Coase Colored Glasses

Archive for January, 2011

Lower-Cost Avoider Straight Down the Pooper!

Yet again I embark on another chapter of Fredman’s tangled web of economical perception on law; but this time find myself less lost and more enlightened on this chapter’s subject. I for one was hit a little close to home, literally, on this subject. Not so much with fire insurance but a decision I made on renters insurance. I have always known that it was an option I could take, but have never thought of it as something in my best interest to get, I never thought about it at all. I guess you could say I was taking the road of the “lowest-cost avoider” by thinking nothing would happen. Until one lazy night I was sitting in my front room watching my brand new flat screen TV to find out the hard way of international students perceptions on unclogging a toilet; they just keep flushing it. After it started to run continuously they had no idea how to shut off the flow leading to gallons and gallons of water throughout crashing through the ceiling ruining everything from most of my clothes, to my bed and numerous electronics (luckily the TV made it out alive). Since then I have weighed my options and decided that renters insurance is inexpensive compared to the outcome. But you have to wonder, considering something has happened once, does that lower my risk of something happening again? Surely a simple statistical analysis would conclude that the probability would be a lower chance, wouldn’t it? For example if the insurance company says that there is a 1 in 100 chance of something happening to begin with, that is a 1% chance. Given that I have already hit that 1% do I conclude under statistical terms that the chance for something to happen to me again is .01 multiplied by .01 leaving me a .0001 chance of something happening again? Still with how inexpensive renters insurance is and with what I now know it is not a chance I am willing to take.

Pirates the Profit Maximizers

With the pirates using the Jolly Roger as a signaling device, to actually reduce the chance that they will have to fight and incur some steep transaction costs with the simple use of flag is amazing. The concept when you think about it makes sense. What is a low cost way to achieve your goal? In this case it is a simple flag. If the pirates could eliminate the cost of battle and limit the destruction of their booty with this threat that if you don’t completely and unconditionally surrender, we will destroy you. And it is implicitly known that when you see this flag that you will suffer the consequence, you won’t engage in the action that will cost you your life, the cost to you is just too high.

It was also striking to me that pirates are not blood hungry battle scared people. But then again all I have known about pirates is what the movies have shown me. When you think about it from an economic sense, it really makes sense that they would be very against starting a fight. If you’re a rationally self interested person who is working for your interests with the rest of the crew doing the same thing, then the best way to maximize your profit it to do so with the least cost. Weather it is the loss of a crew member that you have to now pick up the slack yourself, or a hole in your boat that you have to take time and resources to fix. You aren’t going to want to partake in any of these activities that could result in extra costs, it isn’t efficient, and if it isn’t efficient then you’re not maximizing your profit.

Wait a Second.

“Can you see why?” ends Chapter 6.  “No, Mr. Friedman, I can’t,” I thought.  Friedman said that we can make sense of these examples “in terms of one simple rule for allocating risk: Put the incentive where it does the most good.” (73)  Feeling like I missed the boat, I went back and worked through the examples.

In Example One, the incentive to keep the building from burning down is with the tenant.  It does the most good there becuase the tenant is the one who has the most control over whether or not the building burns down.  Friedman referred to it earlier as the ‘lowest-cost avoider.’  So this one makes sense to me.

The concepts of moral hazard and adverse selection were interesting to read about.  But I don’t understand the next two examples.  What is the “incentive” and “where” is it in each example?  Was the incentive to not be swindled?  It seems like both the original owner and the innocent third party have that incentive–in both examples.  So I’m confused about this one.

But I think this analysis of the economics of insurance, and especially the focus on moral hazard and adverse selection, is another great insight for law and economics.  Obviously Friedman thinks so, too, hence the chapter on it in his book about law and economics.

Jolly Rodger Trademark

When I read Leeson’s chapter about the symbol of the Jolly Rodger, and how it worked for pirates and pirated alike, I couldn’t help but think of generic products versus the original stuff.  The pirates worked hard to establish the fear that came with the Jolly Rodger.  If you valued your life more than your cargo you would surrender.  When others who could not pack a punch attempted to use the Jolly Rodger as a free ride, and were overcome by those being robbed, I’m sure word spread quickly that there were fakers on the seas.  The damage done to the reputation of all pirates included the possibility that they would have to fight at every robbery, and thus make it much more expensive for them to be thieves.

This resembles a company who works hard to produce the best product (we’ll say beef jerky) available.  They begin to establish themselves as the one and only.  Their best asset for advertising is this jingle someone came up with about jerky, and the jingle is in bold letters on the package.  Well, Wal-Mart sees that they are really cashing in on the jerky biz, so they create a package that looks just like it.  People hastily buy up the familiar package, and end up eating Chinese cat jerky.  They never want to see the jerky again, and tell their jerky loving friends never to buy it.

This is why the pirates should have put a trademark on the old Jolly Rodger (not that they would have enjoyed showing up to court if they needed to defend it).  Patent, copyright, and trademark laws are useful because you can protect your good name and image.  It would ensure that no wussies sail under the Jolly Rodger, and no poser meat dryers sell cat meat in your bags.

Fire Insurance

I had significant trouble swallowing Friedman’s fire insurance example. On page 66 he says, “Suppose, however, that you have already insured the factory for its full value. Now if it burns down you lose nothing.” I find this odd because it seems to neglect the costs associated with having a factory burn down, such as the lost business/production while being rebuilt. This seems like such an obvious problem, so I’m assuming it must be accounted for, but then I have a problem with how the full value of a company can accurately be determined. For example, how can one determine how much business would be lost? It is very likely that production will vary from month to month (depending on the kind of business being operated), so how could the potential business lost be accurately predicted? Even if the potential lost value could be accounted for, there is the possibility that rebuilding takes longer than expected, or a million other little things that could happen. If the insurance company were somehow able to account for ALL potential costs, insuring a company for up to that value would seem inefficient because chances are that a fire in a factory would not burn the entire structure to the ground. Do insurance purchasers just assume that the worst-case scenario is not going to happen? Is there some allowance in an insurance policy for adding in unpredicted costs associated with a factory burning down? Even if so, I have a really hard time believing that “Now if it burns down you lose nothing.” It seems to me impossible that all lost value associated with a business burning down could be accounted for to the point that the owner was indifferent about the building burning down or remaining fully functioning. Someone please prove me wrong.

A Dollar is Not a Dollar!

Friedman makes the comment “a dollar is not a dollar is not a dollar”, and this is why to have insurance. This made a lot of sense to me after his example, if his house should burn down, than he is going to be much more out of money than if it doesn’t burn down.  He is trading has he puts it cheap dollars now so in the future, if his house was to burn down they will be much needed and more valuable to him.  So in this instance he is paying insurance while he has lots of money and the dollar doesn’t mean as much to him now, but if his house was to burn down that dollar value will be much higher.  This brings me to another statement Freidman brought up, the value of a dollar to a rich person and a poor person.  He uses the example that a rich person values a dollar much more than as a poor person does.  I have a hard time keeping up with this.  I would think it would be the other way around.  So does this mean the rich person that values his dollar more is more unlikely to have insurance or is more likely?  Since things are more likely to burn down that are insured than ones that are not insured.  If the rich person is insured does that mean he is not going to take precautions?  See to me it is going to be the rich person that is able to afford insurance and take precautions as to the poor person that can’t afford insurance and is also going to have to take precautions.  I think the dollar is valued the same among the rich and poor, the only difference is the amount of money and the ability to protect their dollar.

We need more Pirates

The funny thing with Economics is that it’s something of a ‘natural science’, I would call it.  People don’t inherently solve algebraic equations, write symphonies, or invent computers.  There is generally some sort of training/educating involved (with some exceptions of course).  But everyone is practicing economic principles and behaviors all the time.  When I see a young lady with a ring on her left finger, I know any action I take is futile.  When the light turns red, I know not to go, and when I see snow I know to put a jacket on.  These signals are learned through experience and informal education, but signals none the less.

Upon reading this chapter, I thought about signals and all the things we should have signals for but don’t, and vice versa.  Sex offenders may have to register, but is that the only thing they ought to do? (just as a side,18844)  Information is valuable, and in some cases could reduce costs, create competition, and be more economically beneficial to consumers.  I see billboards in Utah showing wait times at Hospital Emergency Rooms and I’ve never seen them in Las Vegas.  Perhaps more than that though, prices of certain surgeries by certain doctors at certain hospitals, kind of like an orbitz or priceline for medicine.  You could then shop online for surgeries! is great for reducing transaction costs, but what about a method for signaling to everyone that you are actively looking for something.  Solution:  Flagpoles in everyone’s front yards.  Different flags for different items/services.  Of course it would be optional, but think of the efficiency!  Yeah, I think we need more Pirates.


As promised in class my e-mail address is:


Pigouvian Taxes, Are they the best way?

Pigouvian Taxes, created by economists Arthur Pigou, are essentially taxes on institutions (people, companies, etc) who produce negative externalities. They are are designed to create a disincentive for the polluters, producers of the negative externality, etc.  They seem effective but Friedman (who I figured out has signed my copy of the book) seems to suggest their is another way. Using Ronald Coase’s theorem seems to be the answer. Instead of just charging a tax to the producer of an externality, where positive or negative, Coase hopes another party can buy it. The example in Laws Order of the bees and a farmer illustrated this well. My question of the day is the following: Are people really so self-interested that they don’t care how their negative externalities effect the world, everyone else? Its a mildly loaded question but I have been feeling that economics take no account for emotion, rhetoric, and values (as in personal, not what we want to buy) and simply look at how the world “should” work. Regardless, Coase’s ideas are very intriguing and are beneficial when the can be applied.

What is the purpose of Friedman’s chapter this time around?

As I noticed, its to show the complexities of decision making involving property and the rights associated with property. The spaghetti diagram demonstrates this well. He also responds to the situation of sparks flying from passing trains on to a farmer’s field and starting a fire on the wheat crop growing there. His fixes are that the farmers can grow another crop, the trains can place spark arrestors or someone just has to absorb the cost of the impending fires if neither of the previous options are taken seriously. He even discusses the public good and hold out problems and some possible solutions. But why didn’t he explain the solution at the beginning of the chapter.

“Farmers could reduce the problem by leaving the land near the railroad track bare…”

I guess it was to leave us with some room to see how this could easily fit into the equation and discuss whether or not is an efficient solution or not. Besides it would make the spaghetti diagram a bit more messy.

I believe that it would be the most efficient in all of the scenarios. How far from a train can a spark fly? I have no idea, but I’m just going to say a generous 20 feet. If the farmers just don’t plant the 20 feet next to the track then no harm done. They will be out money though. The railroads can then rent that section of land for a fraction of the price that it costs to have the farmers pay for new crops or for a totally burned field. The farmers don’t have to pay for a field and or spark arrestors.