Economics 4550/5550 Homework #5 Dr. Michael Nieswiadomy

Economics 4550/5550 Homework #5 Dr. Michael Nieswiadomy Law and Economics Chapter 10 Due: Dec. 9, 2010

Answers must be typed.

1. (15 points) Working from the last possible event to the first possible event is called solving a problem “recursively.” The tree in Figure 10.4b is identical to Figure 10.4a, except that a trial costs the plaintiff $40 instead of $20 (notice that there is a typo in the figure here), and settlement is for $51 instead of $50. Solve recursively for the expected values of the legal claim by filling in the blanks at each stage in the tree. What is the plaintiff’s expected net profit from filing a legal complaint? Show your work.

2. (15 points) In Europe, the party who loses at trial pays the litigation cost of the winner. Assume that the plaintiff in the preceding figure pays litigation costs of $40 if she loses at trial, and the plaintiff pays litigation costs of $0 if she wins. Re-compute the expected values of the legal claim under this assumption. Show your work.

3. (15 points) From an economic viewpoint, restrictions on advertising by lawyers look like a device used by the bar to limit competition. From and economic standpoint, is advertising by lawyers any different from advertising by other professionals, such as accountants or insurers? Explain.

4. (15 points) Assume that false optimism causes trials and predict whether compulsory mediation in divorce cases would cause more disputes to be settled without trial. Explain.

5. (15 points) Assume that litigation will cost the plaintiff $100 and the defendant $100. Assume that settling out of court is free (SC=$0). What is the largest value of relative optimism (EJ) at which the parties can still settle out of court? Explain.

6. (15 points) Assume that the plaintiff demanded $1,000 to settle, the defendant rejects the offer, and jury awards $900 at trial. Who “won” for purpose of the rule of “loser pays all”? Explain.

7. (10 points) Will there be more nuisance suits under the rule of “each pays his own” or “loser pays all”? Explain.