Showing papers in "The Journal of Law and Economics in 1979"

Transaction-Cost Economics: The Governance of Contractual Relations

Abstract: THE new institutional economics is preoccupied with the origins, incidence, and ramifications of transaction costs. Indeed, if transaction costs are negligible, the organization of economic activity is irrelevant, since any advantages one mode of organization appears to hold over another will simply be eliminated by costless contracting. But despite the growing realization that transaction costs are central to the study of economics,' skeptics remain. Stanley Fischer's complaint is typical: "Transaction costs have a well-deserved bad name as a theoretical device ... [partly] because there is a suspicion that almost anything can be rationalized by invoking suitably specified transaction costs."2 Put differently, there are too many degrees of freedom; the concept wants for definition.

The Problem of Externality

Abstract: ON the modern research agenda externalities occupy a rather prominent position. The increasing complexity of modern technology and society seems to create yet additional unwanted side effects that require classification on a lengthening list of externalities. However, externalities are of interest not only as current policy issues but also from a more theoretical point of view. Using Pigou's terminology, we say that when an externality is present there is a divergence between private and social cost. We interpret this to mean that when all voluntary contractual arrangements have been entered into by market transactors, there still remain some interactions that ought to be internalized but which the market forces left to themselves cannot cope with. This is the basis, for example, for the assertion of Buchanan and Stubblebine that "externality has been, and is, central to the neoclassical critique of market organization."' Without interference in the price mechanism, some transactions that would be beneficial are not carried out. Two conclusions follow: first, that since market forces by themselves are unable to eliminate the remaining inefficiencies, some government action is automatically necessitated; second, a conceptually feasible alternative to government action is that, through a suitable establishment of appropriate markets, economic agents can be made to take into account the side effects they generate.2 One may then inquire why market transactors are unable to make the emittor of an externality internalize the costs of his actions. The only reason why wealth-maximizing economic agents do not undertake these transactions must be that the cost of carrying out the actual transaction is greater

Self-Interest, Ideology, and Logrolling in Congressional Voting

Abstract: LAWS may be passed because of self-interest or because of ideology. All national laws are ultimately passed by Congress; therefore, an analysis of the factors which determine the way in which congressmen vote can be used to determine the extent to which each of these factors is involved in passage of legislation. Because of the development of statistical tools such as logit analysis, which enable the analyst to handle situations in which the dependent variable is dichotomous, determinants of voting have recently been examined using roll-call voting data. The basic technique in this work has been to define the vote by a congressman on a bill as the dichotomous dependent variable and to use economic factors associated with the district as independent variables. But if this research is to proceed, it is necessary to separate out the factors-self-interest, logrolling, and ideology-which actually determine voting. This separation is the purpose of this paper. Kau and Rubin' and Silberman and Durden2 have analyzed voting on minimum wages; Danielsen and Rubin3 have examined voting on energy issues; Davis and Jackson4 have examined voting on income redistribution; and Kau and Rubins have examined the effect of public-interest lobbies such as Common Cause on the legislative process. Thus, statistical analysis of roll-call voting has been, and is likely to continue to be, a useful tool. This work in economics has differed somewhat from related work by political

A Decentralized Method for Utility Regulation

Abstract: A new institutional arrangement for regulating utilities is suggested that minimizes the costs of natural monopolies. A mixture of regulation and franchising, the plan draws on the advantages of each and eliminates many of the problems. The proposal allows utilities to set their own price on the basis of demand and marginal-cost projections. Subsidies are provided by the regulatory agency if there is a consumer surplus. The system encourages the utility to select a competitive price and to produce only the amount of service needed. Operating efficiency is encouraged by rewarding cost reductions and discouraging cost overstatement at the rate review. The regulatory agency would not need to take action to bring price and marginal costs into equality. The franchise sale can be made by competitive bidding, in which the bidders would capitalize part or all of the subsidy or the regulatory agency could recover the subsidy in a lump-sum tax on the utility.

A Theory of Nonmarket Failure: Framework for Implementation Analysis

Abstract: THE principal rationale for public policy intervention lies in the inadequacies of market outcomes. Yet this rationale is really only a necessary, not a sufficient, condition for policy formulation.1 Policy formulation properly requires that the realized inadequacies of market outcomes be compared with the potential inadequacies of nonmarket efforts to ameliorate them. The "anatomy" of market failure provides only limited help in prescribing therapies for government success.2 That markets may fail to produce either economically optimal or socially desirable outcomes has been elaborated in a well-known and voluminous

The Development of Individual Rights to Property in Tribal Africa

Abstract: S EVERAL economists have questioned the usefulness of conventional economic theory in the analysis of resource allocation in African subsistence economies. Those who adopt this position claim that resources in the indigenous or subsistence sectors are not allocated efficiently because the subsistence farmer does not use economic criteria when making decisions. Dalton states, "It is not that he is indifferent to material abundance or efficiency; rather unlike the West, the . . . [tribal] economy neither compels producers to seek out minimization, nor provides them with economic directives (factor and output prices) to make economizing decisions in work arrangement."' Sadie went much further than Dalton, arguing that the basic cause of the lack of economic progress is the nonmaterialistic, noncapitalistic nature of African culture and institutions.2 A number of empirical studies, however, conclude that the tribal African responds in an economically rational manner to economic stimuli.3 Dean has even applied Becker's market discrimination model4 to the exchange and trading patterns that developed between persons of different tribes in West Africa5 and Beals, Levy, and Moses applied a Sjaastad-type model6 to migration patterns in Ghana.7

The Effects of Price Regulation in the Automobile Insurance Industry

Abstract: IN recent years there has been a growing suspicion that the process of regulation in many industries has not resulted in superior market performance. Instead, it has been argued that regulation either has had no effect on the markets in which it operates, or that it has caused society to incur substantial social costs.2 Perhaps more disturbing to some policy planners, a body of literature has arisen that treats regulation as little more than a means for producers to improve their own well-being at the expense of consumers and society as a whole. This view is inherent in a number of studies of regulation,3 but has been recently elevated to a general theory by Stigler.4 The Stiglerian hypothesis holds, simply, that "as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit."s To the extent that it is valid, this theory has widespread significance for antitrust policy. If regulation is viewed in its traditional role as a governmental corrective device that improves market performance in instances in which competition "fails," as perhaps in the case of natural monopoly, then antitrust and regulation policies are complementary: both work toward aligning

Occupational Licensing and the Interstate Mobility of Professionals

Abstract: This paper attempts to measure the effect of occupational licensing, restrictions on reciprocity, location specific investment in reputation and earnings on the interstate mobility of professionals. While 34 professional occupations are analyzed, special attention is focused on the legal profession. The comparatively low interstate mobility rate of lawyers may be due to state licensing and restrictions on reciprocity or to the investments made by lawyers to develop local reputations or to the investments made by lawyers in state specific law. Tests are conducted to distinguish among these three hypotheses.

The origin of compulsory drug prescriptions.

Abstract: BEFORE 1938, the only drugs for which prescriptions were needed were certain narcotics specified in the Harrison Anti-Narcotics Act of 1914.1 Any other drug could be obtained by walking into a pharmacy and buying it. If a person wished to see a doctor and get a prescription, he could. But any nonnarcotic drug he could buy with a prescription could also be bought without one, and any prescription could be used as many different times and for as many different people as desired. This state of affairs ended in 1938 when two different categories of nonnarcotic drugs-prescription and over-the-counter-were created. Although the Federal Food, Drug, and Cosmetic Act was passed in 1938, this distinction was not spelled out in that law. In fact, it seems clear that the legislative intent of that law was violated by this distinction. This paper recounts the story of how a new category of nonnarcotic prescription drugs was created in 1938 and how it was finally written into law in 1951. The story is told in three parts. The first part recounts the organizational and legislative history of the 1938 law. The second part shows how the Federal Drug Administration's regulations extended the law to create the distinction between prescription and over-the-counter drugs. The third part describes the subsequent history of this regulation in the Supreme Court and Congress. A final section summarizes the argument.

The Causes and Consequences of Rising Industrial Concentration

Abstract: IN the October 1977 Journal of Law and Economics, Professor Sam Peltzman concludes from a statistical analysis covering 165 manufacturing industries that increases in concentration between 1947 and 1967 brought unit cost reductions far outweighing the price-raising effects associated with enhanced monopoly power.' Underlying these relationships, he argues, is a particular set of historical dynamics. The process begins when some representative firm finds a way to reduce unit costs significantly. It and early imitators grow rapidly, increasing their combined market share and hence the total share of industry output benefiting from the new, lower-cost method. The greater the initial unit cost reduction, the more rapidly the innovators' market shares and hence industry concentration rise; and the more rapidly concentration rises, the more pervasive the cost reductions will be, leading to larger observed declines in average industry-wide costs per unit.

Keynes and Chicago

Abstract: IAM both honored and gratified to present this lecture in memory of Henry C. Simons, one of my first teachers at this University when I entered it as an undergraduate student in economics over thirty-five years ago. My memories' of Simons begin with the undergraduate course in price theory which he taught, using as the main text his own famous mimeographed Syllabus, 2 with its distinctive and challenging numerical problems in the theory of demand and supply under both perfect and imperfect competition. Many were the productive hours which we students spent in intensive discussions of the solutions to these problems. From this Syllabus I learned much more than the subject matter itself: I learned the hard way that just reading and listening were not enough; that full understanding of the principles of economic analysis could be achieved only after sweating through their application to specific problems, with pencil and paper in hand. I learned it then-and have applied it ever since in my own teaching. Simons also gave an undergraduate course in public finance, in which context I read his famous pamphlet A Positive Program for Laissez Faire (1934).3 I still remember my aesthetic enjoyment of its clean and incisive style (Mozart, not Beethoven-he once told us-was the music for him) and my intellectual enjoyment of its trenchant argument. What was particularly exciting were the same qualities that made Marxism so appealing to many

The International Salt Case

Abstract: INTERNATIONAL Salt Company owned patents on a machine (called a Lixator) which dissolved rock salt into brine for use in a variety of industrial processes. In areas of the country where International sold salt, it only leased its machine and required that salt used in it be purchased from International. In 1946, International had outstanding 840 leases of an equal number of Lixators. All but 13 leases contained the "standard" tying clause. Probably under 10 per cent of International's total shipments of rock salt were for use in Lixators, an amount equal to about 4 per cent of the total rock salt consumed in areas where International sold salt.1

A Decentralized Method for Utility Regulation: A Comment

Abstract: The author comments on the article by Loeb and Magat in this journal issue (P 399); he feels their idea is worthy of more-detailed examination on an industry-specific level. He confines his comments, however, to a more-general comparison of the Loeb-Magat (L-M) scheme, traditional rate-of-return regulation, and pure franchise bidding. The basic L-M proposal consists of two parts. First it is shown that if a utility is subsidized by an amount corresponding to total consumer surplus, then it will have the incentive to pursue cost-minimizing behavior and to set its price equal to the marginal cost of production. Mr. Sharkey believes that this pure subsidy scheme would be wholly unworkable in practice. The second part of the L-M proposal consists of the subsidy scheme combined with either franchise bidding or a lump-sum tax. Mr. Sharkey feels that this proposal has considerable merit if conditions exist such that the net subsidy paid to the utility is sufficiently small; net subsidy is defined as the excess of the actual subsidy plus revenues of the firm over the total cost of production. Thus, the net subsidy is the excess profit the utility receives compared to a utility perfectly regulated by traditional means. Mr.more » Sharkey elaborates on some of his objections to the L-M proposal for cases in which the net subsidy is large. Then, he briefly considers the characteristics of a natural monopoly market which could potentially be regulated by a combined subsidy-franchise-tax scheme.« less

The Northern Pacific Case

Abstract: WHILE numerous commentators have noted the legal significance of the Northern Pacific decision in establishing a per se rule regarding the illegality of tying contracts under the Sherman Act,' apparently no one has investigated the record of the case to see how well the available facts support the courts' interpretation of the purpose of Northern Pacific's tying contracts or how well these facts fit the other prevalent explanations for such contracts.2 In this paper we examine the information from the case and other sources to evaluate the basis for the decision. Following this examination, we demonstrate that the peculiar features of Northern Pacific's contracts and the way they were used make the generally accepted rationalizations for tying arrangements inapplicable to Northern Pacific's activities. Finally, we explain the activities with a novel analysis, an analysis that does have various kinds of empirical support and that perhaps suggests some beneficial effect of the decision, even though that decision was based on an incorrect view of the contracts' effect.

Gains and Losses from Concentration: A Comment

Abstract: IN a recent paper, Sam Peltzman' analyzed the impact of changes in industry concentration ratios on production costs and output prices. His empirical estimates indicated that in the absence of industry growth, or in the presence of low initial levels of concentration, increases in concentration ratios were associated with only trivial cost reductions but moderate increases in prices over costs. However, when the growth rate of output and level of concentration were at all industry average values, cost reductions accompanying increased concentration were large enough to outweigh price effects such that the net result of increased concentration was lower output prices. The model developed by Peltzman is appealing because it links concentration changes to cost differences between large and small firms and explains a relationship heretofore ignored in a voluminous literature on industry concentration. However, there are several troubling aspects that qualify the conclusions of the model. (1) The conclusions depend crucially on a growthinteraction relationship which the author admits is incorrectly specified. This interaction may be a statistical artifact arising out of the elaborate regression specification which is necessary to estimate the model. (2) The regression equation contains several terms that are combinations of the same variables thus confounding direct and interaction effects and increasing the possibility that errors in the variables dominate the results. (3) The assymetrical effects observed for increasing versus decreasing concentration are difficult to explain. (4) The estimated effects of concentration levels contradict some intuitive expectations. In this paper I reestimate the relationships addressed by Peltzman's model, using a regression specification derived from a simplifying assumption within his model and also an ad hoc but more flexible specification. I

Indivisibility, Decreasing Cost, and Excess Capacity: The Bridge

Abstract: THE example par excellence of decreasing cost is found in the case of a bridge. At the heart of the matter is a postulated indivisibility and, consequently, fixity of costs and excess of capacity. In this paper I shall analyze the case of the bridge crossing, an interesting economic problem in its own right and also the classic example of a decreasing cost case. Jules Dupuit used the bridge in 1844 in discussing decreasing costs, but the modern formulation is generally attributed to Harold Hotelling.1 I will therefore examine in detail Hotelling's analysis of the bridge, which, despite its acceptance, contains errors that have gone essentially unnoticed.2

The Causes and Consequences of Rising Industrial Concentration: A Reply

Abstract: P ROFESSOR Scherer's elaboration of some of the history of post-World War II changes in concentration does a service in raising issues that have heretofore been lightly treated.' His point that increases in concentration have been largely confined to consumer goods markets is a provocative challenge to further research.2 I find less useful, however, his reading of this history as somehow in conflict with the main thrust of my article. I do not propose to take issue with the details of Scherer's case-by-case interpretation of the causes of concentration. So I am prepared to assume that a systematic examination of the conjectured causes of increased concentration in his Table 2 will not detract from his well-earned reputation as an astute student of market structure. However, I believe that much of the discussion surrounding this table is simply irrelevant to the main argument of my paper. Professor Scherer has misread my criticism of an exclusive focus on economies-of-scale explanations of market structure as a wholesale dismissal of their importance. I should therefore make clear that the model I sketched can easily comprehend Scherer's insistence on the importance of scale economics. The most general statement of that model is simply that more efficient firms will tend to grow faster than others. If the source of that efficiency happens to be scale economies rather than a lowered horizontal cost curve, the net result will be the same: increased concentration and increased efficiency. Either process will generate rents to large firms if the marginal firm has higher costs or the concentration permits above-cost pricing. Much the same story can be told about other items on Scherer's list. In particular, I see no reason to distinguish product from process innovation, even though I used the latter to illustrate the workings of the model. Some product innovation will, as Scherer points out, permit a firm to take advantage of scale economies as it broadens a firm's market. More fundamentally, a successful product innovation is a cost reduction-it reduces the resource cost of providing a given level of utility. Since the old product remains potentially available, it would not otherwise have been displaced. To be