CSCFFS 5130 Final Exam

Systems of Social Control

Sheet

The Late 1970s-1990s: Deregulation Takes Hold

Some Related Executive Orders -Ford: • E.O. 11821 (1974): Requires inflation impact statements -Carter: • E.O. 12044 (1978): Requires regulatory analysis for major regulations -Reagan: • E.O. 12291 (1981): o Benefits of regulations must exceed costs (major rules) o Must maximize the aggregate net benefits to society -Clinton: • E.O. 12866 (1993): o Benefits of regulations must justify costs (major rules) o Sets up working group to write best practices for reg. analysis (OMB circular a-4 results) o Through 2016 was still primary document concerning regulatory analysis

Remedies: Damages

$$$ • Compensatory to make the plaintiff whole • Consequential damages to cover indirect costs that were foreseeable by the defendant • Incidental damages to cover breach-related expenses • Punitive damages: defendant acting in bad faith - rare • Damages may be reduced if the plaintiff did not do anything to mitigate damages once a breach is discovered. -Specific Performance • Require the breaching party to fulfill contract • Not a first choice of remedies

Why does government fail?

(1) Government often has less information than the market does. When this occurs, a government fix might actually make things worse, rather than better. (2) Government is composed of people. These people are not saints, they are not completely selfless. Like the rest of us they have their biases and are subject to political pressures. What appears to be a regulation aimed at promoting health or safety may, in fact, be a regulation designed to eliminate competition from the regulated industry. In each case, where a market failure is found one must look at the structures of the institutions of society, what information decision makers in those institutions are likely to have access to, the incentives of the various decision makers, and the administrative cost of the proposed solution. While true efficiency will probably never be achieved, an honest assessment will expose the strengths and weaknesses that each institution has in dealing with a particular issue. In some instances government regulation will be the preferred solution. In others the legal system or market-based solutions may be best.

Intentional Torts: Invasion of Privacy

(One's interest in being left alone) • Appropriation of name or likeness o Used for commercial purposes without permission • Intrusion o Invasion of solitude • Public disclosure of private facts o When disclosure of private facts would be offensive • False light o Publicity of offensive claims that cast victim in false light in the public mind

Government Failure

****Important**** -Just because there is market failure does not mean government will be able to solve the problem!!! -Government can cause or exacerbate market failure!!! -Why does government failure occur? • Information: o Government experts often do not have more information than experts in the market. o Utility can't be accurately measured • Self Interest: o Government employees respond to incentives ♣ Political Pressure ♣ Promotion Financial Rewards

CPSC Statutes

- Flammable Fabrics ACt • Allows flammability standards for textiles and fabrics used in upholstery -Refrigerator Safety Act • Requires that refrigerators be able to be opened from the inside -Fire-Safe Cigarette Act • Requires CPSC to study the role cigarettes play in starting fires

CPSC Statutes

- ____________Act • Created CPSC, gives jurisdiction over products • Requires voluntary standards when such standards will adequately reduce risks -Federal Hazardous Substances Act • Requires precautionary labeling of hazardous household chemical products -Poison Prevention Packaging Act • Allows agency to promulgate child-resistant packaging standards for certain household products

Duty-How Far Does it Extend?

-"Generally the law does not require one person to act for the benefit of another unless there is some relationship between the people that requires such action. It should be obvious that a doctor is obligated to act to attempt to save the life of a patient who has had a sudden heart attack. But a stranger who sees the person having a heart attack is under no legal obligation to perform CPR even if the stranger is well trained to do so. In the law we would say that the doctor has a duty to the patient as a result of the doctor-patient relationship but strangers have no duty to other strangers." By Leonard H. Glantz, JD Professor of Health Law Boston University School of Public Health Duty -What about duty when there is no preexisting relationship or anticipated harm? • Moral duty vs. legal duty • Implied contractual duty • Legally specified duty -Examples • Child jumps into the water and is drowning • Find injured person on the street • Woman at bar

Consumer Financial Protection Bureau (CFPB)

-"The central mission of the Consumer Financial Protection Bureau (CFPB) is to make markets for consumer financial products and services work for Americans—whether they are applying for a mortgage, choosing among credit cards, or using any number of other consumer financial products." • Response to crash - Created in 2011 - Richard Cordray • Consolidates functions once spread across many agencies (including FTC) • Regulates banks, credit unions, and other financial companies • Educates consumers

The 1990s to 2016: A Deliberative Approach and a Resurgence

-1992-2008: Renewed interest in regulation, but... -Understanding of need to write rational regulation ⇒ Increased use of economic analysis to justify and shape regulation (E.O. 12866 - see last slide) ⇒ Bush II adds more White House oversight/control of agencies' regulatory activities (E.O. 13258, E.O. 13422) -2008: Regulatory efforts increase under Obama ⇒ Bush II oversight repealed ⇒ War against whistleblowers • "If Donald J. Trump decides as president to throw a whistle-blower in jail for trying to talk to a reporter, or gets the F.B.I. to spy on a journalist, he will have one man to thank for bequeathing him such expansive power: Barack Obama.... Over the past eight years, the administration has prosecuted nine cases involving whistle-blowers and leakers, compared with only three by all previous administrations combined." - The New York Times

Institutions and Organizations

-1st Party • Manufacturers may be ethically bound to create safe products -2nd Party • Injured customers may impose bilateral costly sanctions on manufacturers -3rd Party: • Social forces may punish a manufacturer through reputation effects or through other sanctions

Norm Enforcement: Ellickson's Systems of Social Control

-1st party (personal ethics - self sanction): • Guilt • Shame - 2nd party (contracts - personal self-help): • Bilateral sanctions • Shame -3rd party social ('norms' - vicarious self-help): • Multilateral sanctions • Shame

Question

-A contract written in the United States says "Barney will pay Fred $200 for landscaping services." After Fed does the landscaping Barney pays Fred $200 Australian (equal to $150 U.S.). Fred says "Hey, I thought we were talking about U.S. dollars." Barney says, "Really, I thought that because you are Australian you wanted Australian dollars." Both are being truthful. If the case goes to court, what is the judge likely to do and why? • It comes down to what's reasonable, the reasonable interpretation is U.S. Dollars, which means he owes him $50 more. -Both the United States and Russia have legal systems with provisions that protect property and recognize contracts. -Why, then, is the United States seen as being a much better place to do business/invest than Russia? • Rule of Law is weak in Russia (enforcement weak) -Corruption is widespread (enforcement depends on political status) -Russia no longer accepts international arbitration of disputes =There is no assurance that investments will be protected -https://www.state.gov/e/eb/rls/othr/ics/2016/eur/254409.htm Rule of law is absolutely essential for economic growth even if you think the law leads to bad outcome in a given case (change the law-don't stop enforcement)

Elements of A System of Social Control

-A controller that enforces institutional rules -Rules of normatively appropriate behavior -Sanctions to enforce substantive rules -Rules for administration of sanctions

What is Government?

-A powerful organization with the authority to create and enforce the laws of the state -An organization created to pursue the public interest -An organization composed of humans who are self interested and imperfectly accountable to the public (the public choice view) -A collection of thousands of orgs with persons we elect to represent our varied interests -All are true to some degree -How does each definition of government affect one's view of when government should be used?

The Problem of Adverse Selection

-A special case of asymmetric information -Asymmetric Information + Goods of varying Quality = Race to the bottom - market only serves low quality participants -Examples: • The buyer of a used car does not know whether the vehicle is a lemon, but the seller does • The purchaser of health insurance knows more about their health status than the insurance company does

What is a Nonprofit?

-A.K.A. a not-for-profit. -A civil society organization designed to pursue a social goal. • Profit is not the goal. Income cannot be distributed to shareholders. Reasonable salaries for employees are ok, excessive salaries may lead to loss of nonprofit status. • Any excess revenues are reinvested in the pursuit of the organization's stated goal. • Can be funded through charitable contributions, membership dues, or market activities.

Elements of the Contract

-Agreement • There is a 'meeting of the minds' -Consideration • Both parties obtain something of value ($, a promise of future service, etc.) -Capacity • Both parties are sane, sober, and of legal age -Genuineness of Assent • The contract was made in good faith -Legality of Purpose • Courts will not enforce contracts that violate the law

Federal Regulation in the early 1900s

-Antitrust efforts • Antitrust Division of the Justice Dept. • Federal Trade Commission - 1914 -Regulation of Banking • The Federal Reserve - 1913 -The Beginnings of Health and Safety Regulation Federal Food and Drugs Act - 1906

Basic Attributes of Democracy: 5. Wide Distribution of Political Resources

-Are political resources spread across different demographic groups... across people with different beliefs? -Why is this Important? -Why is gerrymandering seen as damaging to democracy?

"The Market for Lemons" George Akerlof, 1967

-Assume: • Only sellers know whether vehicle is a lemon (worth $500), an average car (worth $750), or a cream puff (worth $1000). • Buyers initially believe that all used cars are equally likely to be of all qualities. "The Market for Lemons" • If the buyer is risk neutral, she will only be willing to pay for the expected value of the vehicle ($500+$750+$1000)/3 = $750 • Sellers of cream puffs, knowing this, will not attempt to sell their cars. • The buyer, knowing this, re-estimate the expected value of the car ($500+$750)/2=$625 Overcoming the Lemons Problems -Markets • Persons without information can invest in information (hire a mechanic) • Persons with information can find a way of credibly communicating quality - Give a signal (give a warranty, provide an independent inspection report, have service records, etc.) -Legal • Allow purchasers of lemons to sue sellers -Government • Impose standards to keep lemons from making it to the market

Consumption Decision

-At the base of consumer economics is the consumption decision. -Consumers consume until marginal benefit/utility (MB or MU) of consumption equals marginal cost (MC) of consumption MB=MC. -Marginal benefit is also often called marginal utility (MU)

What Government Does

-Attributes of Government • Empowered to make decisions for the public (Authority) • Has enhancing public welfare as a primary goal (Public Mission)

Automatic, Informational Sanction

-Automatic • Violation of a norm carries its own cost - no enforcement needed • Examples: Wire your house for DC power in a country that uses AC power. Others? -Informational • Action by violator conveys information that violator doesn't want others to know. • For this class: informational sanctions are completely covered by shame, bilateral and multilateral sanctions (the harm to one's reputation from violating the norm)

How old should you be to vote?

-Before 1960s: • 21 was common -26th Amendment (1971) • 18 is maximum -21 states allow those aged 17 to vote in primaries/caucuses if they will be 18 by time of election (Ohio) - Many states allow localities to set lower voting age. • Tacoma Park, MD: 16

3. Evaluation of Benefits and Costs

-Benefit-Cost Analysis (BCA) • Estimates the benefits and costs of a proposed rule • Uses monetary measures for both benefits and costs -Cost-Effectiveness Analysis (CEA) • Estimates the cost of a rule per expected unit of benefit -Example: rule costs $1 million per life saved Benefit-Cost Analysis (BCA) -Advantages: • Gives understandable summary measures for costs and benefits • Allows a policy maker to maximize net benefits of regulation -Disadvantage: • The monetization of benefits may not be possible or may be controversial -Advantage: Allows for optimal regulation -Disadvantage: someone gets sick, It is a loss (pain and suffering ) -economic loss Cost-Effectiveness Analysis (CEA) -Advantage: • No need to monetize health, environmental amenities, etc. -Disadvantage: • Can be difficult to compare alternatives. e.g how do you compare : o measure 1 (1 life saved, 300 illnesses avoided per $1 million cost) o measure 2 (1000 illnesses avoided per $1 million cost) -Loss of health and loss of environmental amenity is still a loss even if there is no monetary value

How is Reputation Established?

-Branding: • Identification of a product with a brand. (i.e. Sony, Mercedes, Barbie) • Positive experiences with a brand enhances the brand's reputation -The Absence of Brands: • Berkeley experiment-back then it was widely believed that branding was a harmful thing, they went out to prove this was the case, they wanted to show that you can sell goods for less money and have them be the same quality, but didn't work out, yes the prices were lower but so was quality. If the name of the brand is taken off, the company has an incentive to provide a lesser quality because no one will know it's yours.

Federal Trade Commission (FTC)

-Bureau of Competition- regulates unfair competition • Upholds anti-trust laws -Bureau of Consumer Protection- regulates "unfair or deceptive acts or practices" • Unfair trade practice is: (1) likely to cause substantial injury to consumers (2) not reasonably avoidable by consumers (3) • Deceptive act is (1) false or likely to mislead reasonable consumer (2) material to consumer decision making (similar to fraud) • Quality claims not supported by fact • Deceptive advertising - pricing -Agency investigates suspect practices on own initiative or in response to consumer complaint

CPSC Statutes

-CPSC regulations: • 50+ mandatory standards • 40+ product bans • 60+ product label requirements -CPSC litigation: • Several cases a year to enforce regulations Many fines paid without litigation

The Exxon-Valdez Regulation

-Captain below decks drunk & asleep -3rd mate left to pilot ship through =>Prince William sound without radar -Bligh Reef hit 12:08 AM -10 million gallons of crude spilled: 2nd largest U.S. spill -Exxon sued: $5 billion in punitive damages - Judgement proof? Moral hazard? Agency problem? Post-Valdez Regulation -Require double hull ship designs -Require stockpiling of cleanup equipment -Tug escorts in PW sound -Expensive 2nd best solutions. -Why not just focus on eliminating possibility of captains' negligent actions? Post-Valdez Strategic Response -Some oil companies divest tanker fleets. -Leads to some one vessel companies. -Purpose? Reduce liability -How does this affect incentives? • Hint: does it create judgement proof, moral hazard, or agency problems? -Legal response: oil companies still responsible because it is their oil being carried.

How Do Publics Choose?

-Democracy-->Majority Rule -But... Political Decisions • Don't necessarily represent majority • Don't necessarily represent what is best for the public Aren't typically made based on calculations of what is best for society as a whole

Why Is There More Regulation?

-Changing conceptions of the Constitutional limitations of government • Freedom of contract - caveat emptor • Interstate commerce clause • Decline in states rights -Increased trust in government -Increased wealth of society • Health is a normal good as income/wealth increases the demand for health and safety increases (people are willing to pay more for controls)

Private Law (a.k.a civil law)

-Characteristics • Actions by individuals or orgs. against other individuals or orgs. • The rules are created and enforced by courts and legislatures • Focused on providing compensation from party at fault to party who has been injured. • Also has a deterrent effect -Examples: faulty product, slip on ice -Types of Private Law • Property Law • Contract Law • Tort Law -Private Law Remedies • Compensation for losses caused by others • Punitive Damages (limited) • Specific Performance (contract & property)

CPSC Statutes

-Child Safety Protection Act • Toys representing a choking hazard must be labeled • Requires Federal standards for bike helmets -Consumer Product Safety Improvement Act • Imposes testing requirements and sets safety standards for several substances (such as lead) -Children's Gasoline Burn Prevention Act (CGCPA) • Requires portable gasoline containers to be child-resistant -Virginia Graeme Baker Pool and Spa Safety Act (PSSA) • Requires drain covers in pools

The Importance of Civil Society

-Civil Society • Is a huge part of the American experience • Exists side by side with government • Is often encouraged by government (tax breaks, grants, open public facilities) • Open question: Is it crowded out by government? o Since 2007: ♣ Government Regs ♣ Employment of Nonprofits ♣ But... Number of Nonprofits Civil Society and the Public -Civil Society • 1.5 million IRS registered Nonprofits (2015) • Promote narrowly defined interests o the "public" of concern is limited o But, often also promote public interests • Problem: Not all public interests are addressed by associations and organizations in civil society

Distributional Effects: Industry

-Comparative advantage whether a firm is competitive depends on the relative costs it faces not the absolute costs faced. -Implication: If regulation changes the relative costs of production between industries or within an industry, the regulation will create both industry winners and industry losers. • Between regulated and unregulated industries (substitutes): o Regulation Production cost to regulated industry increases Cost to consumer increases for regulated product (much of increased costs passed on) Some consumers will switch to substitutes regulated industry hurt. • Between firms in regulated industry: o Regulation Per unit costs increase differentially within industry Firm with lowest compliance costs increases price only enough to offset costs Higher cost firms either have to take loss or sell at higher price. Loss of profits or market share for higher cost firm exit from industry potential oligopoly.

Defenses to Intentional Torts

-Consent - Injured party gave informed consent -Mistake - Not intentional -Necessity - ex. when lives are in imminent danger -Self-Defense

Consumers as Science Skeptics

-Consumer belief in science has declined • AAAS CEO Rush Holt: o Decline started with space race - high school science not aimed at avg person o Decline is particularly evident on capital hill -View of science as a menace has led to rejection of science and movements such as the anti-GMO ("Franken-Foods") and anti-Vaxxer (Autism) movements. o These movements use the jargon of science and pseudo-scientific reasoning without employing the scientific method.

State Laws

-Consumer protection statutes • Fraud • Debtor protection • Product Defects • Product Safety • UCC -Note: State laws can be used to enhance private law or to create penalties under public law.

Enforcement of a Contract

-Contract will be enforced if all elements are present. -Common reasons for non-enforcement: • No meetings of the minds- often: vague terms • Insufficient consideration - can't disguise gift as contract • Lack of capacity - Ex. A child can not agree to a contract • Fraud - Intentional misrepresentation of a fact • Mistake - only if the mistake is obvious to both parties • Duress- Agreement made under threat • Contract to conduct illegal activity • Unconscionable contract - too one-sided

Implications for Gov't Controllers

-Controller choice implications for small, unknown, and dread risks: • Juries may find negligence in too many cases because negligence is based on a "reasonableness" standard • Regulators may overregulate small risks because of political pressure to deal with the issue -Implications for large risks: • Juries may find negligence in too few cases because negligence is based on a "reasonableness" standard • Regulators may under regulate large risks because of lack of political pressure to deal with the issue

Public Law: Types of Public Law

-Criminal law • Defines offenses against the community • Typically defined by statute • Individuals and org. leaders face criminal sanctions (ex. jail, fines) -Regulation • Rules written by administrative agencies • Individuals and orgs. typically face civil penalties (ex. fines, revocation of a license to sell) • Criminal laws can be used to enforce regulatory rules

Product Liability

-Deals with tangible goods -Uses 'strict liability' • can also use negligence, but this is harder to prove

The Problem

-Defective products expose consumers to unwarranted risk -Potential Market Failure? • Incomplete or Asymmetric Information • Externalities • Abuse of Market Power -The Public? • American citizens/residents? • Ohio citizens/residents? • Columbus citizens/residents?

The Dangers of Defining "Public" (for governments)

-Defined too broadly (all persons in world) • Community preferences not respected • Extreme cost may bankrupt govts. o Why is this? -Defined too narrowly (those of my race) • Many that contribute to society will be disenfranchised • Disorder may follow • Government becomes a tool to redistribute from outsiders to the narrowly defined "public"

Government Regulation

-Definition: Publically enforceable legal rules aimed at regulating (controlling) the behavior of members of society • Often designed to enhance consumer welfare • Govt action to prevent private disputes from arising • Source of Regulations • Law: Rules written by and approved by Congress • Delegation: Act of Congress gives executive branch agencies Statutory Authority to write regulation in a limited area • Combination: Both rules and delegation

Product Defects

-Design Defect • A toy is designed to have sharp edges that can cause a child that plays with it to have serious injuries. -Manufacturing Defect • An error at the factory causes an automobile to be produced with a leaky master brake cylinder. -Marketing Defect • An insecticide is sold in a bottle that has no warning label and looks very similar to a bottle that a popular brand of fruit punch is sold in. -What is/are the consumer problems (market failures)?

Americans' Attitudes about Government

-Direction of Country: • Country is on: Right track: 35%, Wrong Track 57% (3/20 RCP) -Job Approval of Key Politicians: • Trump: Approve 41% Disapprove 54% (3/20 RCP average) • Republicans in Congress: Approve 24% Disapprove 70% (1/23) • Democrats in Congress: Approve 30% Disapprove 63% (1/23) • John Kasich: Approve 57% Disapprove 30% (7/18) -Is this Healthy? • Jefferson: "The Price of Freedom is Eternal Vigilance" But, cynicism breeds indifference

Liability vs. Regulation 3. Chance that culpable parties will not be sued

-Dispersed Harms: Harm to many, but harm to each is small little incentive for any one party to sue -Time Lapse: Long time between exposure and harm difficult to prove harm, culpable parties may be gone -As chance of being sued falls, incentive to act safely (deterrent effect) falls Regulation may be preferable when chance of suit occurring is small -Examples: irritation, serious injury, asbestos -Example: Economic Adulteration

Distributional Effects: Question

-Distributional effects do not influence our assessment of optimal regulation. Why? What about policy choices?

Nonprofits and Information

-Do nonprofits always provide unbiased information? • No! • Key: Incentives facing the decision maker of the nonprofit. -Examples: • PETA statement on cosmetic safety • Consumers Reports auto repair records • Confectioners (candy maker's) trade group on o nutrition of jelly beans o metal shavings in jelly beans

Dread Risks

-Dread Risk • A risk that evokes a feeling of dread in people • Dread can come from (1) the scope of the risk, (2) the source of the risk or (3) the consequences of the risk for individuals -Perception • Dread risks are typically overestimated -Examples?

Key Economic Concepts

-Economics defines consumer problems -Economics is the study of how people respond to incentives • Assumptions: o People try to maximize utility (well being) o People respond rationally o People have different preferences • People consume until MB=MC • Efficiency: social welfare maximized o Maximize total benefits - total costs o MB=MC for society as a whole • Market Value ≠ Economic Value

Shavell, Liability for Harm vs. Regulation of Safety (1984)

-Efficiency: • Defined as maximizing social welfare -Social welfare: B-C • Parties' benefits from activities (B) • Costs of harms and controller action (C) o Internal/external harms o Prevention activities o Administrative expense -Goal: • Use mix of litigation & regulation that maximizes B - C

Why Economics?

-Enables one to define "Consumer Problem" -Provides a rigorous framework for analyzing methods of dealing with consumer problems. -Has a long history of addressing consumer issues/problems Consumers in Early Economics -"Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer." - Adam Smith, 1776 What Economics is Not -A discipline solely concerned with wealth maximization (but _______ is important) -A discipline that is biased in favor of industry and against consumers

For-Profit Testing & Inspection Services

-Engage in inspections or testing for private companies or individuals -What type of companies might purchase these services? -When might individuals want to use these services?

Basic Attributes of Democracies

-Equality of Voting -Competition for Public Office -Majorities/Pluralities Rule -Freedom of Expression -Wide Distribution of Political Resources -Protection of Minority Rights 1. Equality of Voting : "One person/one vote" -What persons count? • All Citizens (guaranteed subject to limitation) o All races (15th Amend.), women (19th Amend.), over 18 (26th Amend.) • Non-Citizen Residents (allowed by Constitution - state decision) o common in 19th century U.S. - gone by 1926 • Limitations o Mental Incapacity o Age o Criminals

Basic Attributes of Democracy

-Equality of Voting -Competition for Public Office -Majorities/Pluralities Rule -Freedom of Expression -Wide Distribution of Political Resources -Protection of Minority Rights -Why are these attributes important? Accountability

General Issues in BCA & CEA

-Evaluation of Alternatives • Agency must show that BCA or CEA has been done for alternatives • Shows that agency actually attempted to maximize net benefits • Transparency • Science must be well-documented • Methodology must be well-documented • Acts to o Keep govt honest o Allow outsiders to check results - find errors -Scope • Residents & citizens of the US - "public" • Others (analyze separately - why?) -Baseline • The magnitude of the problem in the absence of a rule • Analysis must adjust for expectations of change in baseline o Wealth, market adjustments, other regs, other external factors -Analyze separately for those who are not legal citizens

Startling Facts

-Expected probability of average U.S. resident being killed by terrorist: • ~1 in _two million • Mueller (poli sci prof at OSU) says 1 in 40 million -Expected probability of U.S. Muslim resident being killed in U.S. due to hate crime: • ~1 in one million -0 Terrorism deaths in Ohio since 1986 (6 in last 45 years) -http://www.usatoday.com/story/news/2016/09/21/expert-terrorism-frightens-us-far-out-proportion-actual-risk/90799184/ SEE PICS

The Roles of Nonprofits in Combating Market Failure

-Externalities • World Wildlife Fund efforts to stop deforestation in the Amazon -Public Goods • Neighborhood Watch • Charter Schools -Can be set up to combat Abuse of Market Power • Labor Unions -Often designed to provide Information to consumers/producers • Wikipedia (Wikimedia)

Recall Market Failure

-Externalities - • External cost/benefit not included in price -Public Goods • Pure/Impure - Incentive to free ride -Abuse of Power • Monopoly, Oligopoly, Monopsony • Market power allows inefficient pricing -Information Problems • Incomplete Information, Asymmetric Information (AS,MH) • People/businesses make inefficient choices because of bad information

Liability vs. Regulation: Summary of Effects, Implications

-Factors generally favoring legal rules • Difference in knowledge about risky activities • Magnitude of administrative costs -Factors generally favoring regulation • Ability to pay for harm • Chance that parties will not be sued • Often times, both legal rules and regulations are appropriate • If both are used, regulations don't have to be as onerous as when only regulations are used

The Constitutional Framework (original policy roles)

-Federal Government (leg & exec) • Provide Defense • Regulate Interstate Commerce -Federal Courts • Protect Basic Rights, Rule on Fed law -State Govt • Infrastructure & social welfare -State Courts • Protect rights in state constitutions • Rule on state law

Federal Consumer Protection

-Federal Trade Commission (FTC) -Consumer Product Safety Commission (CPSC) -Food and Drug Administration (FDA) -Consumer Financial Protection Bureau (CFPB) • Consolidates functions once spread across many agencies (including FTC)

Federalism

-Federalism: Power divided between the federal government and state governments • Both Federal and State powers are limited o Initially, not much overlap in power o Growing federal power more overlap • Within states there is a form of federalism o power divided between state, counties, cities Federalism: U.S. Government -Number of Governments Federal 1 State 50 County 3034 City/Town 35,933 Special Districts 35,052 School Districts 13,506

Food and Drug Administration (FDA)

-Foods • Regulates most foods (USDA regulates meat and poultry and processed egg product). • Regulates manufacturing process, distribution, and labeling of foods - limited authority over dietary supplements • Has power to impose sanctions on those providing 'adultered' food and remove it from the marketplace through recalls -Drugs and medical devices • Sets standards for approval of drugs and medical devices • Regulates drug manufacturing • Has power to recall risky product

Mattress: Statutory Authority

-For a standard to be valid... -"The Commission must find: • If an applicable voluntary standard has been adopted and implemented, that compliance with the voluntary standard is not likely to adequately reduce the risk of injury, or compliance with the voluntary standard is not likely to be substantial; • b) that benefits expected from the regulation bear a reasonable relationship to its costs; and • c) that the regulation imposes the least burdensome alternative that would adequately reduce the risk of injury. 15 U.S.C. 1193(j)(2)."

Common Law

-Fraud • Misrepresentation of a material fact • Misrepresentation was intentional • The injured party relied on the misrepresentation • There was an injury -Innocent Misrepresentation • Same as fraud but misrepresentation not intentional -Unconscionable Contract • Procedural - bargaining power extremely unequal o Fine print not read, no choice (similar to duress) • Substantive - contract unfair on its face

Property Law and the Courts

-Generally require that property owners be given back their property • Remedy is specific performance -In some instances will require monetary payment instead • When honest mistake is made and social welfare is improved by doing so o Remedy is compensation for loss -In rare instances will allow unlawful converter of property to keep prop. -Adverse Possession • Occupier of land may keep land if they are in open, continuous, and exclusive possession of prop. for a defined period & true owner does not object o Why might courts do this?

The U.S. Constitution

-Goal: Limit the potential of factions to use government to serve private interests (Federalist Papers) -How: • Separation of Powers • Checks and Balances • Federalism (Division of Power) + The civil service (not in the constitution)

The Role of External Agencies

-Government Accountability Office (GAO) • Upon request by Congress, performs an independent analysis of proposed or existing programs -Office of Management and Budget (OMB) • Office in the White House that reviews all major regulations developed by executive branch agencies -What incentives do these agencies give government managers?

Institutions and Organizations

-Government, through action by regulatory agencies, may promote product safety by implementing regulations, guidelines, or providing consumers with information. • Some Federal consumer product safety agencies: o Consumer Product Safety Commission (CPSC) o Department of Transportation o Coast Guard o Food and Drug Administration o Federal Aviation Administration • State and local regulatory authorities

Institutions and Organizations

-Government, through the legal system, may promote product safety by allowing parties injured by a faulty product to sue responsible parties. • Federal tort law - limited • State tort law o Products liability law often employs strict liability o Different rules in different states encourage forum shopping

Example: Wealth Effects and the Baseline

-Health is a normal good • Increasing wealth increasing demand for health • Increasing demand for health behavioral changes that decrease risk (buy smoke alarm, buy first-aid kit) -In evaluating a regulatory program it is important to separate: the independent wealth effect from the regulatory effect. -Wealth goes up ,Reduce the likelihood of something bad happening or the harm that does occur, products are going to change -Cars have become much safer due to regulation, ex) airbags, anti lock brakes SEE PICS

Policy Evaluation

-Ideal, but rarely done internally -Where is evaluation done? • Media • Academics • Think Tanks • Interest Groups • External Government Agencies -Why doesn't govt do much internal evaluation?

Distributional Effects: Industry

-Identify industry distributional effects in the following examples: • Regulation of food safety risks at egg farms o Example 1: Cost of regulation is proportional to size o Example 2: Cost of regulation is the same for all farms • Require that hazardous substances may not be shipped through populated areas unless stringent safety precautions are followed. • Requirement that every medical practice have a full-time neurosurgeon on staff.

Policy Adoption

-Identify the Problem • Establish Context, Assemble Evidence • Delineate the Problem -Identify & Analyze Potential Solutions • Identify Alternatives • Predict Consequences (Intended, Unintended) -Choose Best Solution(s) • Maximize net benefits (benefits-costs)

Examples of Rules

-Identify the following rules by type (substantive, remedial, procedural, constitutive, controller selecting) 1.) Murder is not an acceptable way to punish someone who cheats on you-Remedial Rule 2.) Fraud is wrong-Substantive Rule 3.) The police will only intervene in a dispute between neighbor's if the neighbors have first tried to work things out first-Controller Selecting Rules 4.) An individual can only be convicted of a crime if a prosecutor proves that the person committed the crime beyond a reasonable doubt. - Procedural Rule 5.) The charter of this nonprofit organization may only be amended by a two thirds vote of the executive committee-Constitutive Rule 6.) The fine for spitting on the sidewalk is $25-Remedial Rule

Examining a Consumer Problem

-Identify the problem -Identify relevant institutions and organizations -Examine the abilities/efficacy of alternative controllers -Compare alternatives and implement the best solution(s)

Other Determinants of Policy (Affect both Federal and state policy decisions)

-Ideology • Should government be involved in this type of issue? -Differences of Opinion • Is there really a problem? • Is the problem likely to be fixed or made worse by government? • How should the problem be solved?

Time Preference Example

-If an agency has a choice between the following two regs. at the same cost ($15 million), which should it choose: • A reduces medical expenditures from illnesses caused by a consumer problem by $35 million today • B reduces medical expenditures from this problem by $40 million in two years. The relevant rate of time preference is 10%. Choose A to maximize net benefits

Optimal Regulation: Question

-If optimal regulation can be determined, why are some in favor of much stricter regulations while others are in favor of much less regulation? -Note: I strongly believe this would be the case even if everyone acted rationally with full information.

Optimal Regulation

-If the goal is to improve social welfare -Optimal regulation will: • Maximize net benefits o If Social Benefits of Regulation = BR o & Social Costs of Regulation = CR o then goal is to maximize BR - CR • This occurs where o marginal benefits = marginal costs or, o MBR = MCR

Calculation of Present Value

-If: • there is a benefit or cost = X • the rate of time preference = r • the benefit or cost will be realized in t years the present value of X is: -SEE PICS

True for Health Too

-Imagine that for the past two years your state of health has fit this description: Because of your doctor's instructions, you need to take medication (pills) once a day. You must also be very careful about what foods you eat, so you spend a lot of time keeping track of what you eat. You find it necessary to visit the bathroom quite often to urinate. You often feel tired and sometimes feel light-headed You sometimes have trouble falling asleep and sometimes have nightmares when you do sleep. Your mouth sometimes feels dry, and foods do not seem to have as much taste as they used to. You don't have as much desire for sex as you used to, and you don't find sex as enjoyable as you used to. You often feel angry or irritated, and it is difficult to concentrate. Imagine that this state of health will continue unchanged for the rest of your life. Treatment A would return you to full health for 1 year and would take effect today. Treatment B would return you to full health for ______ years; however, the treatment would not take effect until 2 years from today. Please fill in the blank with the amount of time in full health treatment B would have to provide to make treatment B just as attractive as treatment A. -Class Average: 11.27 years Implicit rate of time preference: 38% -Class Median: 5 years Implicit rate of time preference: 12%

Will a Member of your Family be Injured or Die as a Result of Terrorism?

-Implications of a 1% Predicted Risk (300 million Americans 1% Risk) 30 Family Members = 100,000 casualties over 10 years ⇒ 10,000 casualties each year (on average) in U.S. over each of next ten years. -Is this realistic? No -Is the risk for Columbus the same for the U.S.?

Sanctions for violations of norms

-In Posner and Rasmusen: • Guilt • Shame • Bilateral Costly • Multilateral Costly • Automatic, Informational -Not in Posner and Rasmusen but also valid: • Organization • Government

Questions for Class #1

-In a classic media failure case, Dateline NBC falsely demonstrated that gas tanks from Chevy trucks will explode on impact. • What incentives drove this outcome? • How often do you think this happens? • Why doesn't it happen more often? -A more common problem

Adverse Selection: Is the Problem Really That Bad?

-In the absence of market, legal, or government solutions • Why will insurance still be sold? • Why will people sell cream puffs? -Possible Reasons • Risk Aversion- A lot of people are willing to pay more in order to avoid risk Disparate Preferences Final Note on Adverse Selection -Even if there appears to be a market serving a variety of persons, adverse selection may still be present. • Key: What is the market of interest? e.g. Health insurance vs. premium care -Market defined as health insurance generally: not much adverse selection - most covered -Market defined as premium care insurance: adverse selection - few choose to pay extremely high premiums

Controllers

-Individuals • Self • Others -Organizations • Informal • Market • Nonprofit • Government

Types of Torts

-Intentional Torts • Voluntary act that harms another. Act was intentional. -Negligence • No intent. Harm is the result of carelessness. -Strict Liability • Carelessness need not be shown. Applies if someone is hurt due to use of an unreasonably dangerous product.

Risk Preferences

-Is Risk Desirable? • People are Typically Risk-Averse o People will pay a premium to reduce risk o There is a value for certainty but... • People often have a preference for the thrill that accompanies risk Different attitudes about different risks Example: Skiing vs. Catching a cold -Implication: • Often, behavioral risks that are the result of informed choice are rational and should not be eliminated. • The thrill value associated with a risk is a benefit that must be considered when making policy choices! -So... do people always make risk choices consistent with their preferences? -No! -Remember incomplete/asymmetric information!

Organizations (REMEMBER)

-Last Class: Focus on participants in core market activity • 1st party controllers (e.g. buyers/sellers) • 2nd party controllers (e.g. buyers/sellers) -This Class: Focus on organizations that may aid in solving (or creating) consumer problems • 3rd party organizational controllers -Remember: key to success for all controllers is how incentives from potential sanctions affect 1st party behavior

Adverse Selection and Insurance

-Lemons reasoning applied to insurance -Only the persons seeking coverage know their true health status Expected cost pricing ⇒ Fewer healthy persons buy insurance ⇒ Price of insurance ⇒ Only the sickest buy insurance Overcoming Adverse Selection in Insurance -Market • Refuse to cover preexisting conditions • Charge different rates for different populations (smokers, old/young, etc) • Require a physical prior to coverage • Create pools with limited choice • Sellers can engage in screening (offer cheap high deductible plans next to expensive low deductible plans) -Legal • Allow insurance contract to be voided if person does not disclose health status in application -Government • Require that all purchase insurance (everyone hates this)

Government Regulation in the 1800s

-Little Fed. govt. regulation before the Civil War -Federal efforts initially aimed at curbing abuses of market power • Railroad rate regulation - ICC 1887 -State efforts initially focused on improving public welfare (e.g. health and safety regulation) • Example - worker safety regulations

Local Govts and the Public

-Local Governments • The "public" is the population of the locality National interests may be sacrificed for local interests • But, localities can more efficiently determine the local needs of their populations Need for local government

Potential Solutions to Externalities

-Market • Internalize benefits/costs -Legal • Tort/nuisance law -Government • Taxes/subsidies (to set efficient price) • Direct regulation (to set efficient quantity) • Government ownership of means of production (internalize all costs/benefits)

Institutional & Organizational Failure

-Market Failure • Incentives of market participants inefficient outcomes -Government/Organization Failure -Government and other organizations are composed of individuals who are members or employees b/c they want to use the institutions for their advantage Incentives of persons making decisions in government/organizations matter.

Market Solutions to Abuse of Power

-Market Solutions: • Threat of competition/Competitive fringe • Competition from substitute goods -Remaining Problems: • Won't work if firm is natural monopoly and product has no close substitutes -Abuse of Market Power Examples: • Exclusive Domino's franchise for a region • Apple iPhone • Sewer service

Additional Important Point

-Market Value doesn't equal Economic Value Market value is based on supply and demand. It is used to refer to a company's market capitalization value. • It is often used as a proxy for econ value, but -Economic value is the greater of: • Market value or • Idiosyncratic value (Market value + CS) -Economic value is based on individuals' "willingness to pay" for a good -Examples: • Your home • Your pet • Your toothbrush

Choosing Between Controllers

-Maximize net benefits (Benefits - Costs) -Net Benefits from using a controller: • Maximized when the marginal benefit from using the controller equals the marginal cost of using the controller (MB=MC) • Increase as the incentives of the controller's decision makers become more aligned with the public interest o More efficient rules o Less Rent Seeking • Increase with better information o More accurate (efficient) rules. • Decrease with the cost of information acquisition. • Decrease as the costs of applying sanctions increase.

Basic Attributes of Democracies: 3. Majorities/Pluralities Rule

-Minorities do not beat majorities -What are the advantages/ disadvantages of • Plurality voting rules? • Majority voting rules? -Is the electoral college consistent with democracy?

Basic Attributes of Democracy: 6. Protection of Minority Rights

-Minority lives to fight another day -What would happen if minority political organizations were disbanded and/or the members jailed?

Why Have Many Rejected Science?

-Misunderstanding about how science works • Lack of knowledge about the scientific method • Lack of understanding of the role of uncertainty in science • Media sensationalism and/or lack of scientific knowledge -The Recent Replication "Crisis" -Poor political leadership • Move from adapting views to fit the science to rejecting science that doesn't fit with views o e.g. Kellyanne Conway's description of "Alternative Facts"

Will Issue Get on Decision Agenda?

-More likely if..... • Leadership push o Is political leadership interested in the issue? • Issue Coalitions form o Are interest groups in favor or against? • Media Attention o Has media been reporting on the problem? • Political Timing o Is the political atmosphere ripe for action?

Multiple Systems of Social Control

-Most institutions are supported by multiple systems of social control -Examples: • Lawn Care • Marriage • Product Safety

Distributional Effects: Consumers

-Most regulation also creates winners and losers among consumers. Why? • Consumers are differentially benefited from a regulation on a product they use • + Consumers have different risk preferences • + Consumers who are purchasers of financial instruments may lose wealth if the industry is represented in their portfolio • = Benefits and costs fall unevenly across consumers.

You as a Science Consumer?

-Most science is real... but that doesn't mean it is definitive. Wait for confirmation studies before making up your mind. -Read science reporting with an understanding that writers tend to sensationalize it. -Rely on experts. If most scientists say something is true it probably is. There will always be crackpots that dissent. Try not to fall victim to their conspiracy theories.

Federal Regulation Today vs. 1990

-Much greater focus on health and safety regulation -Continued interest in financial regulation -Antitrust regulation continues, but is more modestly applied

Formation of a Contract (Agreement)

-Must be an offer and acceptance of that offer. -Offer must: • Show intent to enter into contract • Have reasonable definiteness of terms • Be communicated to offeree -Acceptance • Communication of acceptance the contract is legal -Notes: • Offer can be revoked at any time prior to acceptance • A contract can be either written or oral • A contract can be express or implied

The Early 1970s: The Consumer Movement Peaks

-New Regulatory Agencies Added • Occupational Safety and Health Admin. (1970) • Environmental Protection Agency (1970) • National Highway Traffic Safety Admin. (1970) • Consumer Product Safety Commission (1972) -Regulation increases dramatically -A backlash begins to take shape: Demand for Deregulation increases

Basic Attributes of Democracies: 2. Competition for Public Office

-No one party has a monopoly on power -Is there a "monopoly" when there is... • No opposition? • Opposition that government has made too weak to win? • Opposition that keeps losing elections by 5% of the vote?

Does this mean we should believe everything we read?

-No. Fake news is a real phenomenon. -Keys to determining the truth? • Does the news service have a valuable reputation? o More likely if it has been around for longer. • Does the news service apologize when it gets facts wrong? • Does the news service use credible sources. o Many fringe news sites took stories from Russia Today in 2016. • Does the news service hold both Republican and Democratic candidates to a high standard? o Are the editorial and news departments sufficiently separate?

Public Goods-Potential Solutions

-Nongovernmental Solutions • Privileged minority • Tying with profit-making activities • Nonprofit provision of services -Legal Solutions • Redefine Proprietary rights • Require unanimous contracts. • Allow private provider to sue beneficiaries for contribution. -Government Solutions • Provide Services at taxpayer expense.

What are norms?

-Norms Defined: • Social Rules not dependent on government for promulgation (creation) or enforcement.

Norms and Government

-Norms play a larger role in social control than law/government does -Roles of Government: • Supplement the enforcement of norms • Provide information about violations • Provide incentives for private sanctions • Foster the creation of socially desirable norms • Stay out of the way

The Harley Case

-Note - Wisconsin Law -Why did the court throw out the case? • Misrepresentation? There has to be some evidence that he dealer was misrepresenting the product • Injury? No injured parties • What would need to change to make this a successful suit? Someone who comes forward with their bike defaulting without accident

For-Profit Organizations

-Objective: profit • How does this affect incentives? -Types of For-Profit Organizations • News Media • Rating Services • Testing Services • Inspection Services • Others

Efficiency (Kaldor-Hicks)

-Occurs when no change in the status quo will increase net social welfare (well-being). -Example: Allow U.S. consumers to more easily sue HMOs • Consumers better off by $10B (MB =$10B) • HMO Profits fall, workers lose jobs $8B loss (MC =$8B) • Net gain to society (MB - MC = $2B >0) efficiency enhancing move -Remember: in calculating social gains, how the 'public' is defined matters. -Example: Regulation banning travel to Brazil because of Zika. What are the benefits and costs?

Breach of Contract

-Occurs when one party has violated the terms of a valid contract -When this occurs, the aggrieved party is entitled to a remedy

For-Profit Organizations

-Often used to solve information problems -Reputation of org. brands with value gives them a strong incentive to provide accurate information. • Do all workers for these type of organizations share these incentives? Agency problems may occur when the incentives of workers do not line up with the best interest of the company. -What other types of for-profit organizations might be used to overcome market failure?

2. Alternative Approaches

-Options under statutory mandate • Is regulation required? • Stringency of regulation? -Compliance/Effective Dates • Costs decrease as the time between publication of rule and date of required compliance increases • Benefits typically remain constant -Does it specifically say something must be required at federal level 2. Alternative Approaches -Enforcement methods • recordkeeping, inspections, testing • Balance: cost vs. effectiveness of regulation -Requirements by firm size • Remember the iron rule! -Regionally disparate requirements • Politically difficult, but can make sense -How do you enforce these things (ex USDA, certain number of inspectors at food processing plants at all times) -More enforcement there is, more effective regulation there is in terms of people following it -If there are distributional effects, it might make sense for there to be certain rules for smaller vs. bigger players -You could have situation where the problem is only in the Midwest, only those areas should be subject to the regulation (almost never happens bc politics wont let it fly), rules placed either nationwide or not at all 2. Alternative Approaches -Performance Stds. vs. Design Stds. • Regulate outcomes vs. regulate process • Flexibility (efficiency) vs. enforceability -Market Approaches vs. Direct Controls • Use economic incentives? -Information vs. Regulation • Labeling requirements • Rating systems • Government information campaigns -Problem with performance standards- it only works where testing is an efficient way for determining risk, not efficient for enforceability -Market approaches or direct controls - design standards- you must do x, y and z (direct controls) -Market approaches is more effective (economic incentive) -One very successful; effort, FDA required trans fat to be added to the label (trans fat is bad) Ex) Krispy crème doughnuts

Organization and Government

-Organization sanctions • Imposed by 3rd party organization controllers -Government sanctions • Imposed by 3rd party government controllers • We will address these controllers in future classes!

Institutions and Organizations

-Organizations may promote product safety through information campaigns, lobbying, or certification of products: • Industry Orgs o The Chamber of Commerce o National Association of Manufacturers o Underwriter Labs o Various product-specific industry organizations • Consumer Orgs. o Consumers Union o Consumer Federation of America o U.S. Public Interest Research Group The Media

The Constitutional Framework (Federalism)

-Over time the Federal role has grown • Regulation of health and safety (FDA, CPSC, OSHA...) • Regulation of Fraud (FTC, Postal Service, FCC...) -State role is still large • State rules often stricter than federal rules -Question: Why would/wouldn't a state want to regulate more strictly than Feds? -Question: Why would/wouldn't a state want to regulate more/less strictly than Feds? • Population Preferences (e.g. ideology) • Population Characteristics (e.g. exposure to risks, income) • Other Economic Factors (industry/resident needs) The net result? "It is one of the happy incidents of the federal system

The U.S. Constitution

-People often complain about "gridlock" in Washington. -Why did the founders design "gridlock" into the U.S. system of government? -What can happen when a national emergency leads to temporary relaxation of the rules that lead to gridlock? -"'Emergencies' have always been the pretext on which the safeguards of individual liberty have been eroded." - Friedrich von Hayek

Key Implication

-People often don't do a good job estimating the magnitude of risks they are exposed to!

The Civil Service

-Permanent federal workers (not appointees) • Retain their positions regardless of administration • Have tremendous influence on policy outcomes -Would we be better off if new administrations could appoint all new people to work in the bureaucracy?

Policy Implementation

-Pick Effective Date • Often up to one year after policy is adopted -Assign Resources for Enforcement • Inspectors, prosecutors, administrators -Notify affected persons • Regulation: Federal Register, media outreach • Law: Congressional Quarterly Pubs, media

The Problem with externalities

-Positive externality (e.g. decreased risk from vaccination of others) • The benefit (reduced risk) that unvaccinated persons get from being around vaccinated persons. • The price of vaccinations to consumers is artificially high (if the unvaccinated paid their share, purchasers would have to pay less). • Vaccinations will be sold when (MB>MC). • Vaccinations will be underproduced -Negative externality (e.g. living downwind from a hog farm) • The neighbors' cost of enduring the smell is not accounted for in the price of pork at Krogers (neighbors are harmed by the smell). • The price of pork is artificially low • Pork producers will continue to produce pork even when the social cost of increased pork production exceeds the social benefit of increased pork production (MC>MB) • Pork will be overproduced

Deterrent Effect of Contract Law

-Potential damages incentive to stick to contract -Party in a contract will not break the contract unless the benefits from doing so exceed the cost of paying damages (+ legal costs + other costs) -Note: there are also private costs associated with breaking a contract (loss of business, reputation)

Separation of Powers

-Power Divided Between: • Executive Branch o The President o Executive branch agencies under the Pres • Legislative Branch (Congress) o Senate (2 Senators per State) o House of Representatives (based on pop) • Judiciary (Federal Courts) o Supreme Court o Federal Circuit Courts

What are some examples of these type of goods?

-Private Good (Excludable, Rival): Food, Clothes, Autos, jewelry, Houses, Phones, Purchases Books -Impure Public Good (Non-Excludable, Rival): Ocean Fisheries, Public Parks and Roads -Impure Public Good (Excludable, Non-Rival): Satellite Radio, Proprietary information -Pure Public Good (Non-Excludable, Non-Rival): National Defence, Public Information, Rules of Commerce (Laws), Over-the-air radio

Review: Applying Types of Law

-Private Law (Torts, Contracts, Property) o Actions by individuals or orgs. against other individuals or orgs. • Torts: Injuries outside of contract and property • Contracts: Injuries due to breach of contract • Property: Real and personal property -Public Law (Criminal Law, Regulation) o Action by the state against individuals or organizations • Criminal Law: Defines offenses against the community • Regulation: Rules written by administrative agencies -Examples: • You buy new refrigerator that doesn't work • Auto thief takes and sells car to chop shop • Poorly made chainsaw throws a blade and injures the purchaser... Injures bystander • Chemical in a food product causes cancer • Neighbor puts fire pit on your property

Types of Brands

-Product Brand: The brand name that identifies a ___________ (i.e. 'Crest ' or 'Dawn') • also called a product brand. Is a word, group of words, letters, or numbers that represent a product or service. an effective brand name should be easily pronounced, distinctive, and recognizable. An example would include big mac. -Corporate Brand: The brand name that spans an _______________(i.e. 'Procter & Gamble') -Note: Companies can invest in either product or corporate brand. Most invest in both to some degree also called corporate brand. Identifies and promotes a company or division of a particular corporation. The trade name is the legal name that a company uses when it does business and is used to promote a positive image or the organization such as quality, value, and reliability. procter & gamble, dell, disney, Nike, and Yahoo are all examples.

Consumer Product Safety Commission (CPSC)

-Protects consumers from "unreasonable risks to injury and death" -Sets Federal safety standards -Has power to recall defective products -more below...

Public Law: Purposes

-Protects the public by • Creating a deterrent effect • Incapacitating dangerous persons/orgs. • Rehabilitation dangerous persons/orgs. Punishment/Retribution the Guilty

For-Profit Rating Services

-Provide ratings/reviews for everything from bonds to basement repair. -May be based on user reviews or expert analysis -What type of rating services are likely to provide the most accurate information? Why?

Regulatory Analysis: Summary

-Provides a check (by OMB) on regulatory agencies • Gives policymakers an incentive to pursue the public interest • Provides a check against rash and ill chosen decisions -Addresses most of the issues we have discussed as being important -a way that the white house can check that individual agencies are doing what they claim to be doing (checking to make sure the science is there) Specific rules about how to do it- regulatory analysis

For-Profit News Media

-Provides current information • News about consumer scams, fraud, and other mkt failure. -How is profit made? • Free: Sell advertising • Paid: Sell subscription and ads -What incentives do individuals in the media have?

Why Have Regulatory Analysis?

-Provides estimates of expected benefits and costs of proposed regulations • Useful for public consumption as well as for government decision makers • Forces agencies to justify their actions using an objective metric • Reduces the possibility of political or other self-interested behavior undermining the regulatory process -On what grounds might regulatory analysis be criticized? -Why?-optimal regulation -Useful for gov. decision leader -Creates transparency, which is good for the public -Demonstrated that the gov has used science and economics to ensure it makes sense -Politics does play a role in regulatory analysis, there is no way around this "On What grounds Question?" Science only becomes accepted as fact once there is a consensus Science has to decide which is right/wrong based on replication (sorted out thru the scientific process) Demand for regulation before the science is set up (cherry picking by politicians of science that backs there views instead of representative facts from the body of science) However, problem is reduced bc it is transparent Danger that science is really credible to its analysis, there is no box to be checked very science is backed by consensus What is the alternative? -based everything off political whims? -not the answer

What are the sources of Market Failure?

-Public Good -Externality -Abuse of Market Power (e.g. monopoly) -Incomplete Information -Assymetric Information SPECIAL CASES -Moral Hazard -Adverse Selection

Questions for class

-Question 1 Posner and Rasmusen discuss a number of sanctions that can be used to enforce social norms. While there is not a perfect one-to-one mapping of Posner's sanctions to Ellickson's systems of social control, there is some overlap. Which controllers (1st party, 2nd party, 3rd party social) in Ellickson's taxonomy use the following sanctions. • Guilt • Shame • Bilateral costly sanctions • Multilateral costly sanctions -When are norms more likely to be more effective than laws as a method of social control? • Fraud (between strangers in a market transaction)? • Fraud (within a friend group)? o Between friends, people know each other, reputation effects tend to be big. Question for Class #4 -How has the increased need to introduce more products more quickly into the marketplace affected the use of brand names in marketing? -Examples: • Dell vs. Inspiron 15 - Most of the focus is on dell, even though they talk about both • Procter & Gamble vs. Crest Question for Class #5 -What happens to a corporation's reputation when its products don't meet the quality standards typically associated with the brand? How would the purchase of low quality (but functional) items at Macys and WalMart affect their respective reputations? • You expect Macy's quality of product to be better than WalMart Question for Class #6 -In what cases might a company want to engage in costly, socially responsible endeavors (e.g. using environmentally friendly suppliers, marketing eggs from free range hens)? -In what cases wouldn't the company want to do this?

Distributional Effects: Industry

-Question: • How does the likelihood that there will be distributional effects affect the demand for regulation? • Government agencies often exempt small businesses from some or all parts of regulations. Is this a reasonable solution to this problem? o This isn't good nor bad

Ellickson Redux

-Recall that in Ellickson the elements of a system of social control include: • A controller that enforces social rules • Rules of normatively appropriate behavior • Sanctions to enforce substantive rules • Rules for administration of sanctions -Important: Don't be confused by Ellickson's description of rules enforced by 3rd party social forces as being 'norms'. • Most (if not all) successful rules are based on norms! • Examples? (contract rules, etiquette, health and safety regulation)

Pre-Policy Development

-Recognition of a Problem • Public becomes aware/alarmed (Researchers publicize work through media, social media) -Demand for Action • Policymakers are asked to do something (private petition for action, White House/Congressional interest) -Formulation of an Agenda • Initial Agency research of the problem The reality of the ease/cost of dealing with the issue becomes known • Issue is prioritized (based on initial assessment and external factors) • Decision agenda: Priority issues make it to the decision agenda (where action is taken)

Why Did Deregulation Occur?

-Recognition that regulation can make consumers worse off -Problems with regulation • Science is a moving target • Political factors often trump the public interest • Distributional concerns such as the iron law and my extension (see below) • Often takes a long time to be put into action

Effects on Market Failure

-Reduces information problems: • Giving parties an incentive to provide accurate information at the time of agreement • Forces parties to abide by the agreement -Has a secondary effect on other types of market failure • Externalities o Ex. Passengers stranded when jet fuel contract not honored • Abuse of market power o Ex. Motorists pay more if big oil companies have an enforceable contract to collude on keeping prices high

Regulation vs. Litigation

-Regulation • Designed to deter inefficient behavior -Liability Rules • generally aimed at resolving private disputes • But... the rules have evolved to perform a regulatory function: deterrence of inefficient behavior • 'Efficiency of the Common Law' hypothesis -Society has a mix of liability rules and regulations -Why?

OMB Circular A-4

-Regulatory Analysis required by Executive Order 12866 -OMB Circular A-4 outlines best practices for conducting a regulatory analysis -Produced by government employees with the aid of prominent academic scholars in law, economics, and public health disciplines

Liability vs. Regulation 4. Magnitude of administrative costs

-Regulatory Costs: • Certainly borne by government • Enforcement (through inspections and administration of fines/legal proceedings) can be costly -Legal Costs: • Only borne if party is not deterred effectively and harm occurs • Most cases (95%) settled out of court • Enforcement is private -Net: If litigation is an effective deterrent, legal costs will be cheaper than regulatory costs

4. Other Analyses Required for Major Rules

-Regulatory Flexibility Analysis • Evaluates impacts on small business -Paperwork Reduction Analysis • Evaluates administrative (e.g. recordkeeping) costs associated with the rule -Analysis of Environmental Impact • Examines negative environmental impacts, if any, from the rule. -Federalism • Discusses whether rule preempts state action

Market Solutions to Public Goods, Remaining Problems

-Remaining Problems: • Free rider problem o Develops because the cost of determining value of public good to each beneficiary prohibitive • Not all public goods can be paired with other revenue producing activity • Many public goods can't be internalized -Public Goods Examples: • Radio Ads • Shared security guard

Market Solutions to Information Problems

-Remaining Problems: • Producer has little incentive to produce information about product defects that are unlikely to be discovered or are unlikely to be tied to the producer. • Fly-by-night companies have no incentive to invest in reputation. • When sales are likely to be once-in-a-lifetime transactions and consumers are unlikely to know persons who have bought from producer, producer cares little about reputation -Information Problems Examples: • Listeria in lettuce • The bad taste of a brand of toothpaste • Increase in cancer risk from chemicals in the plastic that many children's toys are made of • Poorly functioning stereo equipment • Florida land dealers

Remedies

-Rescission • Cancellation of the contract -Reformation • If contract terms can't be enforced because of mistake, the judge may re-write the contract to correct the mistake. • If there was no meeting of the minds due to vagueness, but some terms of the contract have already been fulfilled, the judge will interpret the vague term as a reasonable person would. • Often coupled with damages

Federalism in Action: Marijuana

-Research shows medical benefits • Potential government failure (if it is inefficient to ban) • 1996 (CA) to 2016 (OH) states act to legalize o CA first: why? o Why OH in 2016? (hint: what happened in the 27 other states that legalized medical marijuana between 1996and 2016?) • Why have 21 states not legalized medical marijuana? o Potential market failure? Ideology? -Medical marijuana still illegal under Federal law • Why not legalize? • How can people buy it if it's illegal?

Basic Attributes of Democracies: 4. Freedom of Expression

-Right to write, speak, and assemble -"I disapprove of what you say, but I will defend to the death your right to say it" - Voltaire (maybe) -Why is this so important for democracy's survival? • "When you look at history, the first thing that dictators do is shut down the press" - John McCain (2017) • A few of many many examples: Nazi Germany (1932-1945) , Venezuela (1999-present), Russia (2000-present) -What are the limits of expression?

The Fallacy of a No-Risk Society

-Risk often can not be eliminated! -The elimination of one risk often increases other risks (There are risk-risk tradeoffs) -Much risk is the result of informed individual choices risk is not typically the result of market failure! -Implications: • Risk policy should involve rational assessments of the costs and benefits of alternative approaches • Not all risks can or should be remedied!

Bilateral Costly Sanctions

-Sanctions imposed on a norm violator by another who is affected by the violation. • Imposed by 2nd party controllers • Examples? • Are costly to impose o Cost of time & effort o Guilt and shame costs from violating a norm to enforce another norm o These costs can be reduced by releasing punisher from sanctions for violating norms while punishing -When would/wouldn't you want to release a punisher from sanctions for his/her violation of norms in the course of punishment?

Multilateral Costly Sanctions

-Sanctions imposed on a norm violator by others who are not necessarily affected by the violation. • Imposed by 3rd party social controllers • Examples? • Costly to impose + many who may impose free-rider problems • But, because many may impose, the cost per person necessary to control the behavior is likely to be less than the cost of bilateral sanctions

Science as a Solution

-Scientific Research can: • Uncover problems that were previously unknown • Discover or clarify the mechanisms behind a problem • Estimate the scope/size of a problem • Find solutions to a known problem -What are some examples of how science has solved consumer problems?

Strict Liability

-Section 402A Restatement (Second) of Torts • One who sells any product in a defective condition _______________ dangerous to the user or consumer or to his property is subject to liability for physical harm thereby caused to the ultimate user or consumer, or to his property, if o (a) the seller is engaged in the business of selling such a product, and o (b) it is expected to and does reach the user or consumer without substantial change in the condition in which it is sold. • (2) The rule stated in Subsection (1) applies although o (a) the seller has exercised all possible care in the preparation and sale of his product, and o (b) the user or consumer has not bought the product from or entered into any contractual relation with the seller. -Risk-Utility Test • Plaintiff wins if magnitude of danger exceeds utility of product (is a way of defining Risk Utility Test) -Defenses • Assumption of Risk • Misuse of Product • Substantial Change of Product -What do you think of Strict Liability? Is it fair? Is it efficient?

The Big Picture: U.S. Govt.

-Serves a public that is increasingly distrustful -Democratic -Divided between thousands of governments and government organizations -Large (21% of economy) -Growing -Smaller than many governments - for now

1. The Need for the Proposed Action

-Show statutory or other authority -Demonstrate market failure or other social purpose • "Other social purpose" allows govt. to deal with problems not characterized by market failure - e.g. redistribution -Make a case for Federal regulation over alternative solutions -Economic regulation presumed invalid -Almost always market failure

Guilt vs. Shame

-Similar in many respects, but... • Guilt is feeling bad about the act. Shame is feeling bad about what the act says about the person committing the act • Guilt for an act is entirely imposed internally, shame may be imposed both internally and externally -Example • My daughter pinches her brother, I chastise her, she cries • I feel guilt b/c I violated the norm not to hurt others feelings • I don't feel shame b/c I am supporting the norm to teach your children to be good citizens (my reputation is actually enhanced by teaching my daughter to be good).

Observance of Norms

-Some norms are... • Observed by most or all persons o Driving on the right side of the road • Specific to particular subgroups o What is appropriate dress for a party • Created by markets o To what extent can you make inflated product claims? • Specific to each individual's ethical (moral) beliefs o Is it okay to engage in premarital sex?

Trends in Government

-Spending increasing (CBO) • Federal Budget FY 2000 o $1.8 trillion spending (18.2% of GDP) o $0.2 trillion surplus • Federal Budget FY 2017 o $4.1 trillion spending (21% of GDP) o $503 billion deficit • Federal Budget FY 2019 (White House proposal) o $4.4 trillion spending (?% of GDP) o $984 billion deficit Trends in Government -Government-related employment growing • State and local rising moderately over long term • Federal rising rapidly o Employment in businesses supplying federal government with goods and services up sharply o Contracting with state and local govt up Government is growing!

The Public Policy Process (at federal level)

-Stages of the Policy Process: • Pre-Policy Development • Policy Adoption • Policy Implementation • Policy Evaluation

Example: Rules to Remedy a Negative Externality

-Substantive Rule: Negative externalities are a form of antisocial behavior -- should be eliminated if feasible -Remedial Rule: Impose a tax equal to the cost of the externality/ban externality producing activity -Procedural Rules: Only tax/ban externality if data shows the externality is occurring beyond a reasonable doubt and can be done efficiently. -Controller Selecting Rules: Use the court system (civil suits)or regulatory agencies (govt suits) ... depending on which is better at acquiring information about externalities and which can most cheaply police the activity. -Constitutive Rules: Constitutional and Legislatively enacted rules of Courts. • OMB rules for Executive branch agencies. Statutory limitations on agencies.

Perceptions of Unwanted Risk

-Surveys have shown that people... • overestimate small risks & underestimate large risks, • overestimate unknown (unfamiliar) risks • overestimate dread risks SEE PICS

Choosing a Means of Enforcement

-System of Social Control chosen depends on: • Incentives of controllers • Controller's cost of acquiring information • Controller's cost of applying sanctions • Cost to society of deviant behavior

Focus on the CPSC

-The Consumer Product Safety Commission (CPSC) • Regulates the safety of 15,000 consumer products • Over 1 million firms potentially affected by CPSC regulations • Established by Congress in 1972 o Purpose: "[T]o protect the public against unreasonable risks of injury associated with consumer products"

Risk-Risk Tradeoffs

-The Elimination of one risk often increases other risks. -Direct Tradeoffs: • Within an individual • Affecting other individuals -Indirect Tradeoffs: • Scarcity of Resources (Taxes, fixed budgets etc) -Examples: • Driving vs. Flying • Seatbelt laws • Government spending on homeland security • Taxes Risk Tradeoffs ν Terrorism ν Cancer ν Heart Disease ν Plane Crashes ν Homicide ν Motor Vehicle Accidents ν Natural Disasters ν Fires ν Viral Infections ν Bacterial Infections ν Elevator Accidents ν Bicycle Accidents ν Diabetes ν Doomsday Asteroids ν Nuclear War ν Air Pollution

What is Reasonably Safe?

-The Learned Hand Formula • United States v. Carroll Towing (2nd Cir 1947) • Party is negligent if expected loss from action is greater than cost of prevention • The formula: PL > B Negligent o P = probability of harm from action o L = size of loss if harm occurs o B = Burden (cost) of preventing harm • Negligence is roughly determined by a benefit-cost analysis

Information Problems Due to Lack of Knowledge

-The Problem: Nobody knows 1. That a problem exists, 2. The source of a known problem, 3. The scope/size of a known problem, or 4. How to fix a known problem. Incomplete information Suboptimal (bad) choices/outcomes for consumers -Examples of problems: • The sources for most foodborne illnesses are unknown. • We don't know how to cure many diseases. -It is unclear whether certain foods are healthy.

The Public, The State and Government

-The Public • The people whose interests matter -The State • The accepted foundational rules by which a public is to be governed -The Government • The organizations created to administer the state

The Public: A Summary

-The Public is 'Who Matters' -Every organization in government or civil society serves a distinct public • The public for the Federal government is typically defined as U.S. residents or citizens. -Political decisions do not necessarily serve the public interest -Publics are held together by common values

How is Reputation Established? The Role of Advertising

-The Role of Advertising: • Informing public about a product • Investing in a brand o Builds image of brand in public eye o Establishes a commitment to the future

Sources of Contract Law

-The Uniform Commercial Code (UCC) • A uniform system of contract law in all states except LA o Promotes trade between the states through harmonization of law • Applies to sales of goods o Contract law regarding other types of contracts varies across the states • Given force of law in the states by state statute o Statute: law written by legislature -Other State Statutes -The Common Law • Judge-made law based on precedent

The Dream of a No-Risk Society

-The Utopian Dream • Using the right mix of regulation and legal rules we can fashion a society that is largely devoid of risk. • Question: Assuming this were possible, what would a risk-free world look like? SEE PICS

Tort Law

-The body of law dealing with injuries inflicted by one party on another party -Injuries include • Health (physical/emotional injuries, death) • Monetary losses • Destruction of Property • Reputation loss

Property Law

-The body of law that deals with injuries that occur when one party tries to take or harm another's property. -Types of property • Personal Property (clothes, cars, washing machines) • Real Property (real estate - land + fixtures) -Purpose: • Designed to protect ownership in private property. -Why is this important? • Capitalism can't work without property, it gives them an incentive to invest in their property • Gives property owners an incentive to invest in their property!

The 1960s, Unsafe at Any Speed

-The consumer movement gains strength -Nader's Raiders formed (1968) & attack inaction of regulatory agencies -Demand for government regulation grows

Marginal Cost (MC)

-The cost of consuming one more unit of good X -Typically, individuals face constant marginal costs -Total Cost from consuming n units = MC1 + MC2 + ... + MCn

Different Preferences

-The lemons example: assumes people have the same preferences -The real world: people have different preferences, tastes, & skills • The buyer of a used car may value that vehicle as a lemon more than the seller values it as a cream puff • The buyer may have skills that decrease the harm from owning a lemon (e.g. if the buyer is a mechanic). • The seller may be willing to sell at a loss to satisfy a need for $ or to be free of the hassle.

Scientific Conservatism

-The problem: • For unknown risks there is no way of determining the true magnitude of the risk. • Often, the true magnitude of the risk is eventually discovered • Policymakers do not want to be blamed for allowing a large risk to continue unchecked Scientific Conservatism -A Political Solution: • Scientific Conservatism o Use "conservative" (upper boundary) estimates of risk in policy decisions o Examples ♣ 95th percentile risk ♣ Safety Analysis (multiply by tens) -Problems with this approach: • Safe products are overregulated • Known large risks may be given a lower priority by regulatory agencies than small unknown risks Summary -It is impossible to eliminate most risks. • Risk-risk tradeoffs -People have biased risk perceptions. • Overestimate small, unknown, and dread risks • Underestimate large risks • Publicity of a risk can increase our perception of the magnitude of the risk no matter how large the risk is. -Government responses often reflect public fears not actual risk

Why are People still Anti-Vaxxers?

-The scientific method worked! -Replication Bad science debunked -But.... Many claim conspiracy directed by pharmaceutical companies. Why? • People like Jenny McCarthy more than big pharma. • People don't know how to tell good science from bad. • Media is quick to highlight new discoveries, less likely to publicize follow-on studies.

Purpose of Contract Law

-To provide assurance that agreements will be honored -Reduces and allocates the risk associated with market transactions -How might a contract reduce risk? -How might it allocate risk between 2 parties?

Democracy

-Types • Direct - Citizens vote on the issues • Representative - Citizens vote for representatives -Advantages/Disadvantages • Cost of Decision making (time) • Setting the Agenda • Trust of Self/Others • Quickness of Response

Risk Aversion and Insurance

-Types of People: Risk Averse - A preference against risk • Subjective value of risk > expected value of risk Will pay to receive expected value of risk Risk Neutral - No preference re: risk • Subjective value of risk = expected value of risk Will not pay to receive expected value of risk Risk Loving - A preference for risk • Subjective value of risk < expected value of risk Will pay to continue to experience risk Risk Aversion and Insurance -People are typically risk averse & -Businesses are typically risk neutral ⇒ People are willing to pay to eliminate risk ⇒ The value of insurance > the expected benefit from insurance ⇒ Healthy people are willing to buy insurance even if they are paying the sick person rate

How are norms created

-Typically evolve over time • Exhibit path-dependence: future norms are tied to past norms • Large changes can occur over time if change is made incrementally -Difficult for government to create • Although government can incrementally guide the evolution of norms, radical changes are unlikely • The more radical a departure from current norms the more violence (or threat of violence) is needed to change the norms. o Examples: The Civil War, Iraq, Kampuchea

Marginal Benefit (MB)

-Typically, individuals exhibit diminishing marginal benefits -Total benefits from consuming n units = MB1 + MB2 +...+ MBn

The Future: 2017-

-Unclear, but: • E.O. 13771: Presidential Executive Order on Reducing Regulation and Controlling Regulatory Costs o Requires two regulations be removed for each new regulation added o Incremental cost of regulations must decline each year for each executive branch agency • Could result in unprecedented deregulation -Is this a good thing?

"Unknown" Risk

-Unknown risk • People know a risk exists, but o (1) There is uncertainty about how large the risk really is, or o (2) There is little social experience with the manifestation of the risk -Perception: • Unknown risks are typically overestimated (perceived as being riskier than the mean scientific estimate) -Examples?

When to Use a Controller (Controller Selection Rules)

-Use a given system of social control if and only if the expected benefits from using the system exceed the expected costs of doing so (Benefits > Costs). -Make it easiest to use the system that has the highest potential net benefits.

The Scientific Method

-Use current science and/or validated theory to generate a plausible research question. -Define testable hypotheses and conduct an empirical research study to test these hypotheses. -Based on results of the study, limited claims can be made (with uncertainty clearly identified) • Study limitations should be noted • Correlation should not be equated with causation. -Replications strengthen initial results • Take into account critiques of the original study • Use different populations and/or different methods to study the problem • Replication will either strengthen or weaken initial results

Mariah Carey Example

-Was the judge right?-Yes, answers weren't consistent -What were the reasons for his/her decision?- There was no meeting of the mind -What other issue might have voided this contract if it had been investigated further at trial? -Assuming the step-father was acting in good faith, what was the market failure here?-Assymetric Information -How might this ruling affect the potential for similar market failure in the future.

Distributional Effects: Consumers

-What are distributional effects for consumers when: • A regulation on egg production practices increases the cost of eggs, while reducing the chance that you will be made ill from Salmonella in runny eggs. • Deregulation of airlines leads to a decline in prices (the CAB used to fix prices above the market rate creating a government protected oligopoly) • Regulation requiring that construction worksites have fences surrounding them increases construction costs • Clean water regulation increases costs for industries and farmers.

The Terrorist Threat

-What do you think are the chances (probability) that you or a family member will be injured or killed in a terrorist attack over the next ten years 4.2%. SEE PICS

General Issues in BCA & CEA

-What harms count • Remember, there must be a market failure • Harms resulting from informed choice don't count • 79% of you said drunk driving more serious social problem than smoking even though: o 10,076 Drunk Driving vs. o 480,000 Tobacco-Related deaths in 2013. • Time preference o Take into account that public places a value on the timing of benefits/costs -No market failure if someone has full information of risk, but still chooses to take place in decision involving risk (drunk driving) -Drunk driving hurts more people than smoking, which is why it is more serious social issue -things that will happen in the future, people discount them (not as important ) Example: Time Preference -Realization of the fact that all persons prefer benefits today over benefits tomorrow. • Example: A 5% rate of time preference implies that the present value of $1 promised for a year from today is worth $0.95 today -Similarly, it has been shown that (all other things being equal) people prefer to be healthy today over being healthy in the future. -Implication: The timing of future benefits from risk reduction matters. • Conversely, people prefer future costs to present costs

Question

-You are at a bar feeling a little tipsy (you've had 3 to 4 beers). You offer to sell me your dog for $100. I accept your offer. -Do we have a binding contract? • Yes you would have a contract, tipsy isn't black out drunk but also no it's not an official contract with witnesses

Elements of Regulatory Analysis

1. A statement of the need for the proposed action 2. Examination of alternative approaches 3. Evaluation of benefits and costs of the proposed action 4. Other required analyses

Liability vs. Regulation: What affects relative ability of controller (regulator or private parties through the courts) to maximize social welfare?

1. Difference in knowledge about risky activities 2. Ability to pay for harm 3. Chance that parties will not be sued 4. Magnitude of administrative costs

Example: Mattress Flammability

1. Identify the problem(s) • Do the facts presented suggest market failure? • If so, what type(s) of market failure? • Is the "public" affected by the market failure? Example: Mattress Flammability -More Facts: • Mattress flammability requirements were last addressed in 1973 • Number of mattress/bedding fires o 1980: 61,000 fires, 940 deaths o 1990: 31,000 fires, 620 deaths o 2000: 17,000 fires, 390 deaths o 2009: 9,000 fires, 330 deaths -How might this information alter your perception of the degree of market failure present? Example: Mattress Flammability -Facts: • The mattress industry is characterized by a few large operators and a large number of smaller enterprises. o There are a total of 639 establishments that produce mattresses in the U.S. o The top four U.S. mattress manufacturers produce 60% of mattresses made in the US. o Smaller manufacturers specialize in remanufacturing older mattresses -What problem(s) should a regulator look out for? How could government failure create a new problem?

Example: Mattress Flammability

2. Identify relevant institutions and organizations -Who are the players? • Manufacturers • Consumers • Industry Groups (The International Sleep Products Association - only represents manufacturers of new mattresses - not remanufactured mattresses) • Consumer Groups (Consumer Reports) • Legal System (Tort Law, Contract Law) • Regulatory System (CPSC - Regulation, Guidelines, Information) Example: Mattress Flammability 3. Examine the abilities/efficacy of alternative controllers • Could nongovernmental controllers fix this problem (1st, 2nd, Social, Organizations)? • Could litigation adequately solve this problem? Why or why not? • Does CPSC have statutory authority to examine this problem? What is It? Example: Mattress Flammability 4. Compare alternatives and implement the best solution(s) • Market solutions? • 3rd party social/organizational solutions? • Government solutions:

Public Good

A good that is not excludable and is non-rival. • Non-excludable: Once I have produced X I can't keep you from enjoying the benefits of X. • Non-Rival: My use of the good does not keep you from using the good. A good that, if supplied to one person or group of persons, is available to others at no extra cost. (e.g. Police, National Defense, Levees) The Problem with Public Goods -Because public goods are non-excludable and non-rivalrous... • Incentive to be a free-rider. • The producer of a public good will not be compensated for the full value of the good/service provided • Underprovision of the public good in markets

Abuse of Market Power (e.g. Monopoly)

A seller or buyer with market power may be able to set prices above or below the efficient price. If this occurs, the good being sold will be sold in inefficient quantities. -Types: Monopoly, Oligopoly, Monopsony

Bounded Rationality

A situation where people make choices inconsistent with their preferences because of cognitive limitations (inability to calculate values of outcomes, probabilities, etc) or lack of information. Making decisions under time pressure makes these types of mistakes more common.

Externalities

Costs or Benefits from a transaction/activity that affect persons not involved in the transaction/activity. (e.g. air pollution, loud talking in the library during exams). Externalities are costs or benefits from economic activity that are not fully reflected in the price attached to the economic activity. -Layperson's Definition: Harm or benefit from economic activity that affects persons not involved in the economic transaction -There are both negative and positive externalities. -Examples? • Someone getting cancer from someone else smoking cigarettes = Negative Externality • Recycling = Positive Externality

What is a consumer problem under the economic approach?

Economics by itself does not define a 'consumer problem'. While economics is descriptive, the concept of consumer problems is implicitly normative (prescriptive). Nevertheless, if pressed, most economists would probably define a 'consumer problem' to exist when market failure exists. Market failure occurs when private markets do not provide the socially efficient quantity of a good.

Negligence

Elements -Duty - A has duty to B • (determined by norms, precedent, regulation, and statute) -Breach - A breached the duty to B • Did A exercise due care • Reasonableness is the key • Proximate Cause-A's breach caused B's injury • B's injury was a foreseeable consequence of A's action -Injury - An injury actually occurred

Risk and Decision Making

Every outcome affecting an individual is a combination of decisions and 'nature'. -Decisions: • Conscious choices made by individuals -Nature: • Factors that affect outcomes but are outside of the person's control and are not fully known by the person (the risk of the decision) -Outcomes: • The net values of choices given different manifestations of ris -Example: Assume I have the choice of buying basketball tickets but I don't know who I will be sitting next to. It could be a spirited but respectful fan (a good fan) or a drunk and obnoxious fan who gets sick on me (a bad fan). • If my neighbor is a good fan, the net value I receive from going to the game is $50 • If my neighbor is a bad fan, the net value I receive from going to the game is -$100 see pics

Negligence Examples

Example 1 -A breaches his duty to handle his gun safely by firing it randomly in a city -B is hit by A's bullet and receives $1 million worth of injuries -B sues A for $1 million and wins -Deterrence: • Other gun owners know that they too may have to pay $1 million if they are negligent • Creates incentive to handle guns safely -When would firing a gun not be a breach of a duty? • When you're protecting yourself Example 2 -An employee of restaurant A has just mopped the floor. -Signs are everywhere warning patrons to be careful -A patron (B) recklessly runs in and slips on the wet floor -B sues A and loses - A had made all reasonable efforts to warn B -Deterrence: • A has successfully been deterred from unsafe behavior • A has reaped the reward of not paying B

Moral Hazard

Inefficiently risky behavior caused by the risk-taker's knowledge that she will not have to bear the entire cost of the risk. - For example, an individual may drive more recklessly if they have auto insurance or are driving a rental car. An insured driver knows that the risk of having an accident is largely covered by insurance. The person leasing a rental car knows that excessive wear and tear on the vehicle probably will not result in a breakdown during the term of the lease and that, if it does, the harm caused will be covered by the rental company. Similarly, the Craftsman unlimited warranty on hand tools encourages many to use screwdrivers in ways they were not designed to be used. -A special case of asymmetric information -Occurs when a person who is insured acts recklessly, knowing that the expected cost of her recklessness will largely be born by others (insurance) -Those that pay cannot see whether insured is being reckless -Ex: Drunk Driving The Problem with Moral Hazard -Insurance • incentive to be reckless • inefficiently high level of recklessness Solutions to Moral Hazard -Market • Don't offer warranties • Raise premiums when insurance claims made -Legal • Allow insurance contract to be voidable if reckless behavior occurs/not reported -Government • Impose rules against reckless behavior (speed limits, ban skiing, ban smoking, ban alcohol, helmet laws)

Knowledge and Control of the Risk

Knowledge -The expected value (EV) of the choice to buy a ticket is: -EV = Probgood×Valuegood + Probbad×Valuebad -EV = (60% × $50) + (40% × -$100) = $30 - $40 = -$10 I should not buy the tickets Control -Suppose the arena has security officers who look for bad fans to eject from the game. This reduces the risk of having a bad fan to 10% -The expected value of the choice to buy a ticket is now: -EV = Probgood×Valuegood + Probbad×Valuebad -EV = (90% × $50) + (10% × -$100) = $45 - $10 = $35 I should buy the tickets -The expected value of my ticket has risen by $45

Market Solutions to Externalities

Market Solutions: -"Internalize" the Externality • Person(s) affected by externality may purchase source of externality • e.g. Buy neighbor's property -Coasian Bargaining • Person(s) affected by the externality may pay producer to remedy harm

Market Solutions to Public Goods

Market Solutions: -Unanimous contract • All benefited by public good agree to pay -Priviledged Minority • A subgroup/individual finds it in its interest to provide public good -Pair with revenue producing public bad -Internalize the Public Good • Buy interest of all that can't be excluded

Incomplete Information

May present a problem when people act without the benefit of all relevant information. A person may have incomplete information because the cost of acquiring the missing information is too high. For example, a consumer of wine may not know whether she will like a particular vintage until she has tasted it. She may have to buy the bottle before she knows whether she likes it. -Def. Inefficiencies that occur when people act without the benefit of all relevant information. Incomplete information • Perception of value ≠ True value o Inefficient decisions made -Examples? Solutions to Incomplete Information Problems -Market Created Information • Repeat purchases • General Reputation (Brand value) • Buying Guides (Consumers Reports) -Legal • Litigation incentive for firm to generate info. -Government • Regulation requiring investigation (e.g. FDA approval of drugs, CPSC safety testing)

Ellickson: Systems of Social Control Systems of Social Control:

Mechanisms to enforce institutional rules

Incentives to Negligence, Defenses to Negligence

Negligence-Incentives -Incentives Created by Negligence Std. • Deters potential injurers from breaching their duties to others • Does not punish party causing the injury when that party was acting reasonably safely Defenses to Negligence -Comparative Negligence • Reduce damages to plaintiffs by portion of fault attributable to plaintiff. -Contributory Negligence • If plaintiff had any fault at all, he/she may not recover any damages -Assumption of Risk • Recovery of damages barred if (1) plaintiff knew about the risk and (2) plaintiff voluntarily took the risk. -Can be complete bar or simply reduce damages.

Adverse Selection

Occurs when there is a lack of information about the quality of a particular good. For example, if consumers of good X believe that each seller's product is equally likely to be worth between $1 and $5, the consumer may be willing to pay for what she thinks will be the average value of the good ($3). At this point, no seller will be willing to sell a good worth $3, which means that the average value of the good on the market is $2. Eventually, the consumer may figure this out and set a maximum price of $1.50, leading to withdrawal of all products worth >$1.50. The consumer and producer keep adjusting their availability and willingness to pay for the good until only low quality goods worth $1 are left on the market. Roles are reversed for insurance companies. For example, because individuals have more information about their overall health status than do the insurance companies, persons with many health problems are more likely to gravitate towards plans with low deductibles and easy access to specialists, while healthy people choose less expensive plans with less coverage. The result is that healthy persons cannot get the higher quality care without paying a rate based on the illnesses of sick people.

What can be done about market failure?

One solution for market failure is government action. The government may regulate industries, give citizens a private right to sue, or simply take over the industry as a government owned monopolist. However, government does not always do a good job in these roles. Often government will fail more miserably than the private sector ever could. The proof of this is found in the fact that the United States, historically the most free market country in the world, today is one of the wealthiest and healthiest countries in the world. Thus, while government action has the potential to improve our lives, one must be as wary of government failure (perhaps more so) as we are of market failure.

Examples

Questions for class -Identify the controllers at work in the following statements 1.) I may get a ticket if I speed-Third Party, Government 2.) I'll feel bad if I don't leave a tip- First Party 3.) Other movie goers say "shh" if I talk during a movie-Third Party 4.) A stranger chastises me if I act rudely towards my wife- Social Forces 5.) My neighbor tells me if I leave grass clippings in my yard- Second Party 6.) My community association will fine me if I paint my front door bright pink-Organization 7.) I am sued for selling defective goods-Government

Examples: Rationality vs. Bounded Rationality

Rational: Eating unhealthy food (as long as you know it is unhealthy and your preference for the taste of the food exceeds your preference for health) Bounded Rationality: Eating unhealthy food that you believe is healthy. Rational: Seeing an item on a shelf and immediately buying it (if you would have bought it after careful reflection) Bounded Rationality: Seeing an item on a shelf and immediately buying it (if it was an impulse purchase that you wouldn't have made if you had taken the time to think about It). Rational: Playing roulette. Betting on black, but losing when it turns out to be red (as long as you knew the odds before playing) Bounded Rationality: Playing slot machines thinking that you are going to break even on average (when the payout is really only 80%) Rational: Smoking (if you accurately estimate that the benefits to you today exceed the expected health costs tomorrow) Bounded Rationality: Smoking (If you do not adequately account for future health costs) Rational: Eating dessert at dinner when you are on a diet (as long as you have accurately taken into account how that dessert adds to your daily calorie total) Bounded Rationality: Eating dessert when you are on a diet (if you forget that you ate dessert at lunch too!) Rational: Buying a shirt that you like knowing that your parents won't like it (Rational if your benefits from liking it exceeds the cost of disapproval from your parents). Bounded Rationality: Buying a shirt you think is one shade of green that you like, but turns out to be a shade of green you don't like in better lighting.

Rationality

Rationality is defined by compliance with one's own preferences. Making fact-based decisions based on cognitive reasoning that are consistent with ones preferences.

Market Solutions to Externalities

Remaining Problems: • Externalities with widespread effects • Transactions costs Externality Examples: • Accidents due to poorly made tires • Counterfeit purses

Market Solutions to Information Problems

Remember: -Incomplete information problems deal with the situation where one or both parties to a transaction don't have relevant info. -Asymmetric information problems deal with the situation where one party to the transaction does not have relevant info. (often, but not always, the consumer). -Solutions: • Producer/Seller invests in production of info. o Product testing, expert appraisals • Producer/Seller invests in giving consumers info. o Advertising, signaling, third party certification • Producer/Seller gives assurance of product quality o Warranties, Guarantee of satisfaction • Consumer invests in production of information o Online research (buying guides/ratings, C2C marketing), ask friends, experiential, outside appraisal... -Why would a producer want to know about problems with its products? • Reputation, reputation, reputation! • The sale of poor quality/unsafe products is likely to lead to a general decline in consumers' perceived value of the goods • This decline in reputation typically leads to a decline in future revenues and sales

Can Government Act More Rationally?

Scientists/risk assessors often have a better idea about true risk levels than the public. • Can try to help inform the public • Can refuse to overregulate safe products. but .... -Government workers are often subject to political pressures. Government can either counter or exacerbate public fears.

Monopoly

The Problem with Monopoly -Monopoly: A single seller of a good • Single Firm can set market price/quantity o Profit maximizing price for monopoly is above efficient price • Market price will be inefficiently high and too few items will be sold • Examples? o Power Grid Solutions to Monopoly -Market • Profits incentive for innovation development of substitutes • Fear of new entrants into industry -Legal • Create a private cause of action for restraint of trade (e.g. Sun Microsystems suits against Microsoft) -Government • Rate regulation (utilities) • Fines for unfair competition

Monopsony

The Problem with Monopsony -Monopsony: A single buyer of a good (e.g. employer in a company town that is the only buyer of labor) • Buyer can set market price • Price inefficiently low Solutions to Monopsony -Market • Sellers can refuse to sell in that market (e.g. laborers leaving company towns) -Organizational • Sellers can band together and form a union. -Government • Rate regulation (minimum wage) • Increase mobility of sellers' resources (e.g. provide relocation expenses)

Oligopoly

The Problem with Oligopoly -Oligopoly: A few firms dominate a market -If these firms collude and form a cartel, they can act as a monopolist • Inefficiently high prices & too little sold -Examples?- Opec Solutions to Oligopoly -Same as monopoly + -Market • Incentive to cheat & secretly underprice/overproduce (OPEC in 1980s) -Government • Make explicit collusion illegal • Make it easier for firms to cheat

The State vs. Civil Society

The State • Composed of governmental organizations to enforce the rules of society Civil Society • Composed of private voluntary associations and organizations designed to promote the interests of members of the organizations

What the economic approach is not.

The economic approach does not rest solely on calculations of wealth. Wealth is merely a means to an end - human happiness (utility). The economic approach recognizes that factors other than wealth affect happiness (utility). On the other hand, because an increase in wealth does often lead to improved well-being, those who use the economic approach recognize the importance of preserving incentives for wealth enhancement and economic growth.

Asymmetric Information

Unequal knowledge of relevant information by persons involved in a market transaction. • Can be seen as a subcategory of incomplete information -Special Cases: • Adverse Selection • Moral Hazard Asymmetric Information- The Problem -Seller has quality information that the Buyer does not • Seller can pass off low quality goods as high quality goods • Buyer may not get bargained for value -Buyer has information that seller does not - Less of a problem, seller has more incentive to generate relevant information. Asymmetric Information- Solutions -Market • Individual market research • Media investigations • Reputation -Legal • Make fraud a crime • Allow individuals to sue under contract law -Government • Require disclosure • Regulate product labeling • Regulate product quality

An Example of Bad Science and Bad Outcome: Autism and the Anti-Vaxxers

Wakefield et. al. (1998) https://www.youtube.com/watch?time_continue=445&v=o65l1YAVaYc -Theory: Ethylmercury can cause neurological problems so it might be a cause of autism. -Research question: Are children who take the MMR vaccine more likely to get Autism? -Testable Hypothesis: Getting vaccines lead to autism -Empirical Study: not randomized, small sample, no real stats, ultimately shown to be faked. A classic example of junk science! -Media: reports as a fact and the anti-vaxxer movement is born - Jenny McCarthy popularizes it. -Results? • Fewer are getting vaccinations • Once rare diseases are making a comeback • No effect on autism

Example: Mattress Flammability

http://www.nfpa.org/news-and-research/fire-statistics-and-reports/fire-statistics/fire-causes/household-products/mattresses-and-bedding Facts: In 2009 there were 9,000 fires involving mattresses and/or bedding materials • 330 deaths from these fires • 1,340 injuries from these fires • $382 million in property damage from these fires • Smoking materials were ultimately responsible for 20% of these fires and 51% of deaths • Many dead and injured are not mattress owners

Value of Replication when Uncertainty Exists

see pic

Checks and Balances

see slides

Intentional Torts: Fraud (can be pursued under contract or tort law)

• A material fact was misrepresented • Misrepresentation was intentional • Injured party justifiably relied on the misrepresentation • Injury Resulted -Why is selling a fake Rolex fraud? • Defamation (libel or slander) o A false statement o That harms the victim's reputation o And is made available to others o Actual harm (typical) -Why is defamation important as a means of battling market failure?

How Public Law Protects the Public: Punishment/Retribution

• A way of satisfying the anger of those harmed • Some suggest that "punishment" is not an appropriate goal of the state • But, it reduces the incentive for vigilante action -Examples: • Anger after 9/11 • Families of murder victims (Hatfields and McCoys) • Anger towards irresponsible bank executives?

Public Law: Characteristics

• Action by the state against individuals or organizations May involve a private dispute, but is focused on protecting the public as a whole

Procedural Rules

• Address how controllers obtain, weigh and make judgment on information. • What is the required process for determining whether an individual has violated a rule?

Public Choice Theory

• Applies economic reasoning to government decision making • Policymakers are self-interested • Policymakers are imperfectly accountable to the public Decisions are based on a combination of personal interests and public interests -Examples: • Politicians? • Government managers? • Government employees (civil service)?

Remedial Rules

• Delineate the nature and magnitude of sanctions for violations of substantive rules • What is the appropriate punishment/reward for the identified violation?

Producer Oriented Nonprofits: Industry trade groups

• Designed to o combat negative reputation externalities from rogue industry participants o promote industry policy interests • Achieve their goals through o certification of members o education of members o lobbying for or against regulation

Producer Oriented Nonprofits: Independent testing labs and rating agencies

• Designed to give producers a means of conveying quality information to the public • Similar to for-profit labs/rating agencies, but without the profit motive. o How might this affect incentives? • There are fewer non-profit organizations doing this work than for-profits. Why might this be?

Constitutive Rules

• Determine the internal structure of controllers • What are the rules governing the scope and limits of controller authority?

Substantive Rules

• Distinguish normal, prosocial & antisocial behavior (for Primary Conduct) • Behavioral Triggers o Normal Behavior no sanctions (the vast majority of actions) o Anti-social Behavior punishment (the stick) o Pro-social Behavior reward (the carrot)

In Economics: Market Failure

• Exists when markets do not provide the efficient quantity of a good

How Public Law Protects the Public: The Deterrent Effect (cont.)

• General Deterrence o Deterrence that the law creates for society as a whole • Specific Deterrence o Future deterrence that conviction of a crime/civil ordinance creates for the person convicted o Person reevaluates chances of getting caught, disutility from punishment

Controller Selecting Rules

• Govern which controller(s) are used to address a violation of a substantive rule. • Are social sanctions enough or do we need a law?

Consumer Oriented Nonprofits: Issue-Related Groups:

• Groups designed to focus on a specific issue affecting consumers. • Provide information (media, web, outreach) • Lobby lawmakers • May directly provide public goods • May help organize: o Protests to sway lawmakers/public opinion o Boycotts to sanction firms seen as harming consumers

Consumer Oriented Nonprofits: General Consumer Protection Groups

• Groups designed to protect consumers on a wide array of issues. • Can engage in : o information provision o lobbying • How might these orgs. more general foci affect the approaches they use?

Liability vs. Regulation: 1. Difference in knowledge about risky activities

• If private parties have better info, legal system is better • If regulators have better info, reg. is better • Obvious risks: Private parties know best • Hidden risks: Regulators may know best -Examples: • Leaving a rusty old car on your property • Producing a toy with lead paint

Producer Oriented Nonprofits -Types:

• Industry trade groups • Independent testing labs and rating agencies

Consumer Oriented Nonprofits: Types

• Issue-Related Groups • General Consumer Protection Groups

Civic Duties and Obligations (what allows the democracy to work)

• Obey Laws • Pay Taxes • Military Service (voluntary) • Serve on Jury if Called • Participate in Political Process (No requirement) - 36% of voting age population voted in 2014 - 60% of voting age population voted in 2016 -Why is it important to have civic virtue?

-Litigation vs. Regulation

• Private vs government knowledge/information? • Ability to pay? • Chance of being sued? • Administrative costs? SEE PICS

How Public Law Protects the Public: Rehabilitation

• Social welfare that is achieved by rehabilitating dangerous persons/organizations • Many are skeptical about the ability to rehabilitate -Examples: • Traffic School • Prison counseling programs

How Public Law Protects the Public: The Incapacitation Effect

• Social welfare that is achieved by taking a dangerous individual/organization out of society -Examples: Enforcement of • Speed limits • Restaurant codes • Rape • Murder

Liability vs. Regulation 2. Private parties' ability to pay for harm

• The Judgment Proof Problem: Party is unlikely to be able to pay for the full cost of harm created less incentive to avoid creation of the harm • Moral Hazard: Insurer can't monitor the behavior of party with liability insurance diminished incentive to act safely • Agency Problems: Employees have less of an incentive to act safely than company. Liability vs. Regulation 2. Private parties' ability to pay for harm -Regulation has an advantage where judgment proof problems, agency problems, or moral hazard is likely to occur -Examples: Exxon Valdez, Post Valdez

Guilt

• The bad feeling a violator of a norm experiences o Is essentially a 'cost' for violation of a norm • Not based on sanctions imposed by others o Purely internal o One sanction imposed by a 1st party controller • Based on socialization (education, upbringing) o There must an investment in the creation of guilt potential -Is guilt rational? • Individually - does it make sense to be a sociopath? • Socially - what if we all were sociopaths? -Guilt potential is created by instilling the importance of morals/ethical values

Shame

• The feeling of lowered esteem the violator of a norm experiences o Is essentially a 'cost' for violation of a norm o Costs: embarrassment, loss of reputation • Based on potential or actual sanctions imposed by others o Internally and Externally imposed o Imposed by 1st, 2nd and 3rd party controllers o Is an informational sanction leading to loss of reputation • Based on socialization (education, upbringing) o There must an investment in the creation of shame potential -In what cases is shame a 1st party sanction?

How Public Law Protects the Public: The Deterrent Effect

• The incentives created by the potential for jail time, fines or other sanctions that one may face if caught breaking rule • Deterrence is increased if: o Sanctions are higher o Enforcement is better o Rules are clear -Examples: Enforcement of ... • Speed limits • Health codes for restaurants • Criminal sanctions for deceptive sales tactics (fraud)