Chapter 4 - Incentives (II. Regulating) (2016)

Apunte Inglés
Universidad Universidad Pompeu Fabra (UPF)
Grado International Business Economics - 1º curso
Asignatura Introduction to business law
Año del apunte 2016
Páginas 4
Fecha de subida 20/04/2016 (Actualizado: 20/04/2016)
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IV. Incentives - Regulating INDEX 8. Default vs. Mandatory rules ......................................................................................... 2 DEFAULT ....................................................................................................................... 2 MANDATORY RULES ..................................................................................................... 2 PATERNALISM VS. EXTERNALITIES: LIMITING CONTRACTUAL FREEDOM .................... 2 9. Rules vs. Standards ....................................................................................................... 3 RULE .............................................................................................................................. 3 STANDARDS .................................................................................................................. 3 10. Property rules vs. Liability rules.................................................................................. 4 PROPERTY RULE ............................................................................................................ 4 LIABILITY RULE .............................................................................................................. 4 1 avillagrasa IBE, 1st year - 2nd Term 8. Default vs. Mandatory rules DEFAULT If the parties don’t agree on something, they have to do what the regulator says. They are only are used if the parties have not agreed on some aspect of their transaction.
They don’t exist if there are mandatory rules because mandatory rules come first.
MANDATORY RULES One can’t agree differently. Usually they protect consumers (because they have less information, so less advantage). They can agree on more, but not less (ex: a guarantee has to be 2 years long, this means that they can’t give a 1 year guarantee but they can give 4 years of guarantee). This could lead - theoretically - into more inefficiency because parties aren’t free to negotiate. However, mandatory rules are necessary because of information asymmetry. The higher the regulation, the lower the freedom in agreeing a contract.
PATERNALISM VS. EXTERNALITIES: LIMITING CONTRACTUAL FREEDOM This means, basically some things are illegal. It is your property but you can’t sell it, for example. For example, we could negotiate the price of my kidney, but if after I’ve been paid I don’t give you the kidney, I can’t go to the court because it is not enforceable (because it is illegal).
2 avillagrasa IBE, 1st year - 2nd Term 9. Rules vs. Standards Standard gives a lot of flexibility but also uncertainty.
RULE Speed limit 80km/h. Consequences are triggered once facts are settled.
STANDARDS Directives on defective products (strict liability). It consists in apply the law and determine if the standard was satisfied. It requires a judgment.
For example, plastic was found in Snickers’ bars, and so the firm was liable of compensating people. Because of that, they decided to withdraw all the bars (which were defective products) because it would be cheaper. Toys advise parents to not buy it if the child is less than 3 because of swallowing risk, therefore if you buy it to your 2 years old child and he gets damaged, the firm is not responsible.
There is no optimal decision for one or the other. They involve trade-offs: RULES - Precise - Horizontal application of the rule (the same for everyone) - Enforcement is easier - Lower accuracy - Lower administrative cost - Useful for controlling subordinates or not-trusted parties - - STANDARDS Vagueness (something reasonable for me may not be reasonable for you, like in Google’s case).
Personalized Enforcement may be more difficult Accuracy (we can adjust to the particular case) Higher administrative cost Agency problems Standards are more subjective. For example, a rule may say “max. speed at 100km/h”.
It is something clear. However, a standard may be “a product will be considered defective if it doesn’t provide safety and the expected quality to the consumer”. So what does this mean? It depends on the firm, so the results will not be the same. It’s more subjective.
3 avillagrasa IBE, 1st year - 2nd Term 10. Property rules vs. Liability rules PROPERTY RULE We know that we take care of our things (we’re talking about entitlement  I own/have the title of something), but why? Because I have the rights of it, so I want to maximize the surplus of that object because the profits I get from it are mine too. To make people behave to maximize (take care of things) we can internalize the costs of that thing, for example, paying a fee. We can work with property rights if the cost of defining and enforcing them is low.
In the perfect (competitive market) property rules work very well because transactions and enforcement are very clear, cheap and easy.
LIABILITY RULE However, if the costs of transaction are high, it is better to use liability rules (assuming that the courts work well). This is that the cost of litigation1 is low. With it we don’t need the consent of the owner. The value has to be determined by the courts/legal system.
To decide which system is better we also have to know which and how they are protected (can I go to court? Can I receive compensation?). For example, if I have an entitlement that says that I own a house, but there is any enforcement and so Okupas can get in, then that entitlement is worth 0 (I can’t get any utility for it because I can’t live nor rent it).
In economics we usually assume that transaction costs are low, and so we can have property rights.
1 Litigate: go to the judge 4 avillagrasa IBE, 1st year - 2nd Term ...