Law Econmidterm 2023

Midterm Examination (Law & Economics, 2023)
1. (18%) An accident costs the victim (V ) 100,000. Litigation cost for victim is 10,000 and
for injurer (I) is 10,000. Also, if litigated, V expects to receive 100, 000p−10, 000,
while I expects to lose 100, 000p + 10, 000. Suppose that I is of two types:
negligent (N ) or careful (C). The former is expected to prevail with probability
0.2, and the latter 0.8. Only I knows his own type and V believes that I is
equally likely to be either.
Suppose I makes a take-it-or-leave-it offer.
(a) What would V expect to receive in litigation?
(b) Is there any separating equilibrium? If so, how much will the N -type injurer
offer? How much will the C-type injurer offer? What is the minimum
amount V will accept?
(c) Will I offering 40,000 be a possible pooling equilibrium? Why or why not?
2. (18%) Amy offers opera tickets for sale at the price $1,000. Ben orders two tickets and
promises to pay when he picks up the tickets on the day of the performance. In
reliance on Ben’s promise, Amy purchases two tickets at the wholesale price $600.
If Ben had not ordered the tickets, could have contracted to sell them to Carl
at the price $800. Close to the date of the performance, Ben announces that he
will not pick up or pay the tickets. In the meantime, the show has flopped and
the price of the tickets has fallen; so, Amy resells the tickets at the lower price
of $500 to another consumer. Under the following remedy rules, what should be
the remedy for the breach of the contract? Please briefly explain your answer.
(a) Expectation damages.
(b) Reliance damages.
(c) Opportunity cost damages.
3. (30%) An accident occurs with probability p. If the accident occurs, it causes harm with
monetary value denoted by A = 2. Resources can be spent to lower the prob-
ability and let xv and xi denote the investment level in precaution by potential
victim and injurer, respectively. Suppose that

1√ 3√
p(xv , xi ) = 1 − xv − xi , xv , xi ∈ [0, 1],
4 4
and the √
price of precaution efforts (such as xv and xi ) is normalized as 1.
∂ x
(Hint: ∂x = 12 √1x ).)
(a) What is the social optimal level of xv ? What is the social optimal level of
xi ?
(b) Let x∗v denote the social optimal level of xv and let x∗i denote the social
optimal level of xi . For simplicity, we only allow the victim and the injurer
to choose between 2 levels in precaution: 0 and the social optimal level.
Calculate the expected value of harm when
1
i. (xv , xi ) = (0, 0);
ii. (xv , xi ) = (x∗v , 0);
iii. (xv , xi ) = (0, x∗i );
iv. (xv , xi ) = (x∗v , x∗i ).
(c) Under no-liability rule (the injurer does not need to compensate and the
victim endures all loss), what is the (Nash) equilibrium? (Hint: write down
the payoff matrix first.)
(d) Under the rule of simple negligence (in our case the injurer is liable as
xi = 0; otherwise not liable), what is the (Nash) equilibrium?
(e) Under the rule of negligence with a defense of contributory negli-
gence, is (x∗v , x∗i ) a Nash equilibrium?
4. (16%) A coal-fired power plant makes a profit of 10 million, but it causes air pollution;
a laundry factory makes a profit of 3 million without air pollution, but can only
make a profit of 1 million if air pollution exists. The power plant can spend 5
million to install and maintain a dust-removal facility, while the laundry factory
can spend 1 million to install and maintain a dust-free room. If either the power
plant or the laundry factory installs pollution control equipment, the laundry
factory can avoid pollution. Suppose the power plant and the laundry factory
have a dispute in court over air pollution, and the court has the following three
judgments.
J1 : The power plant can pollute at will.

J2 : The power plant must compensate the laundry factory for its losses.
J3 : The laundry factory can obtain an injunction to prohibit the power plant
from polluting.
Answer the following questions:
(a) Describe the final result in the above judgments (J1, 2 and 3) when the power
plant and laundry factory CANNOT cooperate together. (For example, who
will pay for the cost of installing pollution control equipment? How much
can the power plant and the laundry factory totaly earn, respectively?)
(b) Describe the final result in the above judgments (J1, 2 and 3) when the
power plant and laundry factory CAN cooperate together.
2
5. (18%) Consider a big lake near a village. The relation between the number of fishermen
and the money made per person is shown in the following table. Suppose the
cost of fishing is $25 for each fisherman.
Number of Average Total Marginal

Fishermen Revenue Revenue Revenue
1 $100 $100 $100
2 90 180 80
3 80 240 60
4 70 280 40
5 60 300 20
6 50 300 0
7 40 280 -20
8 30 240 -40
9 20 180 -60
Answer the following questions:
(a) Suppose that no one has the right to exclude others from catching fish in
the lake. In this case, how many fishermen will be fishing in the lake?
(b) Suppose that someone owns the right to exclude others from catching fish
in the lake, and thus fishermen need to buy fishing permit from the owner.
In this case, how many fishermen will be fishing in the lake?
(c) Suppose that there are two individuals, A and B, own the right to exclude
others from catching fish in the lake. Both A and B sell fishing permits, and
one needs to buy two permits, one from A and the other from B, in order
to catch fish in the lake. In this case, how many fishermen will be fishing in
the lake?

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Midterm Examination (Law & Economics, 2023)

J1 : The power plant can pollute at will.

Answer the following questions:

Number of Average Total Marginal

Answer the following questions:

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