4-5. My office number is 702-9589, home number 373-7881; please do not call before 10 A.M. or after 11 P.M.




Becker, Gary, "A Theory of Competition Among Pressure Groups for Political Influence, 98 Q.J.Econ. 371 (1983)

___ Pressure Groups and Political Behavior, in Capitalism and Democracy: Schumpeter Revisited 120 (R.D. Coe and C.K. Wilbur eds. 1985)

Boggs, Judge Danny, "..........................

Cohen, Lloyd,Increasing the Supply of Transplant Organs: The Virtues of a Futures Market, George Washington Law Review, November 1989.

____ Marriage, Divorce, and Quasi Rents; or, "I Gave Him the Best Years of My Life," Journal of Legal Studies, June 1987.

Friedman, David, Price Theory: An Intermediate Text, first edition (1986), second edition (1990)

___Courts, Regulators, or Markets: Alternative Institutions for dealing with Risk, Journal of Political Economy, forthcoming. (Review of Viscusi book below)

Heinlein, Robert, "Solution Unsatisfactory," in Expanded Universe, Ace 1980.

Hill, P.J. and Andersen, Terry, "Privatizing the Commons: An Improvement?", Southern Economic Jnl (1983)

Huber, Peter W., Liability: The Legal Revolution and its Consequences, 1988.

Murray, Charles, "The British Underclass," The Public Interest Spring 1990.

____, Losing Ground: American Social Policy 1950-1980, 1984.

Niskanen, William A., Bureaucracy and Representative Government. Chicago: Aldine-Atherton, 1971.

Niven, Larry, "The Jigsaw Man," in All the Myriad Ways, Ballantine (1971)

O'Neill, June, "Poverty: Programs and Policies," in Thinking About America, Annelise Anderson and Dennis L. Bark, editors, 1988.

Orwell, George, Down and Out in Paris and London, original publication date 1933.

Orwell, George, Review of The Road to Serfdom and The Mirror of the Past, in The Collected Essays, Journalism and Letters of George Orwell, Sonia Orwell and Ian Angus editors, Volume III, pp. 117-119. Originally printed 1944

Peltzman, S., "An Evaluation of Consumer Protection Legislation: 1962 Drug Amendments." JPE September/October 1973.

Popenoe, David, "Family Decline in the Swedish Welfare State," The Public Interest Winter 1991.

Stigler, G. "Director's Law of Public Income Redistribution," Vol. XIII (i) JLE 1-10 (April 1970).

Thorne, Emanuel D., Tissue Transplants: The Dilemma of the Body's Growing Value, The Public Interest, Winter 1990.

Tucker, William, "How Housing Regulations Cause Homelessness," The Public Interest Winter 1991.

Viscusi, W. Kip , Reforming Products Liability, Harvard University Press, Cambridge 1991. pp. 62-70

Whitehead, Barbara Dafoe, "Dan Quayle Was Right," The Atlantic Monthly, April 1993.



I. I would like to set my office hours at a time when most of you are free. Please mark the periods when you have classes or other commitments.


Time Monday Wednesday Friday Time Tuesday Thursday

10:30-11:30 10:00-11:30


11:30-12:30 11:30-1:00 xxxxx xxxxx


12:30-1:30 1:00-2:30


1:30-2:30 2:30-4:00


2:30-3:30 11:30-1:00


3:30-4:30 11:30-1:00



2. The following are topics that may be covered in the course of the quarter. Please circle any you find especially interesting and cross out any you find of no interest at all:


Allocating Organs for Transplant, Divorce, Encryption, Global Climate, Natural Monopoly, Poverty and Homelessness, Product Safety.


3. Please circle any which have been covered at length in previous courses you have taken.


Allocating Organs for Transplant, Divorce, Encryption, Global Climate, Natural Monopoly, Poverty and Homelessness, Product Safety.


4. Do you have any suggestions for additional reading material on the topics on the preliminary syllabus? If so, list.







5. List any additional topics that you think suitable for this class and would like to see included. They should involve problems for which a good case can be made against any proposed solution of which you are aware.






6. If a paper is assigned for this course, the requirement will be to find a serious problem which fits the course requirement and analyze the difficulties with at least the most obvious possible solutions. Would you prefer a paper, an exam, or both? (circle one).


Solution Unsatisfactory: End of Quarter Questionaire


1. The following topics were covered in the course of the quarter. Please circle any you found especially interesting and cross out any you think should be left out next time:


Allocating Organs for Transplant, Divorce, Encryption, Global Climate, Natural Monopoly, Poverty and Homelessness, Product Safety.


2. Do you have any suggestions for additional reading material on the topics we covered? If so, list.







3. List any additional topics that you think suitable for this class and would like to see included. They should involve problems for which a good case can be made against any proposed solution of which you are aware.






4. If the course is taught again, what changes should be made? In particular:


Should there be more emphasis, in class and readings, on the underlying facts relevant to the various problems?


Should there be more or less time spent on the economic theory underlying the analysis of market and political failure?


More topics with less time on each, or fewer with more time on each?




First Class


I. Orwell review

A. Context

B. Read it

C. Moral


II. The Course: New. Name--Heinlein. (story)

A. The idea--no satisfactory solution

B. Failure:

1. Economic efficiency. Precise but too strong.

2. Clearly unsatisfactory. Deaths from lack of organs--when harvestable organs are rotting.. Fuzzy but ...

C. Reasons:

1. Market does not work and

2. Political does not give the right answer(explain) or ...

3. There seems to be no right answer. Divorce?

D. My expertise or lack thereof.

E. Not including moral conundrums

1. Everything about people is morally arbitrary, only equality is just, or ...

2. Everything is moral luck, all punishment unjust.

F. Readings, optional and required. Exam or paper.


III. Outline:

A. Explain Efficiency

B. Explain Market Failure

C. Explain Political Failure

D. Topics.

1. Natural monopoly, explain. 3 alternatives.

2. Product safety: Market, Liability, Regulation.

3. Poverty: Orwell-->homelessness, Murray.

4. Divorce: Fault, shameful vs easy. vs wife. vs kids. When I ... .

5. (Children) Ties into 3, 4.

6. Allocating organs. Present mess. Potential mess ... . Rape.

7. Encryption--Privacy. FBI worried.

8. Global climate. Warming etc.


IV. Suggestions wanted:

A. Additional readings--especially if unfair. Public Interest, what is a good left equivalent?

B. Additional topics--timing of course uncertain.


V. Economic efficiency:

A. My definition

B. Weaknesses in the implicit definition of the good

1. Interpersonal rule (measure value by dollars)

2. revealed preference for value. Value of heroin to the addict? Becker/Murphy

C. Efficiency vs improvement. Bureaucrat God. Best v good?

D. Fuzzy definition of a "Problem"--a large improvement seems possible but no way to get there.

1. Organ shortage

2. Poor in a rich society

Second Lecture


I: Problems w/o solutions. Title story.

A. Defining problems--how? Does calling something a problem imply a solution exists?

1. The death problem--mortality rate of 100%.

2. Poverty problem, 1820. We want a solution right now (by 1821).

3. For our purposes, these do not count as problems since no reason to believe there is a solution.

B. Solution appears to exist, but we do not know what it is?

C. For example ... global warming. Organ shortage. Evidence, not proof.


II. Economic Efficiency as a way of making that definition precise: Two qns. Can&Improve

A. Define improvement

1. Money measured, not in money.

2. Interpersonal problem, defenses.

3. Revealed preference problem, defense.

B. Define efficiency: Best possible

1. What does possible mean?

2. Why useful as outer bound.

3. Why too strong?

C. Useful as diagnostic tool.

D. Fuzzier--not just inefficiency but large inefficiency.


III. Market perfection:

A. Profits vs People. Profit would be right if ...

1. All costs of inputs correctly reflected their human value ...

2. All value of output ditto, and ...

3. What does that mean? Value in dollars as above.

B. Inputs--price =MV leisure. Same across users. Generalize to all users, highest valued use.

C. Outputs ditto.

D. Competitive layer cake

E. Ergo efficient, provided that ...

1. People know value to them (information) and ...

2. Firms must pay for what they use (no externalities) and ...

3. Firms can get paid for what they produce (ditto) ...

4. i.e. simple model of exchange covers it.


IV. Market failure:

A. Externalities ... .

1. Pollution.

2. Pretty buildings

3. Information

4. Moral hazard in information

5. Depends on property rights, form of contract, but ...

6. Not infinitely flexible. There may be no good definition. risk vs incentive For instance ...

B. Coasian view of ...

1. Factory/resorts, define problem. Solutions?

2. Nothing works. Joint product.

3. Everything works.

4. Transaction costs.

5. Absolute factory, absolute resort, damages either way.

C. Public good problem.

1. Sue for negative damages?

2. Market solutions--radio and television.

3. Tie-ins--insurance and health ads.

D. Adverse selection.



Third Lecture: 4/6/93


I. Review:

A. Problem-->inefficiency

B. Improvement and Can, defining and problems with

C. Market efficiency, but ...

D. Depends on assumptions that ...

E. Are violated for market failure

1. Externality/public goods. Coase... but no perfect property rights defn.

2. Moral hazard a (usually voluntary) example. Imperfect solns.

3. Firms as evidence of best efficient soln (as in 2 above)

4. Adverse selection.

F. Imperfect provision, to compare to alternatives ...

1. Radio and TV

2. Tie-ins as Insurance and health info

3. Markets to generate info. Robin Hanson scheme for idea futures.



Fourth Lecture 4/8/93


II. The political market: Becker gives formal version

A. Basic assumptions--rationality, diverse interests.

B. Simple democracy: Civics class model. Vote for the good. But ...

1. Majorities exploiting minorities, possibly ameliorated by ...

2. Vote trading, or ...

3. Restricted agenda to issues where large commonality of interests. For example ...

a. Flat rate tax

b. Equal treatment rule in the constitution.

4. But ...

C. Rational ignorance...

1. The public good/externality problem on the political market.

2. High cost of information, low benefit. ergo ...

3. Simple democracy based on free information, low quality. Plus

4. Special interest market for legislation, via bribes (to legislatures) and propaganda.

D. The market for legislation.

1. Money or votes for congressional votes or passed bills.

2. Expenditure proportional to gain. Pub Gd case. Would be efficient except ...

3. Weighted by an interest group's ability to raise money

4. Outcome (efficient but ... but ...

a. Transfer to concentrated even if inefficient, and

b. High information cost transfers even if less efficient than lower, but

c. More efficient transfers preferred, including net desirable ones.

5. Process costly, inefficient. Puzzle of small size of campaign expenditures?

E. Who gets the goodies?

1. Well organized group gets--but pays for.

2. Inelastic group gets--or pays:

a. Farmers

b. Declining industries

c. Becker knife edge argument. Agriculture, big vs small sector.

F. Rent seeking in general: Spending resources on transfer v production

1. The economics of theft.

2. Airline price fixing. Complete dissipation.

3. Subsidy to the blind--very slight dissipation.

4. The difference: does MC=AC?

G. Economics of Bureaucracy:

1. Assumptions: Budget max? Profit max?

2. Dealing with legislature

3. Cut the lean



Fifth Lecture: 4/13/93


I. Review: Economic theory of politics

A. Becker interest group model + information costs

B. Niskanen bureaucracy. Max budget or profit? Like a firm.

C. Majority vote, cycling. Hotelling theorem.


II. Natural Monopoly

A. The economics of single-price monopoly.

1. MR=MC vs competitive P=MC

2. Why it is inefficient in quantity

3. Why it is inefficient in produce/don't produce decision

B. Regulation with wise and benevolent regulators:

1. For P=MC you need to know cost curve.

a. Firm may lie.

b. How do you observe? Stock as value? Circular.

2. For 2nd eff condn you need demand curve.

C. Real regulation.

1. Monopoly is a concentrated interest

2. Some customers may be

3. Most customers are not

4. Railroad and trucking case.

D. Government monopoly.

1. Employees: Post office

2. Customers: National forrests.

3. Party in power


III. Artificial monopoly?

A. Problems with--McGee article, story.

B. Merger policy--if competitors complain, permit.

C. Govt enforced monopoly.

1. Professional licensing.

2. Private express statutes.

Sixth Lecture: 4/15/93


I. Review monopoly:

A. Private inefficient for two reasons. Price as signal.

B. Benevolent public hard for both reasons. Info and control pblms.

C. Govt interest unlikely to be public interest.

1. Modern literature on railroads, trucks, airlines, prof regulation

2. Govt owned monopoly problems.

D. Disadvantage of regulation or nationalization--better defensive tools.

1. Rockefeller quote

2. Maintain monopoly in changing world--consider regulators' interest.


II. Product safety discussion.

A. The problem. Dangerous and hard to know about.

1. Wide range, from obvious (poison medicine) to nobody could know.

2. Optimal safety != complete safety

3. Multiple causes. User precaution.

a. Peltzman seatbelt study

b. Warning as an alternative to or form of safety?

B. Alternative solutions:

1. Market regulation

a. Perfect information

b. Reputation

c. guarantees

2. Direct regulation--FDA.

3. Regulation by the courts--liability law.

4. Freedom of contract: choice between 1c and 3. Third parties?


III. Choice of solution: Problems

A. Market:

1. Simple case--information often expensive and hard to get.

2. Reputation--long term risks? Advantage to large firms? middlemen--Sears.

3. Guarantee, ordinary liability.

a. Ignorance about guarantee (fine print), risks.

b. Judgement-proof defendants. Ignorance about whether the seller will be judgement proof if sued... .

B. Direct regulation:

1. Enormous size of the problem--products/year?

2. Bias towards conservatism (free info). Beta blockers.

3. Or bias towards firms (political market).

4. FDA. Drug companies benefit from difficult approval process? Raises their quasi rents on existing drugs.

C. Regulation by the courts: The liability crisis.

1. arguments for: insurance plus responsibility.

2. argument against:

a. juries, perhaps judges, incompetent to judge.

b. ex ante, ex post, and the temptation of deep pockets.

c. Difficulty of redistributing by the court system.

3. Lousy insurance.

4. Defensive medicine, avoid risk studies, ...

5. Judgement proof defendants with high variance outcomes.

6. Making warnings useless.

D. Freedom of contract least bad?

1. Choice of law by market?

2. Info as hard, but at least a private good for consumer, public for voter.

3. Incentives of plaintiffs' bar? Judges.




April 20, 1993


I. Review: Product safety.

A. The problem. Dangerous and hard to know about.

1. Wide range, from obvious (poison medicine) to nobody could know.

2. Optimal safety != complete safety

3. Multiple causes. User precaution.

B. Alternative solutions:

1. Market regulation x3

2. Direct regulation--FDA.

3. Regulation by the courts--liability law. v Freedom of contract. Huber.


II. Choice of solution: Problems

A. Market:

1. Simple case--information often expensive and hard to get.

2. Reputation--long term risks? Advantage to large firms? middlemen--Sears.

3. Guarantee, ordinary liability. Ignorance. Judgement proof.

B. Direct regulation:

1. Enormous size of the problem--products/year? Only important ones?

2. Bias towards conservatism (free info). Beta blockers.

3. Or bias towards firms (political market).

4. FDA. Drug companies benefit from difficult approval process?

C. Regulation by the courts: The liability crisis.

1. arguments for: insurance plus responsibility.

2. argument against:

a. juries, perhaps judges, incompetent to judge.

b. ex ante, ex post, and the temptation of deep pockets.

c. Difficulty of redistributing by the court system.

3. Lousy insurance.

4. Defensive medicine, avoid risk studies, ...

5. Judgement proof defendants with high variance outcomes.

6. Making warnings useless.

7. Conservative bias.

D. Freedom of contract least bad?

1. Choice of law by market?

2. Info as hard, but at least a private good for consumer, public for voter.

3. Incentives of plaintiffs' bar? Judges.



April 22, 1993


I. Review--Choice of solution: Problems

A. Ex Ante vs Ex Post: Product quality

1. In one sense, all precautions are ex ante. But ex post gives incentives.

2. Observation is ex ante by customer, regulation by regulators.

3. Reputation, liability (either way) is ex post-->ex ante by firm.

B. Quality of decision

1. Firm is most expert, may have organizational biases. Could hire outside consultant.

2. Consumer has some expert knowledge (how he used it).

3. Court is least expert?

C. Cost of decision

1. Litigation and regulation involve conflict, are expensive.

2. Observation and reputation are cheap.

D. Decision about decision ... .

1. Political mechanism (not clear what) to decide, or ...

2. Market decision via freedom of contract.



April 29, 1993


I. Thursday problem: Lorraine Schlomas: 702-0220, me 702-9589


II.In what sense is poverty inefficient?

A. Narrowest--direct externalities.

1. Crime

a. mostly against other poor people.

b. May still make transfers efficient.

c. But... special pleading. There may be positive and negative externalities.

2. Bad voting. Buckley joke. Evidence?

B. Altruistic externalities. A public good problem?

C. Insurance against being born poor: makes efficiency --> utilitarianism.


III. Best will in the world problems ... .

A. Welfare state

1. Permanent transfers. Consequences?

2. Makes it permanent

3. Lack of power over lives, ... . One employer. Political, emotional.

4. Incentives--child problem.

a. Innocent, support them, but ...

b. Affects incentive to produce them ... . Multicausal.

c. Illegitimacy rates.

B. vs war on poverty.

1. What is the problem?

a. No money or

b. No training, etc.

2. Market failure re human capital

3. Results? Murray.

4. Two explanations:

a. Missing ingredient is in the person--early childrearing? Genes?

b. We are doing it--but wrong. Consider public education.


IV. Political problems--Director's law et. al.

A. Why would transfers go to the poor?

B. Rent seeking.

C. Real world:

1. Higher education

2. Social Security

3. Homeowner's deduction

4. Quality of govt services? Expenditure or cost factors?


V. Orwell's proposal, and problems with: -->homelessness


Converting Orwell's numbers to modern equivalents:

120F=1[[sterling]] . U.K. 1929

[[sterling]] : in 1930 U.K. income $433/capita---U.S.1975:$1500/capita

1d U.K. (1929) =$.15 (1987); 1 F (1929) =$.30 (1987)



I. Review: Poverty

A. In what sense it is inefficient.

B. Best will in the world problems

1. Welfare. Disincentive inevitable--someone has to pay. NIT and other schemes. Both ends.

2. War on poverty

C. Incentive not to help the poor.

1. Redistribute away, poor as excuse

2. Director's law? Middle or top? Coarse control, fine control.



May 6, 1993


I. Marriage--the economics of ...

A. Marriage as a long-term contract.

B. Why long term contracts exist

C. What has been happening to this one.

1. Enormous change in status of women. Why?

2. Consequence for marriage and divorce. Specialization not inequality


II. Problems with divorce

A. General problems of long term contracts.

1. If not enforcable, incentive to reneg due to time pattern or changes.

2. If strictly enforcable, get stuck due to (unpredictable?) changes.

3. If enforcable with negotiation, negotiation costs, strategic default. Not enough fine print.

B. Specific application to marriage and divorce

1. Under no-fault, strategic behavior by husband to exploit time pattern.

2. If strictly enforcable, ruined lives? Can sex-mad adolescents be trusted? Parental role?

3. Can you sue for cooking badly? Making love badly? Nagging?

C. Special problems and solutions of marriage and divorce

1. Altruism, sunk costs as enforcer,

2. Interdependence, via market and social pressure.

3. Children.


Adjustment to current law--postpone childbirth. Corporate equivalent.


III. Taking care of children

A. The general problem--principal agent.

B. The obvious solutions

1. Pick someone who internalizes child's welfare

a. modern parental solution--biological basis.

b. adoption. Agency or market?

2. Pick someone who depends on child's future success

a. traditional parental solution

b. Profit making orphanage? Gets cut of income tax? Parents get same?

c. The state? Mamelukes?

3. Modify above by legal rules, but ...

a. Hard to monitor and enforce most of what matters.

b. Main sanction removing children, which requires some new solution.

4. Raise children by government. Orphanage, foster care, etc.

C. Relevance to marriage and divorce.

1. A reason to oppose illegitimacy--which welfare fosters? Sweden and U.S.

2. A reason to oppose divorce?

a. Counter--one peaceful parent is better than two quarelling ones? but ...

b. Consider current divorce rates vs (anecdotal?) badly failed marriages.


V. Coase on divorce: Teaches us something about divorce and about Coase Theorem.

A. The question--what are the consequences of different divorce laws?

B. The Theorem:

1. Nothing works

2. Everything works. Mary Becker on custody.

3. It's all transaction costs. Are rights well defined and transferable?

C. Given the marriage, redistribution (+ effect of transaction costs)

D. Before the marriage--nothing, if enforcable! Freedom of contract again.

1. Assumes rational actors forming the marriage and negotiating divorce.

2. Assumes well defined and transferrable property rights.

3. Children's interest problem! Both assumptions false.

May 11, 13 Organ problems.


I. The numbers:

A. Demand: Stock v flow. Actual vs apparent.

1. Kidney: 10,000 on line, 22,500 est, 80,000 on dialysis

2. Heart: 450 on line, 15,000 estimated, 700,000 max flow.

B. Supply:

1. Potential: 12,000-27,000/yr auto acc die in hospital. +++?

2. Actual: 4000 cadaver kidneys.

C. Technology: Must be gotten fast.


II. The options: Supply side

A. Donation, no market. Current law.

1. Unsuccessful--why?

a. Donor reluctance--80% w/o will. Religious etc. objections??

b. Next of kin reluctance

c. Doctor's reluctance

2. Fixes? Force doctor? Required request.

a. Must ask before turning off?

b. For all cases? Or else ...

c. Won't.

B. Escheatage--change the default rule.

1. Morally uncomfortable? "Don't commit suicide, ..."

2. Saves people uncomfortable thoughts, but ...

3. Doctor's bottleneck still there--moral obligation and prof interest.

4. French failure.

C. Market:

1. Buy from whom

a. Hospital only? Adoption market analogy.

b. living donors

c. Next of kin

d. Dead donor.

e. Cheaper from the dead. At present levels, price too low for ... ? Transplant cost? but if ...

2. When? (if from donor)

a. Payment in advance for conditional right.

b. Agreement in advance for conditional sale.

c. a covers non-altruists, b much easier to run.

3. Legal rules?

a. Next-of-kin cannot veto (unless beneficiary?)

b. Doctor responsible.


III. The market--Cohen's future market version.

A. Advantages

1. Incentive to donate.

a. Some--not clear how much.

b. Low probability. 25,000/4,000,000 = 1/160

c. Expected return about $200.

2. Incentive by doctor ... but.

3. Minimizes moral and emotional costs?

4. Direction of error relative to escheat. Correct if oversupply.

B. Disadvantages.

1. Economic

a. Incentive to murder? Only by heir, if knows, must arrange--implausible.

b. Fraud? Pretty tricky at the price.

2. Moral: Commodification? Radin piece.

a. The argument--should not think of people as things, for sale.

b. Will lead to living donor market (bad? good?). Drive out charity? Blood.

c. Prostitution analogy.


IV. Broader market.

A. Cohen's case depends on large supply, inelastic demand, no rationing problem.

1. Supply may be smaller than he thinks.

2. Demand rises with supply (tissue matching) and with technology, wealth.

B. Two solutions re supply: (+ higher price)

1. Stronger incentives for dead. Irrevocable for cash donation--$100?

2. Living donors. Kidney vs heart. Rich vs poor--Import?

C. Market to allocate organs.

1. Advantages.

a. Reflects value to recipient

b. Generates money

c. Incentive to doctors etc. smoother than tort.

d. Fair?

2. Morally objectionable?

3. How are they allocated now? British Kidneys. Mayo.


V. Incentive problems if bodies are marketable.

A. Private crime

B. State Crime--domestic

C. State Crime--foreign


VI. General classes of arguments against freedom of contract.

A. Externalities.

1. Physical--assasination contracts. Proxies for--bets on life.

2. Ideational.

a. altruism (?), moral revulsion, etc.

b. commodification, bad ideas, etc.

c. difficulty of proving.

d. free speech argument.

B. Bargaining argument.

1. Not enforcing forced bargain--writing a mugger a check.

a. "forced" as an economic rather than moral category?

b. mugger spending resources to get you in that situation, auction case, vs.

c. water in the desert. Monopoly employer?

d. latter efficient, but what about distributional effects?

e. Consider captive: slave/kill choice. Would mugger kill for fun?

f. To keep you from stopping payment on your check to him?

2. How relevant in the real world.

a. Employment market, no. "Bargaining Power," etc.

b. Crime--easily distinguished. We don't enforce contracts to commit crimes.

c. Political??? Tests on soldiers. Offer a bill so as to be bribed not to pass it.



5/18/93: Encryption


II. Two Approaches to Privacy: One is protecting privacy by regulating the ways in which people who have information can use it. An alternative approach is for people to control information they want kept secret.

A. This is analogous to two approaches to freedom of speech:

1. Consider a centrally planned economy, where presses, paper, etc. belong to the state. It could try to maintain freedom of speech by laws requiring government run publishers to be open to dissenting books, etc.

2. The alternative is to give people strong rights to say things, have the necessary property widely dispersed.

3. Method 1 has been used widely for broadcast media (BBC, FCC, etc.) and published media in communist countries. Method 2 seems to give a lot more diversity. Free speech v "Fair speech."

B. Real control over information means that you can prevent others from getting it, not just sue them if they use it in ways the law says they should not.

C. Computer technology can provide such control, via encryption.

D. The same government that passes laws to protect privacy by method 1 tries to prevent or slow down the developments that are implementing method 2.

1. By using restrictions on export of products involving cryptography to slow the development of cheap, good, widely available products.

2. The FBI has proposed legislation to require networks, phone companies, etc. to provide facilities for tapping, or to only use setups preapproved as tappable (two different proposed bills, neither of which has been introduced so far).

3. The clipper chip.

a. Key escrow

b. Secret algorithm

E. Possibly with reason. As we will see, strong privacy enforced by technology has bad as well as good uses. These developments weaken the power of the state (and others) to know what people are doing--which may be good or bad.

1. If you believe the state only does good, then the benefit of such technologies is protection against private snooping, the cost is limiting the state's ability to do good.

2. If you believe the state has its own purposes, not identical to yours, then the restriction on its ability is in part a benefit.

3. This roughly corresponds to the distinction between the "philosopher king" view of government and the "public choice" view--although the latter is not the only example of a view sceptical of the benevolence of government.


III. Encryption: The technology

A. One time pad.

1. Unbreakable in principle.

2. Requires exchange of pads. With modern technology (optical disk?) one such exchange could provide for tens of thousands of pages of messages.

B. Public Key Cryptography.

1. Generates two keys, each of which can decrypt messages encrypted by the other.

2. It is believed that there is no practical way of deducing one key from the other.

3. It is believed that, if the key is sufficiently long, decryption is not practical--although it is theoretically possible given enough time and computing resources.

C. Concealing the origin of messages:

1.Anonymous remailers (Mixes). Encode the forwarding address using the remailer's public key; only he can decode it (and forward); he cannot decode the (encoded) message.

2. Anonymous return address. Inside your message (encoded with the recipient's public key) is the address of a remailer and your address encoded with the public key of that remailers.


IV. Encryption--weaknesses of.

A. Cracking a code. May be possible (except 1 time pad)

1. Either with enough computer power (our unbreakable code may be child's play in twenty years)

2. Or by being very clever. Sometimes there is an ingenious way to solve a particular decryption problem that nobody has thought of before.

3. Or by deliberately designing the encryption algorithm to be vulnerable to a trick only you know of, then getting other people to use that algorithm. It has been suggested that the official algorithm promoted by the government may be of this sort. Back door.

B.The code is only as safe as the key.

1. A one-time pad is no use if the snoop somehow got a copy.

2. Your private key must be somewhere. A snoop might find it in your computer, or your desk drawer.

C. Spoofing the system

1. Someone who wants to read your mail for the next few days sends out a message claiming to come from you, with your return address, but with his public key. He intercepts return mail to you and reads it--until you notice either missing messages or messages you cannot decode.

2. The solution to this is a physical exchange of keys, or the use of trusted intermediaries, or a published "phone book" with public keys in it.

3. Someone could pretend to be an anonymous remailer and keep track of what gets forwarded to him.

4. The solution is to use a series of anonymous remailers. As long as one is real, who sent what to whom stays secret.

5. Phone tap version of spoofing.


V. Uses of the technology:

A. Ordinary privacy.

1. Why EMail needs privacy more than mail, phone. Also cellular and cordless.

a. Reading mail requires physically getting the mail and tampering with it.

b. A phone message is going from one place to another, can be tapped only by sticking a wire where it is not supposed to be, or the electronic equivalent. But ...

c. An EMail message on the Internet is relayed from one computer to another until it reaches the recipient. Someone controlling any one of those comptuters could read the message en route.

d. So something like public key cryptography may be the only way of getting privacy with EMail.

2. Everyone has his public key in the phone book. Any time you want to send a message you easily and routinely encrypt it with the recipient's private key. Now nobody, with any tapping technology, court order, or anything else, can read my mail.

3. Is this a good or bad thing?

a. It provides strong privacy for ordinary citizens.

b. It makes it possible for firms, which require some secrecy to protect internal information, to use EMail on something like the internet. But ...

c. It also makes it possible for illegal firms to communicate privately with each other and customers.

B. Digital signature to verify identity: Encode your message and name with your private key. If it makes sense when decoded with your public key, you must be the one who sent it.

1. Useful for banking, broker's transactions, etc. Pay by computer.

2. Also useful for illegal firms.

C. Digital cash--Can one get the anonymity of regular cash for something to be used on a computer net?

D. Brand name reputation on illegal markets. Get out public key once, it defines the firm.

1. Firm can send out messages, define protocols for payment, etc. using anonymous remailers. No secrecy, since anyone can decrypt the message with the firm's public key, but since only the firm could have encrypted it, the message must be from that firm, not the police.

2. Firm can receive messages without interception risk, but ...

(3. How do you manage a secure mailbox for receiving mail from potential customers?

a. Foreign EMail address.

b. Create new addresses, use them as remailers. Can customers use them faster than enforcement closes down?

c. Messages published--bulletin board, NY Times ad, etc., but ...

d. Enforcement may try to block such, since protocols are public.

4. How do you keep the police from identifying sender? Dining Cryptographers? But being on that is suspicious. Anonymous remailers.)





I. The Situation:

A. Increased need for secure transactions because:

1. Use of easy to tap media (EMail, Cellular, Cordless--phone satellite microwave)

2. More business at a distance--ATM, home banking, etc.

3. More private interaction at a distance.

a. EMail today

b. VR tomorrow. Privacy in Cyberspace as in realspace.

B. What we need is

1. Encryption

2. Digital signature

3. Digital money (explain)

4. Anonymous path???

C. We can get it because:

1. Encryption advances, especially public key encryption, make it easy

2. Computer advances make it fun (phone message in real time)

D. But ... Privacy also poses a threat.

1. Wiretaps becoming impossible

2. Mass market criminal firms becoming possible? Brand name via digital sig, pub key crypt.l


II. The Clipper Issue: An attempted solution to the dilemma

A. What the administration announced:

1. Chip available, not compulsory, alternatives not yet banned.

2. Will be used by government but not for very secure purposes.

3. Key escrow plan--get with court order.

4. Algorithm secret--some experts will get to look at it???

B. Puzzle of the policy.

1. If strong encryption is not banned, chip is useless?

2. Or ... standards argument. Once it catches on, most criminals will not bother. (current)

3. Alternative encryption will stand out? Additional encryption?

4. If strong encryption is banned, then further objections.

C. Arguments against.

1. If either a standard or compulsory, inhibits further development.

a. Encryption becoming useful, rapidly developing.

b. Computers becoming more powerful.

c. Paparazzo argument.

2. May have back door--deliberate or accidental.

a. Why else keep algorithm secret?

b. If secrecy necessary against private crackers, then Clipper is useless against public spies.

c. To prevent cloning?

3. One court order lasts for ever?

4. May make traffic analysis easy. Family key, chip ID.

5. Weakness to spoofing relative to public key solution.

D. Argument for: The least intrusive solution that eliminates criminal possibilities?

E. Cost argument+

1. Is it worth rewiring every phone in the U.S. to permit a few hundred wiretaps/year? % version

2. Servant analogy.

3. Should government ability only rise?


III. Is there a better solution?

A. Do nothing.

1. Private market will provide a secure standard or standards

2. Police will live with some new limitations on their power

3. Is that on net a bad thing? Not clear.

B. Do something--what?

1. Clipper as is.

2. Clipper with all else banned?

3. Other suggestions? Court order to compel decryption?

5/25/93:Global Warming and All That


O: Vitamin E story. Caution kills?

A. Calculations. Is it sensible not to start taking the E until we are sure such doses are safe?

1. 700,000 deaths/year x .4 = 280,000 lives/year saved if we take 100 I.U. of E daily.

2. How high would the excess mortality from E have to be in order to balance that?

a. Suppose 50,000,000 people in high risk group. If all take E, risk sufficient to balance the gain is X

b. 50,000,000 x X = 280,000; X=aprox 1/2000/year excess mortality from 100 I.U. of E. daily

3. 1000 I.U. common in drug stores. Its corresponding mortality rate of >1/2%, nobody notices???

B. Is 3 more likely than 1? Implausible unnoticed vs result of best research so far?

C. Why this murderous caution?

1. Liability law--only downside.

2. Professional bias against self medication?


I. Standard Externality Analysis.

A. Private solutions.

1. Contract.

2. Merger.

B. Public solutions.

1. Regulation

2. Effluent fee

C. Mixed--liability law. Law of nuisance.

1. Damages

2. Injunction.


II. Public choice view of ... .

A. Regulation dominates, bc info costs high, opportunity for payoffs high?

B. Efficient != Politically profitable--high sulfur coal from western states.

1. Might work via simple democracy if arguments, facts are easy, but ...

2. They never are.

3. Cost problems.

a. Linear extrapolation and carcinogens

b. complicated systems.

c. Incentives in both directions to lie. Schools and power lines. Radon.

C. Externality argument means insecure property rights, means ...

1. Private property, trade, only good means known for solving coordination problem.

2. Does not work well in presence of serious externalities involving many people.

3. Or with legal regime that suspects 2. Litigation as rent seeking.


III. Some examples:

A. World climate. Global Cooling. Global Warming.

1. The scientific facts.

a. Mechanism agreed on, but one of many. Sign only pretty clear.

b. Climate models fail to accurately predict--hard problem.

c. Data very uncertain. Cities warming?

d. Northern Hemisphere: 1880-1940 +1.2deg. , 40-70 drop 1/4deg. , part recovery since.

e. Double CO2, 1.5-4.5deg. C warming, 20-100 yrs to 2/3 equil bc of oceans. (+25% CO2 so far)

f. Suggests 2deg. rise over next century+!

2. The consequences of CO2 growth, warming.

a. Distributional--good for Canada, Chicago? bad for NYC, Bangla Desh

b. Increased food output.

c. Max warming in winter, in North (by models)

3. Action in any direction is costly--requires political action, regulation, etc.

4. Information accumulates over time, but ...

5. Political incentives to act?

a. Public believe given rational ignorance--good story.

b. Provides informational screen for politically profitable acts.

B. World Population?

1. Is it growing out of control?

2. Is it a problem?

C. Large scale pollution, especially of oceans.

D. Fish and whales

E. VLF, ELF, power lines, cancer, etc.


IV. Additional problems of international politics

A. Public good problem among nations.

B. Whaling. Brazilian rain forest.

C. Intellectual property?


V. Prophets of Doom:

Limits to Growth: What was wrong?

Ehrlich and mass starvation

Overpredicting world population by a billion

Global cooling





I. Prelim:

A.Law School 610, 11:30-1:30?, Tuesday June 1

B. Student evaluation

C. My Questionaire

D. Questions re Exam?


II. Global problems

A. Private solns to public good problem inapplicable. (Can still solve associated private problems)

B. Public solutions.

1. Simple democracy does not solve because issues are complicated.

2. Interest group incentives may run towards inventing or ignoring problems.

3. Liability law requires courts to make decisions which, on this scale, are hard. Also diffuse damage.

4. Possibility of regulation, litigation, leads to rent seeking, insecure property rights, high costs.

5. International aspect adds another layer of public good problem above the individual government.


III. Some examples:

A. World climate. Global Cooling. Global Warming.

1. The scientific facts about size and timing of the predicted and past effects are very uncertain.

2. The consequences of CO2 growth, warming are uncertain in sign, different for diff countries.

3. Action in any direction is costly--requires political action, regulation, etc.

4. Information accumulates over time, but ...

5. Political incentives to act?

a. Public believe given rational ignorance--good story.

b. Provides informational screen for politically profitable acts.

B. World Population? Does childbirth have externalities? Are poor countries dense?

1. Resources argument, Hotelling analysis, works for securely owned resources.

2. For insecurely owned resources, negative externalities, but ...

3. Positive externalities in extent of the market, production of ideas, etc. ...

4. Pattern is mimicked on a small scale--schooling and taxes.

5. On world scale, political costs of population control enormous. India and Congress Party's fall.

C. Large scale pollution, especially of oceans.

D. Fish and whales. Hard to define property rights in mobile species.

1. Could define ownership in the whole species, but ...

2. Monitoring is hard.

E. The General problem.

1. No specific global problem seems convincing at the moment, but...

2. Market solutions depend on drawing property rights to keep externalities, transaction costs down to a tolerable level.

3. As we get more powerful that may become harder and harder to do, unless...

4. "More powerful" means better at monitoring, negotiating, controlling emissions, ...

5. Or we find more room (asteroid belt? Space habitats?)

F. Intellectual property!

1. Seems to be a solution of a very similar problem. Negotiation?

2. Small worlds (language groups) may help for negotiating copyright. What about patent?

3. Privileged minority and negotiation. Large Benefit/Cost ratio?

4. Term of patent has been very stable over centuries, suggests it is not the efficient term.


IV. Summary of the Course

A. What do we mean by a problem? What does it have to do with economic efficiency?

B. Why do problems exist? Because there is no bureaucrat god.

1. Market gives the efficient outcome, but only under special conditions.

a. Private goods, secure property rights

b. Lines can be drawn that eliminate externalities, public goods

c. Perfect competition or zero transaction costs.

2. Political market--only with zero transaction costs.

a. Rational ignorance + large information costs ->voting using free information, coarse control mechanism.

b. Interest group lobbying + public good problem within interest groups ->fine control mechanism

c. Outcome: Random + discreet transfers to "concentrated" groups.

d. Inefficient transfers because of the constraint of keeping info costs to voters high.

3. There may be no political solution to some market failures (divorce).

C. What have we learned?

1. Why problems may be insoluble, and how to try to minimize them.

2. That a bad solution may be the best available.


"Don't make the best the enemy of the good."

Final Exam

Solution Unsatisfactory


The following problems have been discussed in this course:


Natural Monopoly Allocating Organs for Transplant

Product Safety Encryption

Poverty and Homelessness Divorce

Global Climate et. al.


I. Pick one. Briefly explain the nature of the problem, describe what you believe to be the best solution, and explain what is wrong with it. (10 points)



II. Pick one. Briefly explain the nature of the problem, describe the major alternative solutions and explain what is wrong with each. (15 points)



III. The following is a list of issues that we have not discussed. Pick one and briefly discuss alternative approaches and their difficulties. If you have already used one of them in your answer to IV, pick a different one. Do not pick one for which you think there is a clear good solution. (10 points)


Panhandling Gun control

Alcoholism Illegal immigration.

Drug addiction Helping poor countries get rich

Child abuse

Treatment of sensitive issues, such as sex and evolution, in the public schools.



IV. Pick a policy problem not included in our syllabus which you believe would be suitable for the class. Describe possible solutions and why they will not work. (This is the one you are supposed to have prepared in advance.) (25 points)



V. A. What do we mean by economic efficiency?

B. What do we mean by market failure?

C. Sources for market failure include externalities, public goods, moral hazard, adverse selection and monopoly. Pick one of these, or any other that we have discussed, and briefly explain why it leads to market failure.

(15 points)



VI. Describe the model of the political market we have been using in this course. What does it predict about the efficiency of political decisions? The pattern of decisions? For our purposes, what does it mean to describe an interest group as "concentrated?" (10 points)




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