Economic Analysis of Law

This article will provide an overview of the economic analysis of law. The article will explain the basic concepts that are foundational to an economic analysis of legal theories, including efficiencies, positive law, normative law and the Coase Theorem. In addition, this article also explains how economic analyses have been integrated into the basic areas of the common law, including torts, contracts and property law. Economic analysis of law is also critically important in government regulations that have been created and enforced to regulate financial markets. This article explains how government regulations affect antitrust enforcement, intellectual property protections and oversight of the various financial markets. Finally, examples are provided that illustrate how an economic analysis of the law continues to shape our modern legal framework. These examples include discussions of distributive justice, taxation and law enforcement within the criminal justice system.

Keywords Allocation of Resources; Common Law; Efficiency; Opportunity Costs; Positive Law; Retribution; Transaction Costs; Wealth Maximization

Business & Public Policy > Economic Analysis of Law

Overview

Economic analysis of law is a method of incorporating ideas taken from the discipline of economics and melding them into considerations of legal theories and principles. Economic analysis of law generally involves both the study of human behavior in response to legal rules and the economic implications of that behavior and an evaluation of the economic and social effects of legal principles across the spectrum of socioeconomic and sociological classifications. While economic analysis of the law has become an increasingly influential field, it is not a modern school of thought. In the 18th century, economist and philosopher Adam Smith wrote about the economic effect of legislation on merchants and commerce. However, the study of economics in relation to laws that regulate non-market activities, such as due process or law enforcement, is a relatively new phenomenon.

The inception of the modern school of law and economics is often considered to be the publication of two articles in the early 1960s by economists Ronald Coase and Guido Calabresi that revolutionized legal theory and laid the groundwork for many of the ideas that were developed in the following years. Coase and Calabresi, working independently from one another, published "The Problem of Social Cost" and "Some Thoughts on Risk Distribution and the Law of Torts," respectively. The movement gained even more traction with the publication of Richard A. Posner's "Economic Analysis of Law," which he wrote while a professor at the University of Chicago. Posner's work, which was followed by other academics and legal theorists associated with the University of Chicago, led to an era of economic principles being applied to all aspects of the law, which became dubbed the "Chicago School" of thought. This period of legal theory in particular examines the impact on the law when courts adopt economic efficiency as their guiding standard. More recently, the study of law and economics has essentially been divided into two classes-one that seeks to oppose the efficiency view of the Chicago School by maintaining that there is an ideological bias inherent in the application of economics to law, and the other that seeks to incorporate law and economics into a broader spectrum of interdisciplinary theories about law.

Economic analysis of law is usually divided into two subfields; positive and normative. Positive law and economics uses economic analysis to predict the effects of various legal rules. The positive school restricts itself to the study of the incentives produced by the legal system, largely because its adherents believe that efficient legal rules evolve naturally. On the other hand, the normative school, historically associated with the early contributions of the Yale school, sees the law as a tool for remedying "failures" that arise in the market. Thus, a positive economic analysis of liability as it relates to tort law would predict the effects of a strict liability rule as opposed to the effects of a negligence rule. Normative law and economics would make policy recommendations based on the economic consequences of various liability theories.

As these schools of thought have developed, the theories stemming from the economic analysis of law have become increasingly influential. Today, courts, legal professors and even attorneys frequently apply economic principles to a range of potential legal outcomes to aid in the process of arriving at a more equitable outcome in a legal dispute or a greater understanding of the social costs of legal precedents. The following sections will provide a more detailed discussion of the basic concepts of the economic analysis of law.

Basic Concepts on the Economic Analysis of Law

The application of economics to law can help explain the consequences of laws and legal outcomes in terms of their social and economic impact. The economic analysis of law therefore uses economic methods and principles to evaluate how well laws and legal outcomes advance legal and moral objectives and the degree to which they also serve such social objectives as efficiency or fairness. Efficiency, as a social objective, is based upon the concept of allocative efficiency, or the allocation or distribution of resources according to their most valuable uses to the members of a society. In addition, economic analysis of law is usually divided into two subfields, positive and normative. Positive law and economics uses economic analysis to predict the effects of various legal rules, while the normative approach suggests ways to reform legal doctrines and institutions in light of a society's core beliefs. The following sections will further explain these concepts.

Efficiency

Efficiency in business or economic terms is often associated with the concept of accomplishing an outcome at the lowest possible cost. However, there are other concepts of efficiency that are also important in an economic analysis of the law. For instance, allocative efficiency is the study of whether an industry is producing the appropriate amount of a particular good or service. For instance, it is economically sensible for a company to produce an item as long as the value attributed to it by buyers exceeds the social cost of its production. This is because the demand for the item will likely ensure that the supply of items produced will be consumed, and thus the resources allocated to the production of the good will have been used efficiently. Companies will likely continue to produce the good as long as it is allocatively efficient, or economically advantageous, to do so, which is generally until the demand and supply for a good intersect. Any continued production of the good after that may meet with diminishing demand, and thus continued allocation of resources for the production of that good is no longer efficient.

Another concept of efficiency is Pareto optimality and Pareto superiority. Vilfredo Pareto, an Italian economist, studied the distributions of wealth in different countries. Pareto noted that, consistently, only a minority, or about 20% of the population, controlled the remaining majority, or approximately 80%, of a society's wealth and resources. This same distribution has been observed in other areas and has been termed the Pareto effect. For instance, the Pareto effect has been noted in the context of quality improvement, in that 80% of problems usually stem from 20% of the causes. This concept led to the development of two further theories of efficiency, which are that an allocation is Pareto superior if achieving it means at least one person is better off and no one is made worse off, and an allocation is Pareto optimal if any movement from that allocation would make at least one person worse off.

Finally, a more recent version of efficiency is the Kaldor-Hicks, or wealth maximization, theory. In the context of legal analysis, the Kaldor-Hicks efficiency theory holds that in order for a law to be efficient, those individuals made better off by the law would have to be made sufficiently better off that they could compensate those who are made worse off. In other words, the Kaldor-Hicks criterion requires not that no one be made worse off by a change in allocation of resources, but only that the increase in value be sufficiently large that the losers can be fully compensated.

Positive Law

The positive approach to the economic analysis of law seeks to understand how the behavior of people is affected by incentives created by the law. This approach uses the analogy of the law as a type of pricing machine. The law "prices" various forms of human behavior through the use of fines, penalties and other measures. These alter the balance of costs and benefits individuals face in deciding whether or not to engage in certain behavior.

For example, this approach might predict that implementing mandatory automobile safety legislation, such as requiring the use of seatbelts, penetration resistant windshields and other safety equipment, would be unlikely to reduce the number of driver deaths. An economic analysis of such legislation might argue that such equipment-by reducing the probability of death following an accident and thus reducing the implicit "price" of speeding-would increase the incidence of speeding, or the amount of speeding drivers are willing to implicitly "purchase," and thus increase the number of accidents. In actuality, one study of accident statistics showed that the increase in the number of accidents just balanced out the decrease in driver deaths, resulting no net decrease in driver deaths but a net increase in the number of pedestrian deaths from car accidents.

Normative Law

The normative approach to the economic analysis of law proposes an efficiency criterion for shaping the legal system based on wealth maximization. Wealth maximization is based upon the maximization of the sum of the "willingness to pay" exuded by a society's members. In an economic context, willingness to pay is a measurement of the value in dollars that people are willing to pay for something or the dollar amount that they demand to give it up. In the legal context, this approach asks how much each individual would be willing to pay to either get rid of or keep certain laws or rules.

For example, economists could determine how much a safe workplace means to people by examining employees who work in unsafe environments and figuring out how much higher their wages must be to compensate for the unsafe workplace. This concept is also used by insurance companies that seek to determine the point at which a rise in premiums would result in behavioral changes of the insured.

The Coase Theorem

A final concept that has been extremely influential in the economic analysis of law is the Coase Theorem, attributed to Ronald Coase, whose work earned him the Nobel Prize in Economics in 1991. The Coase Theorem holds that in the absence of transaction costs, or costs associated with buying and selling investments, resources will ultimately be allocated to their most valuable uses, regardless of how the resources are initially allocated, because interested parties will bargain privately to correct any inefficiency in the allocation. However, many critics have argued that the Coase Theorem can only exist on paper because transaction costs are almost always present and are frequently set too high to facilitate the most efficient bargaining.

Economics & the Common Law

The common law is the body of law that has developed in the United States, based on principles and precedents developed in England and Great Britain, that includes customs, general principles and precedents set by court decisions that are applied to situations not covered by statute. The common law forms the basis for many significant areas of law, such as torts, contracts, evidence, criminal law and even wills and trusts. Economic analysis has been applied to all areas within the body of law. The following sections explain the intersection of economic analysis of law and the basic subjects of common law, including torts, contracts and property.

Torts

A tort is a civil wrong that subjects the wrongdoer to a suit for damages by the victim. Torts may be intentional or unintentional, and the economic implications of each is different. In unintentional torts, the injury occurs from an accidental harm that one person causes to another. An economic approach to unintentional torts seeks to minimize the costs of accidents by allocating the costs of accidents resulting in injury to the persons or parties who are in the best position to avoid or minimize the losses. This is because, in theory, that person or party is able to make a decision about whether the benefits of the activity outweigh the costs to which the activity gives rise, including the risk of injury.

The most significant scholarly work to examine this theory is Guido Calabresi's "The Costs of Accidents." In his work, Calabresi identifies three types of costs that result from accidents. Primary costs are those associated with the harm to the injured party, such as the cost of medical care and lost earning capacity. Secondary costs are the societal costs resulting from accidents. The third type of costs is associated with administering the tort system. Calabresi noted that eliminating or minimizing one cost may not be consistent with minimizing another cost. For example, a system that always assigns the primary costs of accidents to the party that causes the accident may be very expensive to administer, and this raises the question of whether that is the most efficient allocation of costs associated with accidents.

Further, while the categorizing the types of costs is a useful way to enumerate the harms and costs associated with accidents, an economic analysis of tort law would not necessarily seek the minimization of these costs. For instance, at some point the cost of avoiding accidents inevitably becomes greater than the harm that would be caused by those accidents, and thus a more appropriate economic analysis would be to both search for a way to minimize the sum of the costs of accidents and the costs of prevention efforts to avoid accidents.

In intentional torts, the economic analysis shifts from accident avoidance and prevention to compensation of the victim and retribution or punishment for the wrongdoer. Tort law has adopted a number of economic theories to develop the principles of negligence, liability and damages. For instance, in the landmark case United States v. Carroll Towing Co., 159 F.2d 169 (2d Cir. 1947), Judge Learned Hand saw the issue of liability as being the function of three variables: The probability of the harm (P), the amount of harm should an accident occur (L) and the cost of prevention (B). Judge Hand noted that P multiplied by L is the "expected harm." Thus, under the Hand formula, when PL exceeds B, or when the expected harm is greater than the cost of prevention, a party is regarded as negligent. Conversely, if the expected harm is less than the cost of prevention, the party is not negligent.

If a party is not negligent, the party may still be required to bear the costs of the injured based upon a finding of strict liability. Strict liability means that a party is liable for damage caused by her activity even if there is no showing of negligence. This theory is justified in terms of economic efficiency in that, presumably, those parties who are more likely to be in control of the activity and could have taken measures to prevent the injury will be the ones held strictly liable. Furthermore, streamlining the fault finding process can reduce the administrative costs of the legal process, and this cost savings can also be allocated toward compensating the victim.

If a party is found negligent or strictly liable, the victim is entitled to collect damages from the wrongdoer. Compensatory damages compensate the victim for actual damages suffered by the injury, while punitive damages are awarded to the victim to punish the wrongdoer and to attempt to deter the defendant and other persons from pursuing a course of action such as that which damaged the plaintiff. Generally, negligence victims are only entitled to compensatory damages, while victims of an intentional tort may sometimes obtain punitive damages as well as compensatory damages.

Contracts

The economic function of modern contract law is to facilitate the voluntary transaction of property rights so that goods and services move into the hands of those who value them the most. While the actual exchange of goods or services for money may also be regulated by other areas of the law, contract law governs the process of the exchange, once the terms of the exchange are agreed upon. Because contracts are frequently created in situations where the performance of both parties does not occur at the same time, the lapse in time between when the contract is formed and when the parties perform as agreed introduces the possibility that unforeseen events will disrupt performance and that one of the parties will be tempted to exploit any strategic opportunities that may arise during this interval. Contract law includes remedial measures that courts may implement to deter people from exploiting unforeseen events to the detriment of the counterparty, and to make costly self-protective measures unnecessary.

Another important function of contract law is to protect the parties' expectations in the event of an occurrence that is not covered by the contract's provisions. The longer the interval between contract formation and performance, the harder it becomes for the parties to foresee every contingency that may affect the performance of one or both parties. Moreover, while parties may be able to conceive of some contingencies, these events are so unlikely to occur that the costs of dealing with them might exceed the benefits associated with providing for the event in the contract. When this occurs, a contract may be silent on a matter before the court, and in certain circumstances, the court may fill in the contractual term necessary to deal with the contingency if and when it occurs.

If a court is asked to apply a contract to a contingency that the parties did not foresee, the court will generally imagine how the parties would have provided for the contingency if it had occurred to them to do so. In doing so, courts have to think in economic terms to determine the most efficient way of dealing with the contingency. Courts can use fundamental economic principles to guide the process. For instance, parties have an obvious interest in their own profit-maximization, but they also frequently have an interest in joint profit-maximization as well; the larger the joint profit, the bigger the "take" of each party is likely to be. A corollary of this is that parties likely also have a mutual interest in minimizing the cost of performance. Economic principles such as these help courts fill in gaps in a contract in a way that is likely keeping with what the parties would have approved at the time of making the contract.

Property

The law of property is concerned with creating and defining property rights, which are rights to the exclusive use of valuable resources. Thus, a property right, in both law and economics, is a right to exclude everyone else from the use of some scarce resource. This right is absolute in the sense that someone who wants a resource that belongs to another person cannot justify simply taking or using the resource by arguing that he will put the resource to better use. For example, if A's land includes a sunny field while B's land is dry and rocky, B cannot plow A's land and plant crops, even if B plans to use the produce to give to needy neighbors. B must negotiate with A for use of the land, and refrain from entering the land if A refuses to accept an offer for B to use the land.

Because the law of property is so broad and includes a wide range of rights, there is no singular economic analysis of property rights. Instead, the interplay between economics and property rights turns on the type of property right at issue. For instance, property rights include trespass and eminent domain. In trespass cases, although a trespasser may claim a superior use of certain land, the owner of the land may still eject the trespasser without altering his use of the land. Or, the landowner may negotiate a deal with the trespasser in which the trespasser is able to pay for a right to use or access the land upon payment of a fee. However, if the government wants to use the land, it can seize the land under the eminent domain power without negotiating with the landowner at all, although it must compensate the landowner by paying just compensation for the property. The eminent domain power enables government to pursue the highest use of property that best enhances a community's use of its land and resources, while the requirement that the government pay just compensation serves as a check to ensure that the government does not abuse this right.

Other property laws, such as nuisance prohibitions, easements, zoning requirements and even intellectual property rights also create different analyses of the benefits and costs associated with protecting these rights against violations. In each circumstance, however, any economic analysis includes such factors as transaction costs, transference rights and competing uses in reaching a determination of settling property disputes.

Law & Economics: Government Regulation of Financial Markets

While financial markets are regulated in one sense by competition in the marketplace, the U.S. government has also implemented regulations that affect almost every area of industry and the financial markets. The purpose of these regulations is to correct imperfections and inefficiencies in the market that, left unaddressed, may cause valuable resources to be misused or even abused. For instance, in markets that are not sufficiently competitive, consumers may be faced with higher prices or artificially limited supplies. Government regulations can help control price fluctuations or preserve competition in the market by preventing companies from merging or acquiring competitors. In addition, in an unregulated market, businesses may not have incentives to provide consumers with accurate or sufficient information regarding products and services. Regulations can help minimize these dangers by requiring that companies disclose information about the ingredients or possible side effects of products, or the energy efficiency of an appliance or gas mileage of an automobile. The following sections provide explanations of some of the areas in which the government has created regulations that balance the competing economic interests of property owners, businesses, consumers and the society at large.

Antitrust Laws

Antitrust laws protect competition. Free and open competition benefits consumers by ensuring lower prices and new and better products. In a freely competitive market, each competing business generally will try to attract consumers by cutting its prices and increasing the quality of its product or services. Consumers benefit from competition through lower prices and better products and services. Inefficient firms or companies that fail to understand or react to consumer needs may soon find themselves losing customers or even facing bankruptcy.

When competitors agree to fix prices or act in collusion, consumers lose the benefits of competition. The prices that result typically begin to spiral upward, until they no longer accurately reflect the cost of the item. When this occurs, the resources of consumers are no longer allocated efficiently and the inefficiencies begin to clog the flow of money and resources.

Antitrust regulations aim to prevent actions that would eliminate competition from the marketplace. Both the Federal Trade Commission and the Department of Justice have implemented regulations that these public enforcement agencies enforce through legal actions against companies that violate antitrust laws. Economists help government regulators determine how to best shape and apply antitrust laws. Economists study such factors as the defining of the relevant market in any industry and the impact of any potential antitrust violation by considering alternative definitions of the market. Economists also help define the market structure for many industries and consider the effects of mergers, acquisitions or the disappearance of competitors from the market on factors such as price increases and pricing issues, including predatory pricing, price discrimination, price fixing, brand pricing, bundling and tie-ins.

Intellectual Property Laws

Economists have long known that economic innovations are a more powerful force in determining how fast an economy's productivity and output rises than either increases in capital investment or improvements in the skills of workers. Thus, the economic advantage in inventing and creating new technologies and new ways of doing business depends heavily upon protections for the intellectual property embodied in every innovation. However, the innovations that most enhance economic activity originate primarily in advanced economies where commitments to research and development are strong, the political and economic environments are stable, barriers to starting new businesses are relatively low and intellectual property rights are respected.

Developing countries face different concerns with regard to intellectual property and globalization. These countries have less economically-valuable intellectual property and hence are often significant importers of innovative technologies and expertise. This prospect may tempt developing countries to simply ignore foreign intellectual property rights. This is especially true because during the period in which a patent applies, intellectual property rights guarantee that its owner can charge prices substantially greater than its marginal costs to produce the good. Hence, recourse to piracy or counterfeiting can significantly reduce the costs of a given patented product in a developing country. In many parts of the developing world today, however, lack of respect for intellectual property rights or lax enforcement of those rights remains the rule rather than the exception.

Because of these marked differences in economically-valuable intellectual property and respect for intellectual property rights in countries around the world, the economic analysis of intellectual properties law occurs at the global level. Today, it has become readily accepted that analysis and evaluation of intellectual property law is conducted within a framework of economic efficiency. In forming appropriate intellectual property laws and regulations, courts and legislators grapple with questions such as how to enable the creator of intellectual property to enjoy the fruits of his labor when his creation is heavily influenced by the cumulative process of his education and adaptation of other intellectual properties that influenced his creative process.

In addition, the modern world of seamless technologies and the broadening range of the public domain are causing economists to reconsider how best to craft copyright protections that protect the creative effort while allowing for inputs and adaptations of intellectual property. In terms of trademark protections, economists consider how to optimize the value of a trademark and reduce consumer search costs in the face of unfamiliar or confusing trademarks. Finally, economists continue to study the costs and benefits of the limits of durational protections provided by copyrights and trademarks.

Regulation of Financial Markets

The confidence that investors have in the fairness of the financial markets has a significant impact on the amount of capital available for businesses to use. If the general public believes that investing is for a privileged few who can profit from insider connections, there is limited investment and limited economic growth as well. In contrast, capital flows into financial markets that the public perceive as basically fair. Overall, the United States has enjoyed solid growth in its financial markets. Some of this can undoubtedly be attributed to the federal, state and industry regulatory systems that regulate and protect U.S. financial markets. Regulation of financial markets helps to minimize systemic risks in the market and enhance an efficient allocation of funds. Also, regulations can protect consumers from unethical practices so that the markets are fair, efficient and transparent.

In the United States, the financial markets are protected with layers of regulation. At the federal level, the Securities and Exchange Commission consists of four departments-Corporate Finance, Market Regulation, Investment Management and Enforcement-that regulate specific areas of the business and financial services industries. In addition to other federal statutes and administrative agencies that play a role in regulating the financial markets, states have also enacted legislation to protect consumers and enhance market efficiencies. Finally, the financial services industry has developed self-regulatory organizations, known as SROs, that provide a mechanism for the expertise and practical experience of the industry to contribute to the development of regulatory policy.

While critics have argued that the corporate fraud, accounting debacles and mutual fund trading scandals that have occurred in recent years illustrate the ineffectiveness of these layers of regulations, still others have pointed out that those misdeeds were ultimately uncovered and that the ensuing investigations and prosecutions have led to significant adaptations to the financial industry and its regulatory framework that have further enhanced the security and efficiency of these markets. Thus, while regulation of financial markets is not fail-proof, it can assist in balancing investor protections, competition in the market and the growth objectives of business and individual portfolios.

Applications

Law & Economics in the Modern World

The basic function of law in a wealth-maximization environment is to alter incentives and thus regulate behavior to facilitate the most advantageous and efficient allocation of resources. Yet the law must also protect the social and economic interests of individuals who have neither the education nor the resources to maximize their own wealth or to protect themselves from the unethical behavior of others. Without a legal framework to regulate wealth-maximization, the disenfranchised and impoverished classes of people are left to the mercies of the most resourceful. Thus, economists must consider the social implications of the allocation of goods and the costs of social services within the context of taxation and redistribution of income. Finally, economists must weigh the extent to which economic policies impact criminal activity and law enforcement. These issues will be discussed in more detail below.

Distributive Justice

Distributive justice concerns what is just or right with respect to the allocation of goods in a society. In essence, distributive justice is concerned with the fair allocation of resources among diverse members of a community. Fair allocation typically takes into account the total amount of goods to be distributed, the distributing procedure and the pattern of distribution that evolves from the allocation process. Often contrasted with procedural justice, which is concerned with just processes, such as in the administration of law, distributive justice concentrates on just outcomes and consequences. The most prominent contemporary theorist of distributive justice is the philosopher John Rawls.

Because societies have a limited amount of wealth and resources, a question arises as to how those benefits ought to be distributed. One answer is that public assets should be distributed in a reasonable manner so that each individual receives a "fair share." But this leaves open the question of what constitutes a "fair share." Various principles might determine how goods are distributed. For instance, equality, equity, need and social utility are all common criteria for the appropriate distribution of goods. If equality is regarded as the ultimate criterion in determining who gets what, goods will be distributed equally among all persons so that every person receives the same amount. However, due to differences in levels of need, this will not result in an equal outcome.

Another possibility is to proceed according to a principle of equity, and distribute benefits in proportion to the individuals' contribution to the society. Thus, those individuals who make the greatest productive contribution to the group deserve to receive more benefits. This sort of distribution is typically associated with an economic system where there is equal opportunity to compete. In addition, goods can be distributed according to need. Finally, resources can even be distributed according to social utility, or what is in the best interests of society as a whole. Regardless of the distribution method, economists must still grapple with the reality that no allocation process is perfect and thus whatever system is used, there will likely be inefficiencies and failures in the process that must be addressed.

Taxation

Taxation can be used to alter the allocation of resources or the distribution of wealth and as a means for funding the provision of public services. The origin of taxation in the United States can be traced to its earliest days, when the colonists were heavily taxed by Great Britain. The colonists had no voice in the establishment of the taxes and their disdain for this taxation without representation fueled a series of revolts, such as the Boston Tea Party. After many years of debate and compromise, the Sixteenth Amendment to the Constitution was ratified in 1913, which provides Congress with the power to lay and collect taxes on income. The objectives of the income tax were the equitable distribution of the tax burden and the ability of the federal government to raise sufficient revenues to function. Since 1913, the U.S. income tax system has become very complex, and taxes are imposed on more than just personal and business incomes.

Today, the Internal Revenue Service ("IRS") is the agency of the U.S. Department of the Treasury that is responsible for collecting income taxes from individuals and businesses. In addition to income tax, the IRS collects several other kinds of taxes for the government, including Social Security, estate, excise and gift taxes. The agency's other responsibilities include enforcement of U.S. tax laws, distribution of forms and instructions necessary for the filing of tax returns and providing counseling to businesses and individuals with uncertainties about the tax regulations.

Income tax, in particular, has been the subject of a great deal of debate among economists and legal theorists. Income tax is a levy imposed by public authority on the incomes of persons or corporations within its jurisdiction. The fairness of personal income taxation is based on the premise that one's income is the best single index of one's ability to contribute to the support of the government. In addition, personal income taxation assumes that as people's financial circumstances differ, their tax liabilities should also differ. The income tax structure in the United States is based on a system of progressive taxes, where taxes fall more heavily on those who earn more money, and individual income tax deductions are allowed for items such as interest paid on home mortgage debt, certain medical expenses, philanthropic contributions and state and local income and property taxes.

Critics of income tax systems have argued that they can be extremely complex, requiring detailed record-keeping, lengthy instructions and complicated schedules, worksheets, and forms. In addition, critics have also claimed that income tax systems can penalize workers, discourage saving and investment and hinder the competitiveness of businesses.

Law Enforcement

Economic analysis of crime and punishment is based upon the premise that punishment is a method of imposing costs on criminal activity and thereby altering the incentives to engage in it. The economist is interested in how the criminal justice system, which constitutes a form of government coercion, is used and how it could be used more effectively to prevent wasteful private activities, such as theft and murder. In addition, economists consider such issues as how to prevent the criminal justice system from being misused, and how to ensure that the distribution of wealth and justice is allocated efficiently within the governing legal framework.

Various studies have examined the benefits and costs of criminal activity. The benefits or gains obtained from a criminal act vary. For instance, some gains from crime are monetary, such as goods acquired through theft, robbery or fraud. Others gains are social or psychological, such as the thrill of danger, peer approval, a sense of retribution as in a bank robbery or a sense of accomplishment. The costs of crime could include material costs, such as acquiring equipment, guns or vehicles and psychic costs, such as guilt, anxiety or fear. In addition, punishment costs include all formal sanctions, including fines and various forms of incarceration, as well as pecuniary costs arising from lawsuits, and informal sanctions, including any personal losses connected with arrest, prosecution and conviction. The more severe these sanctions are, the higher the costs.

Finally, any economic analysis of criminal activity and law enforcement must consider the socioeconomic statistics that link decreased income and educational levels with the potential for increased criminal activity. The lower a person's income, for instance, the lower the opportunity cost of crime, in that the yields from criminal activity may be greater than the costs associated with giving up earning a legal income. In addition, ineffective law enforcement activities may waste valuable resources without minimizing criminal activity, or even worse, may result in increased forms of retributive criminal behavior aimed at striking back at perceived injustices in the legal system. Thus, economists and legal theorists, along with courts and legislatures, must consider many socioeconomic, racial, psychological and sociological factors in weighing how best to shape a society's economic, legal and criminal justice framework to provide incentives to effect the desired behavior while fairly imposing penalties on those who violate laws without the penalties becoming too onerous that they tax the society's resources.

Conclusion

The economic analysis of law is a broad, dynamic field that examines the intersection of law, economics, morality and even sociology and psychology. Every individual and corporate action has economic implications. Economists and legal theorists study the incentives that motivate people to make behavioral changes that follow the society's moral and legal framework and the economic consequences of developing areas of law and past legal precedents. Basic theories, such as efficiencies, positive law, normative law and the Coase Theorem provide economists with the basic building blocks for shaping an economic analysis of the law. In some areas of the law, such as torts, contracts and property, the economic implications of legal principles in those fields have been well established. In other areas, such as antitrust, intellectual property and the financial markets, economists are still studying the interplay between economics and the law, and how both of these fields inform and shape the development of the other. Finally, an economic analysis of the law does not stop with the study of resource allocation or assignment of liability. Instead, economists must consider how economic policies and the legal process affect the administration of justice and resources to the poor and uneducated and the role that the criminal justice system and law enforcement activities play in shaping the behavior of members of a society.

Terms & Concepts

Allocation of Resources: Apportionment of productive assets among different uses. The issue of resource allocation arises as societies seek to balance limited resources, such as capital, labor and land, against the various and often unlimited wants of their members.

Antitrust Law: The body of law, primarily consisting of federal statutes, designed to promote free competition in trade and commerce by outlawing various practices that restrain the marketplace.

Capitalism: An economic system in which the means of production and distribution are owned and controlled mostly by private individuals and businesses for profit, thus what is produced and the quantities of that production are determined by consumer demand and competition.

Caveat Emptor: Let the buyer beware. The legal principle that, unless the quality of a product is guaranteed in a warranty, the buyer purchases the product as it is and cannot hold another liable for any defects. Statutes and court decisions concerning product liability and implied warranties have substantially altered this rule.

Common Law: A legal system derived from the broad and comprehensive principles encompassed within the unwritten laws of England that have been adopted by the United States, although with some exceptions in the State of Louisiana. The principles are created and modified by judicial decision and passed on through custom, traditional usage and precedent.

Compensatory Damages: Payment to someone who has suffered harm, such as for loss of income, expenses incurred, property destroyed or personal injury.

Competition: Rivalry, as between two individuals or entities to secure an advantage over another for customers or a share of the marketplace.

Due Process: A constitutionally determined doctrine requiring that any legal proceeding or legislation protect or respect certain rights of the persons or groups involved in the proceedings or affected by the legislation.

Efficiency: The production of the desired effects or results with minimum waste of time, effort or skill.

Intellectual Property: A product of the intellect that has commercial value, including copyrighted property such as literary or artistic works, and ideational property, such as patents, appellations of origin, business methods, and industrial processes.

Liability: A legally enforceable obligation, or a debt to pay an assessed amount.

Normative Law: A legal theory based upon queries into what the law should be like. It overlaps with moral and political philosophy, and includes questions of whether individuals should obey the law, on what grounds law-breakers might properly be punished and the proper uses and limits of regulation.

Opportunity Cost: The cost of an alternative that must be forgone in order to pursue a certain action.

Positive Law: The body of laws that have been enacted in a particular community and that are upheld by the courts of that community.

Punitive Damages: Damages that are not awarded to compensate the plaintiff, but to reform or deter the defendant and similar persons from pursuing a course of action such as that which damaged the plaintiff.

Redistribution of Income: The transfer of income through government taxation, spending and assistance programs targeted at particular income groups, and programs designed to provide training to workers or to encourage private investments in education or other kinds of human capital. The goal is to transfer money from higher-income groups to lower-income groups.

Transaction Costs: Costs associated with buying and selling investments.

Bibliography

al-Nowaihi, A.M., & Dhami, S. (2013). The hyperbolic punishment function. Review of Law & Economics, 8, 759-787. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=90365390&site=ehost-live

Baird, D. (1997). The future of law and economics: Looking forward. University of Chicago Law Review, 64, 1129. Retrieved June 10, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=9712235952&site=ehost-live

David, B. (2012). Contemporary readings in the economic analysis of law. Economics, Management & Financial Markets, 7, 209-214. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=86434012&site=ehost-live

Edlin, A. (2006). Review essay: Surveying two waves of economic analysis of law. American Law & Economics Review, 2, 407. Retrieved June 10, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=4234091&site=ehost-live

Foundations of economic analysis of law. (2005). Harvard Law Review, 118, 2485. Retrieved June 10, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=17043420&site=ehost-live

Lombardo, S. (2011). The comparative, law and economics analysis of company law. Reflections on the second edition of The Anatomy of Corporate Law. A Comparative and Functional Approach. European Company & Financial Law Review, 8, 47-64. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=59338726&site=ehost-live

Rosenberg, G. (1997). The implementation of constitutional rights: Insights from law and economics. University of Chicago Law Review, 64, 1215. Retrieved June 10, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=9712235956&site=ehost-live

Siegel, N. (1999). Sen and the hart of jurisprudence: A critique of the economic analysis of judicial behavior. California Law Review, 87, 1581. Retrieved June 10, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=2683304&site=ehost-live

Shavell, S. (1999, Spring). Economic analysis of law. NBER Reporter, 12-15. Retrieved June 10, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=1950119&site=ehost-live

Soon, J. (2000). The economic analysis of law. Policy, 16, 58. Retrieved June 10, 2007, from EBSCO Online Database Academic Search Premier http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=3666112&site=ehost-live

Sunstein, C. (1997). The autonomy of law in law and economics. Harvard Journal of Law & Public Policy, 21, 89. Retrieved June 10, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=489302&site=ehost-live

Suggested Reading

Jacobsen, J. (2007). Law and economics: Alternative economic approaches to legal and regulatory issues. Feminist Economics, 13, 224-226. Retrieved June 10, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=24827887&site=ehost-live

Ostas, D. (1998). Postmodern economic analysis of law: Extending the pragmatic visions of Richard A. Posner. American Business Law Journal, 36, 193. Retrieved June 10, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=1593397&site=ehost-live

Posner, R. (1998). Social norms, social meaning, and economic analysis of law: A comment. Journal of Legal Studies, 27, 553. Retrieved June 10, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=8824852&site=ehost-live