Why should you study law and economics?

[I assign this essay for law students in my law and economics class who might be uncertain about the value of connecting economics to law. This essay fairly basic, and reflects the University of Chicago price theory tradition. I may periodically update it to answer questions students have.]

Given that societal resources are, in fact, limited, the value of studying economics is apparent. But why study the intersection of law and economics? To answer, we must first define law.

The law in “law and economics” falls in two buckets. One are foundational rules that govern others. These include (i) the formation of a government with a monopoly on violence and (ii) the basic rules this government promulgates to govern human relations and, indeed, its other laws. Modern law and economics focuses mainly on government-made law (i), rather than informal law of communities. (Bob Ellickson and Lisa Bernstein, for instance, study informal laws, but as exceptions to the field’s predominant focus on government-set rules.) And such governments are assumed to be able to constrain the behavior of humans because they have access to overwhelming force.

The basic rules (ii) correspond to the main subjects of common law legal education: property, contracts, torts, and criminal law. These basic laws govern behavior unless displaced by statute and may even constrain statutes. E.g., 5th amendment of the US Constitution says the government cannot take property, even via statute, without compensation.

The second bucket of law in “law and economics” are second-order rules that modify or supplement the basic rules. These include advanced topics like corporations, antitrust, bankruptcy, etc. For example, antitrust laws constrain contracts that restrain trade in certain ways. But one cannot prescribe or evaluate antitrust laws without having contract law operating in the background. Without contract law, even sanctioned contracts may not function as intended.

One way to see the value of studying law and economics is to ask what you miss if you only study microeconomics, which examines how resources are allocated at the household level or how a few goods are allocated across many households. (Macroeoconomics is the complement: it examines how all goods are allocated across all households at the level of a state or country’s economy.) When you study or employ microeconomics, you are typically making a number of implicit assumptions. Consider the question: how much of its income will a household spend to buy a car? Microeconomics will look at preferences and income, and then make a prediction about spending on a car. But to make that prediction, it presumed that (a) the dealer had property rights in that car, (b) that the household and dealer could write an enforceable contract to trade the car for money. When it set the price, it likely ignored the non-pecuniary cost of buying a car, e.g., (c) the tort liability from driving, or folded that liability into the net benefit of the car to the household. (d) Criminal law, which prohibits vehicular homicide, is treated the same. So law and economics applies economics to understand the bedrock upon which microeconomics is built.

Another way to appreciate the value of law economics is to ask what you would miss if you only studied law, which examines the normative justification for and the technical operation of both what I called basic and second-order rules. Prior to law and economics, American law schools taught property, contracts, tort and criminal law, but did not have a simple theory for how these are connected. Each subject largely stood, normatively, on its own. In contrast, this course will explain that, after constitutional law that gives the government a monopoly on violence, property law is fundamental. Without property rights, society will neither engage in trade to allocate resources efficiently, or undertake investments that produce more goods and services. Without contract law, there may be no reallocation via voluntary trade, even when property rights are well defined. Without tort law, many efficient contracts (to prevent accidents) would not be written due to transaction costs. And finally, criminal law is essential to fixing gaps in tort law when tortfeasors are judgment proof.

In addition to clarifying the connection between areas of common law, economics when applied to law helps predict the effect of law on outcome that lawyers care about. Will the felony murder rule reduce murder? Will the English rule affect the quantity of litigation? Will increasing property exemptions reduce medical bankruptcies? The economic answers to each of these questions typically do not match the intuition of non-economists. Yet the economic answers have empirical support, if not on those specific questions, on questions that are analogically quite similar. That should comfort lawyers, who are accustomed to analogical reasoning.