Law and economics
• Exam: oral exam, closed book; case-oriented (no focus on maths: sometimes in articles, but
this is not asked on the exam)
->head out number of cases, 30min om cases te bekijken, analyse the cases prof economic
perspective (2 out of the3 cases is enough to analyse)
• Based on:
• Literature made available on Blackboard every week ->some articles very old,
‘basics from law and economics’, stayed the same
• Slides and lectures: contain some extensions to the literature, e.g. actual
developments
->prof will explain the fundamental principles of law and economics & talk
about practical implications (is a judge)
Methodology and overview
1. The importance and use of Law and Economics
• Economics is important for law because:
Everything we do (criminal law, acts..): has economical consequences -> bv. Prices, idea is you buy
something, if price is high we’ll pay less, bv. Criminal law: if the penalty is high, we’ll be less likely
to to it
= everything has economical consequences
1. Statutes, regulations and judicial decisions have economic consequences:
• Even if well-intended, the results can be inefficient (adverse effects): therefore there is a
need for cost-benefit analysis
->p.e: housing shortage and the rent is high – politician (with sight on new elections)
proposes a statute wherein it’s impossible to get rid of the tenant & will regulate rent (max
rent) -> effect: no more cheap houses, many people will not rent out anymore (bcs
impossible to get tenant out) (will sell instead): rental market broke down (so intentions
politician were good, but unwanted/ unforeseen effect)
2. Much of law has been influenced by economic principles:
• E.g. (=p.e./bv.) economic reasoning behind EU-law concerning the internal market, state
aid, competition law
• Very specific in EU-guidelines concerning the regulation of “natural monopolies”
->p.e. European competition law is very strongly influenced by economic idea’s (p.e. internal
market: if you have freedom of trade, the prices will be the best = economic idea resulted in
law)
->p.e. economic strategy behind state aid: should you give subsidies to avoid bankruptcy of a
firm, seems good reason to give aid, but there are different reasons why they go bankrupt
(bv. Corona: aid is necessary <-> company doesn’t want to move with new technology: if you
subsidies, it’s waste of money bcs they don’t want to change, bv. Codac: came iphones, they
didn’t want to change their products to differ from old products (that now iphone can do)
1
, ->p.e. competition law: competition is good for market (better products, prices…) <->
monopoly: better profits shareholders – so generally competition is economically better than
monopolies, except p.e. energy transportation (don’t want competition, so very specific
regulation for owner of the company to charge the price that would be the price if there were
competition, fair price)
3. Judges and policy makers are confronted with economic reports: p.e. reports on the “SSNIP-
test”, “WACC”, etc.
SNIPP = how to separate markets, if 2 companies are merging will they have monopoly, or
should we look at the market as a whole?
= to define the relevant market.
It asks:If a firm raises prices by 5–10%, would customers switch to other products?
If many switch → market is broader.
If few switch → firm may have market power.
WACC = Used in finance/regulation.-> It measures the company’s average cost of funding
(debt + equity).
If returns are above WACC → value is created.
If below WACC → value is destroyed.
2. Use of models and empirical studies
• In economics models are used, based on assumptions that are a simplification of the real world;
• The test is not necessarily whether the assumptions are realistic, but if they predict well;
• Predictions can be tested by means of economic models;
• Note: in courts models are used to predict effect after a proposed merger, whether a firm
has the incentive to engage in “predatory pricing” (still enough competition?), etc
->in that case judges often stress the importance of the realism of assumptions
We come with general associates: bv. People will buy less if price is higher (not possible to determine
for every subject, so we take generally, p.e. some people will buy more if price higher, but generally
not) -> they have to predict, the predictions should be tested (based on mathematical calculations,
models for prediction)
->if model is accurate to predict has to be decided by the court
3. Rational Choice and methodological individualism
• The traditional assumptions in law and economics are:
1. An individual “rationally” chooses the alternative that gives the highest individual outcome
(in terms of utility or money);
• Note that “rational” here does not mean “well thought over”, but “in accordance with
one’s preferences”
Rational = you’ll choose the outcome best for you (p.e. normally people will choose more
money over less, p.e. partner with brown instead of bleu eyes) (not always, but that’s the
assumption)
->not ‘well thought over’: babys hungy so it cries, they don’t think ‘if I cry I will be fed’, NO,
crying will have the effect that the parents pay attention and ask what’s wrong
2
, 2. It does so within the restrictions that hold for it (a limited budget, limited time);
3. On markets, that may be:
• Physical (on the street) or virtual (on the internet) markets
• Explicit (markets for commercial goods/ services) or implicit (the market for crime, the
“wedding market”)
p.e.. Buy goods, clearly an explicit market: people look on computer to buy watch
p.e. implicit: market for crime – consider to buy ticket public transport or not (and wait
for fine), also an economic decision
p.e. market for people who want to date (tinder)
4. The behavioural critics
• Behavioural law and economics is based on empirical (“laboratory”) studies by Nobel Prize
winners like Kahneman and Thaler to human behaviour
->these studies showed that people (in a systematic way!) deviate from the traditional economic
assumptions;
->examples
• P.e. bounded rationality: people have limited information, limited will-power
so they often use “heuristics” (rules of thumb = broadly accurate guide/ principle based
on experience instead of scientific) to cope with this
= you are rational, but within limits: people have limited information (bv prijsvergelijking
products, moeilijk naar elke winkel om te vergelijken – nu via internet wel mogelijk) &
limited will-power (bv. Want to loose weight, easy eat less, but it’s difficult: may not be
able to resist the temptation – so put cookies in the shed instead of the fridge)
• Endowment-effect: people tend to value something that they have higher than
something they might buy: relevant for the Coase-theorem (lecture 2);
• E.g. “availability” over-estimating the probability of events they easily know
examples about; example: hindsight-bias in tort law (lecture 5);
= application of heuristics: it’s useful to know the availability of something – p.e.
means of transport: take plane or train: if we look at safety, it’s clear that airplane
is safer than train (= plain crash faster in newspaper than train crash, so people
overestimate the probability of a plain crash)
p.e. atomic energy = safest form of energy, but people overestimate it bcs
they have examples (bv. Hiroshima)
• social norms: people often not do what is rational, but what is in accordance with a
generally accepted norm (e.g. voting, the “ultimatum game”); lecture 6;
= it would be rational to do, but you don’t bcs that would mean violating a general norm
– p.e. Ultimatum game: people reject unfair offers, even if it means getting nothing bcs
fairness norms matter more than pure self-interest.
• Altruism and spite; e.g. important in family law (lecture 8).
p.e. working to pay for housing child, bcs they find child more important than theirself
3
, • The aim of behavioural law and economics is to build models with more realistic assumptions
that predict better;
• Famous example: book “Nudges” (=push in right direction), by Sunstein and Thaler
• The idea: government regulation works better if citizens are “nudged” into the
direct direction, e.g. making use of the empirical finding that people usually do
not deviate from a “default setting”;
E.g. the order in which items in canteen/ supermarket are presented, wil
influende customers’ buying behaviour (p.e. eye-level more likely tempted than if
you had to bend down to see it)
->if you know how people react in reality, useful in government -> p.e. cookies,
we always accept, would be more time-efficient if it only popped up if you don’t
want to accept cookies
• Note that Adam Smith (founder of economics) already used a behavioural approach, e.g. taking
altruism into account in “The theory of moral sentiments”)
->he said that people are altruistic, if people could choose: lose middle finger, but then no
earthquake with lots of deaths, so they would cut it of <-> if it’s you’re whole arm vs. 2 people,
more likely to let them die
->if people act rationally & for themselves, normally positive outcome for others (more money,
better products, better job, more money, more people in service…)
5. Pros and cons of behavioural approach
1. Predictions may indeed be better, particularly if it comes to consumer behaviour (but sometimes
predictions aren’t better -> with consumer behaviour it will work better than strict traditional
rational approach);
2. Makes the economic approach more acceptable for the general public (if you say ‘people are
100% rational’ you’ll loose people, if you say 60%, more acceptance) ;
But: note that the use of behavioural law and economics in court rooms still is limited; reasons:
• More complicated models are more costly to make, more difficult to handle, outcomes
might diverge;
• Traditional models predict quite well if it comes to the behaviour of firms (what is most
important in competition law, the most important practical application), but be aware of
differences between observed & intended behaviour
= what people say about their behaviour may be different from what they actually do (bv.
Yes I will pay 100 euro more for eco-friendly gas, but in reality take the cheap gas)
->this is important for the outcome of market reports.
6. The concept of welfare (see article on methodology on discussion about
money versus utility as a measuring rod);
• Important issue in competition law is whether “producer surplus” should be weighted equal to
“consumer surplus” (USA: yes <-> EU: no, focus must be on consumer surplus);
‘Maximizing the total welfare’: does this also include producer surplus or consumer surplus? -> in
EU they’ll take surplus/ welfare of companies into account, in the EU focus on consume
4
• Exam: oral exam, closed book; case-oriented (no focus on maths: sometimes in articles, but
this is not asked on the exam)
->head out number of cases, 30min om cases te bekijken, analyse the cases prof economic
perspective (2 out of the3 cases is enough to analyse)
• Based on:
• Literature made available on Blackboard every week ->some articles very old,
‘basics from law and economics’, stayed the same
• Slides and lectures: contain some extensions to the literature, e.g. actual
developments
->prof will explain the fundamental principles of law and economics & talk
about practical implications (is a judge)
Methodology and overview
1. The importance and use of Law and Economics
• Economics is important for law because:
Everything we do (criminal law, acts..): has economical consequences -> bv. Prices, idea is you buy
something, if price is high we’ll pay less, bv. Criminal law: if the penalty is high, we’ll be less likely
to to it
= everything has economical consequences
1. Statutes, regulations and judicial decisions have economic consequences:
• Even if well-intended, the results can be inefficient (adverse effects): therefore there is a
need for cost-benefit analysis
->p.e: housing shortage and the rent is high – politician (with sight on new elections)
proposes a statute wherein it’s impossible to get rid of the tenant & will regulate rent (max
rent) -> effect: no more cheap houses, many people will not rent out anymore (bcs
impossible to get tenant out) (will sell instead): rental market broke down (so intentions
politician were good, but unwanted/ unforeseen effect)
2. Much of law has been influenced by economic principles:
• E.g. (=p.e./bv.) economic reasoning behind EU-law concerning the internal market, state
aid, competition law
• Very specific in EU-guidelines concerning the regulation of “natural monopolies”
->p.e. European competition law is very strongly influenced by economic idea’s (p.e. internal
market: if you have freedom of trade, the prices will be the best = economic idea resulted in
law)
->p.e. economic strategy behind state aid: should you give subsidies to avoid bankruptcy of a
firm, seems good reason to give aid, but there are different reasons why they go bankrupt
(bv. Corona: aid is necessary <-> company doesn’t want to move with new technology: if you
subsidies, it’s waste of money bcs they don’t want to change, bv. Codac: came iphones, they
didn’t want to change their products to differ from old products (that now iphone can do)
1
, ->p.e. competition law: competition is good for market (better products, prices…) <->
monopoly: better profits shareholders – so generally competition is economically better than
monopolies, except p.e. energy transportation (don’t want competition, so very specific
regulation for owner of the company to charge the price that would be the price if there were
competition, fair price)
3. Judges and policy makers are confronted with economic reports: p.e. reports on the “SSNIP-
test”, “WACC”, etc.
SNIPP = how to separate markets, if 2 companies are merging will they have monopoly, or
should we look at the market as a whole?
= to define the relevant market.
It asks:If a firm raises prices by 5–10%, would customers switch to other products?
If many switch → market is broader.
If few switch → firm may have market power.
WACC = Used in finance/regulation.-> It measures the company’s average cost of funding
(debt + equity).
If returns are above WACC → value is created.
If below WACC → value is destroyed.
2. Use of models and empirical studies
• In economics models are used, based on assumptions that are a simplification of the real world;
• The test is not necessarily whether the assumptions are realistic, but if they predict well;
• Predictions can be tested by means of economic models;
• Note: in courts models are used to predict effect after a proposed merger, whether a firm
has the incentive to engage in “predatory pricing” (still enough competition?), etc
->in that case judges often stress the importance of the realism of assumptions
We come with general associates: bv. People will buy less if price is higher (not possible to determine
for every subject, so we take generally, p.e. some people will buy more if price higher, but generally
not) -> they have to predict, the predictions should be tested (based on mathematical calculations,
models for prediction)
->if model is accurate to predict has to be decided by the court
3. Rational Choice and methodological individualism
• The traditional assumptions in law and economics are:
1. An individual “rationally” chooses the alternative that gives the highest individual outcome
(in terms of utility or money);
• Note that “rational” here does not mean “well thought over”, but “in accordance with
one’s preferences”
Rational = you’ll choose the outcome best for you (p.e. normally people will choose more
money over less, p.e. partner with brown instead of bleu eyes) (not always, but that’s the
assumption)
->not ‘well thought over’: babys hungy so it cries, they don’t think ‘if I cry I will be fed’, NO,
crying will have the effect that the parents pay attention and ask what’s wrong
2
, 2. It does so within the restrictions that hold for it (a limited budget, limited time);
3. On markets, that may be:
• Physical (on the street) or virtual (on the internet) markets
• Explicit (markets for commercial goods/ services) or implicit (the market for crime, the
“wedding market”)
p.e.. Buy goods, clearly an explicit market: people look on computer to buy watch
p.e. implicit: market for crime – consider to buy ticket public transport or not (and wait
for fine), also an economic decision
p.e. market for people who want to date (tinder)
4. The behavioural critics
• Behavioural law and economics is based on empirical (“laboratory”) studies by Nobel Prize
winners like Kahneman and Thaler to human behaviour
->these studies showed that people (in a systematic way!) deviate from the traditional economic
assumptions;
->examples
• P.e. bounded rationality: people have limited information, limited will-power
so they often use “heuristics” (rules of thumb = broadly accurate guide/ principle based
on experience instead of scientific) to cope with this
= you are rational, but within limits: people have limited information (bv prijsvergelijking
products, moeilijk naar elke winkel om te vergelijken – nu via internet wel mogelijk) &
limited will-power (bv. Want to loose weight, easy eat less, but it’s difficult: may not be
able to resist the temptation – so put cookies in the shed instead of the fridge)
• Endowment-effect: people tend to value something that they have higher than
something they might buy: relevant for the Coase-theorem (lecture 2);
• E.g. “availability” over-estimating the probability of events they easily know
examples about; example: hindsight-bias in tort law (lecture 5);
= application of heuristics: it’s useful to know the availability of something – p.e.
means of transport: take plane or train: if we look at safety, it’s clear that airplane
is safer than train (= plain crash faster in newspaper than train crash, so people
overestimate the probability of a plain crash)
p.e. atomic energy = safest form of energy, but people overestimate it bcs
they have examples (bv. Hiroshima)
• social norms: people often not do what is rational, but what is in accordance with a
generally accepted norm (e.g. voting, the “ultimatum game”); lecture 6;
= it would be rational to do, but you don’t bcs that would mean violating a general norm
– p.e. Ultimatum game: people reject unfair offers, even if it means getting nothing bcs
fairness norms matter more than pure self-interest.
• Altruism and spite; e.g. important in family law (lecture 8).
p.e. working to pay for housing child, bcs they find child more important than theirself
3
, • The aim of behavioural law and economics is to build models with more realistic assumptions
that predict better;
• Famous example: book “Nudges” (=push in right direction), by Sunstein and Thaler
• The idea: government regulation works better if citizens are “nudged” into the
direct direction, e.g. making use of the empirical finding that people usually do
not deviate from a “default setting”;
E.g. the order in which items in canteen/ supermarket are presented, wil
influende customers’ buying behaviour (p.e. eye-level more likely tempted than if
you had to bend down to see it)
->if you know how people react in reality, useful in government -> p.e. cookies,
we always accept, would be more time-efficient if it only popped up if you don’t
want to accept cookies
• Note that Adam Smith (founder of economics) already used a behavioural approach, e.g. taking
altruism into account in “The theory of moral sentiments”)
->he said that people are altruistic, if people could choose: lose middle finger, but then no
earthquake with lots of deaths, so they would cut it of <-> if it’s you’re whole arm vs. 2 people,
more likely to let them die
->if people act rationally & for themselves, normally positive outcome for others (more money,
better products, better job, more money, more people in service…)
5. Pros and cons of behavioural approach
1. Predictions may indeed be better, particularly if it comes to consumer behaviour (but sometimes
predictions aren’t better -> with consumer behaviour it will work better than strict traditional
rational approach);
2. Makes the economic approach more acceptable for the general public (if you say ‘people are
100% rational’ you’ll loose people, if you say 60%, more acceptance) ;
But: note that the use of behavioural law and economics in court rooms still is limited; reasons:
• More complicated models are more costly to make, more difficult to handle, outcomes
might diverge;
• Traditional models predict quite well if it comes to the behaviour of firms (what is most
important in competition law, the most important practical application), but be aware of
differences between observed & intended behaviour
= what people say about their behaviour may be different from what they actually do (bv.
Yes I will pay 100 euro more for eco-friendly gas, but in reality take the cheap gas)
->this is important for the outcome of market reports.
6. The concept of welfare (see article on methodology on discussion about
money versus utility as a measuring rod);
• Important issue in competition law is whether “producer surplus” should be weighted equal to
“consumer surplus” (USA: yes <-> EU: no, focus must be on consumer surplus);
‘Maximizing the total welfare’: does this also include producer surplus or consumer surplus? -> in
EU they’ll take surplus/ welfare of companies into account, in the EU focus on consume
4
