JAMIA MILLIA ISLAMIA

2015-16
PROJECT ON JURISPRUDENCE

Topic : “Economic Approach to Law. ”

SUBMITTED BY: SUSHANT

(SECTION-A) ( 2ND YEAR) (FACULTY OF LAW)
SUBMITTED TO : HAKIM YASIR ABBAS
 Acknowledgement

I would like to express my special thanks of

gratitude to my teacher HAKIM YASIR ABBAS
who gave me the golden opportunity to do this
wonderful project on topic ECONOMIC
APPROACH TO LAW which also helped me in
doing a lot of Research and I came to know about
so many new things I am really thankful to him.

SUSHANT
 CONTENTS

1. Law and Economics

2. Law as an Autonomous Practice
3. Law as a Tool to Encourage Economic Efficiency
4. Economics and Normative Jurisprudence
5. Later Developments
6. Marxist Theory of Law
7. Economic Analysis of Tort Law
8. Economic Analysis of Contract Law
 Law and Economics
The law and economics movement applies economic theory and method to the
practice of law. It asserts that the tools of economic reasoning offer the best
possibility for justified and consistent legal practice. It is arguably one of the
dominant theories of jurisprudence. The law and economics movement offers
a general theory of law as well as conceptual tools for the clarification and
improvement of its practices. The general theory is that law is best viewed as a
social tool that promotes economic efficiency, that economic analysis and
efficiency as an ideal can guide legal practice. It also considers how legislation
should be used to improve market conditions in return. Law and economics
offers a framework with which to model legal outcomes, and common
objectives with which to unify disparate areas of legal activity[1] . The bringing
together of legal theory and economic reasoning has also created new
research agendas in the fields of behavioural economics: how rationality
affects people's behaviour within legal scenarios; public choice theory and how
collective behaviour should have an effect on legislation; and game theory:
understanding strategic action in a legal context. The development of an
economic approach to legal practice has been the most important
jurisprudential development in the last third of the twentieth century.
Economic analysis has been offered as both a positive and a normative
jurisprudence: as an analysis of important features of existing legal practices
and as an ideal against which these practices ought to be evaluated. For some,
economic analysis has a narrow explanatory range (in various fields of private
law, corporations and taxation, and anti-trust law, for example), while others
make broader claims for its ability to illuminate any area of law. Finally, there is
a difference between those who focus on one explanation and those who
focus on prediction, but all offer positive economic analysis of law based on
the concept of economic efficiency as defined in welfare economics and
applied to law by Coase, Posner, Calabresi and others. [2]

[1]. Coleman, Jules, Market, Morals and the Law (Cambridge: Cambridge University Press, 1988)

[2]. Posner, Richard A., Economic Analysis of Law (New York: Aspen, 5th ed., 1998
1. Law as an Autonomous Practice
Most traditional theories of jurisprudence look to uncover the essential or
definitive aspects of the institution of law. Two of the most influential are Legal
Positivism and Dworkin’s Law as Integrity. While these two differ as to their
definition of law and legal reasoning, they agree upon some basic central
assumptions, determining the conclusions that two philosophical
investigations with largely the same aims, can reach. Because of this it is
important to acknowledge some of the assumptions that are held in common
by these jurisprudential stances.

First, both theories agree upon the conceptual nature of jurisprudence. Both
agree that it is important for a philosophical theory of law to define the core
aspects of proper legal practice in order to fulfil the function of philosophical
jurisprudence. In fact, much philosophical discussion of law assumes that such
a characterization is the essential aim of jurisprudence. Second in order to
arrive at a properly analysed concept of law, both legal positivism and law as
integrity are best constructed from specific techniques of analytic and linguistic
philosophy. These techniques include the investigation and clarification of the
way people commonly speak about law and careful parsing of social practice
that separate the legal from the non-legal. The third common assumption is
that the best way to understand legal practice is to understand the necessary
and sufficient qualities that make some rule or statement into a law. Once such
a set of necessary and sufficient conditions is identified (or approximated) it is
thought that the essential aspects of particularly legal practices have been
understood. Instead of following this path, theorists within the law and
economics movement have attacked the study of law from another angle.
Rather than trying to identify unique conceptual aspects of law, what is
advocated is an investigation of legal practices through the means of economic
analysis. The conclusion offered is that legal practice is best understood
through its function as a social tool promoting economic efficiency, in common
with other social practices. [3]

[3]. Coleman, Jules, The Practice of Principle: In Defence of a Pragmatist Approach to Legal Theory (Oxford:
Oxford University Press, 2001)
2. Law as a Tool to Encourage Economic Efficiency

So, instead of looking for the unique and defining features of law, the
practitioner of law and economics looks at law as a social tool and tries to
evaluate it functionally. What is emphasized is not its uniqueness as an
institution, but its place within the general and common economic structure of
society. The descriptive claim most often associated with law and economics is
that legal practices are best characterized as tools for encouraging
economically efficient social relations. To understand this claim it is important
to examine some of the basic concepts used in models of economic
reasoning[4].

a. Basic Concepts in Economic Reasoning

Essential to an understanding of the law and economics movement is a set of

fundamental concepts. The most central assumption in economics is that
human beings are rational maximizes of their individual satisfactions, and, in
turn, respond to incentives. A rational maximize of personal satisfaction
adjusts means to ends in the most efficient way possible. It is important to
realize that economics, as understood here, is not restricted to analysis of
monetary issues; there are nonmonetary as well as monetary satisfactions.
Every potential satisfaction is implicated in the calculus of economic
satisfactions and therefore can be investigated according to economic or
means-end rationality and the trade-off of costs and benefits. Normally what is
aimed at through economic reasoning is the improvement of efficiency.A more
efficient allocation is one that increases the net value of resources. Efficiency
in the allocation of resources is distinguished from equity, which is concerned
with justice in the distribution of wealth. Because some people value specific
goods higher or lower than others, economic efficiency can often be raised
through voluntary transfers of goods.

[4]. Coleman, Jules, "Efficiency, Auction and Exchange: Philosophic Aspects of the Economic Approach to
Law," 68 California Law Review 221 (1980)
The most common example of a transfer promoting efficiency is that of a freely
entered into contractual relationship. Because one party to the transaction
values money more than the item owned, and the other values the item
owned more than the asking price, the exchange produces a net gain in
economic goods. Each person ends up better off than before. Some
economists have gone so far as to argue that such a contractual exchange is
morally optimal because it works within both Kantian and utilitarian theories
of morality. They argue that it works with Kantian theories because a contract
is thought to represent a good example of interaction between free and
rational agents. It works with utilitarianism because the idea of wealth
maximization intuitively translates into more utility.

Economists have a variety of terms to describe possible outcomes of economic

exchanges. For instance Pareto optimality is defined as a point where
resources are allocated such that no one is willing to trade further. Pareto
optimality is the eventual endpoint of a series of Pareto superior moves. A
Pareto superior change makes at least one person better of without making
anyone worse off. Because no one is worse off after the trade there are no
losers in Pareto improvements, although there may be many different Pareto
optimal endpoints. Furthermore, economists have developed the concept of
Kaldor-Hicks efficiency to compensate for obstacles to freely contracted
exchanges. Kaldor-Hicks efficiency, or potential Pareto superiority, results
when the overall economic gains outweigh the losses. In other words, the gains
in economic efficiency are large enough that the winners
could, if they had to, compensate the losers in the new allocation of goods and
still remain better off.

b. How Law Can Encourage Economic Efficiency

The law and economics movement claims that law is best understood as a tool
to promote economic efficiency. But how can the institution of law help
encourage efficient transactions? One way is to help avoid situations that lead
to market failure. One example of market failure is the existence of
monopolies: a situation where one party is able to extract more profit from a
good than a healthy market would allow. Law can be used as a tool to ensure
that monopoly situations are hard to bring about and maintain. Another way
legal systems can be used to ensure economically efficient transactions is
through the enforcement of valid contracts. By ensuring compliance with
contractual terms courts can give parties to a contract confidence that the
other party will fulfil the agreed-to obligations. This becomes especially
important in situations where the parties must complete their obligations at
different times.

But some types of market failure are less obvious, and the legal means toward
remedying them subtler. One problem in market transactions is that of
externalities. An externality is a cost not reflected in the market price of a
good. For instance, a factory may not have to internalize the costs it imposes
upon the environment into the selling price of its goods. In this case the
market price of the good will not reflect its real cost – and therefore some of
the costs are imposed upon parties in an involuntary manner. Pigou argues in
regard to this that legal means should be used to impose a marginal tax upon
the offending party, to internalize any externalities.

The economist Coase argued that this conclusion, while warranted in specific
cases, was too global. Coase argued that in a market where transactions are
costless and people do not act strategically, rights assignments are irrelevant
because from any starting point the results will be economically efficient. In
other words, the Coase Theorem states that if there are no transaction costs
the assignment of entitlements will be irrelevant to the goal of allocative
efficiency. In such a situation there will be no need for law to internalize costs
because people will bargain to the most efficient possible allocation of goods.
But outside of conceptually ideal markets there are always transaction costs
such as information costs, opportunity costs and administrative costs. If
transaction costs are somewhat high, then it does matter how property rights
are assigned. Therefore the enforcement and allocation of legal entitlements
will be an important factor in ensuring economically efficient exchanges. So
law can be used to encourage economic efficiency [5]

[5]. Coase, Ronald, "The Problem of Social Cost," 3 Journal of Law and Economics 1 (1960)
c. Can All Law be explained as Economic in Nature?

It may be no real surprise that law often is used to encourage efficient

exchanges. But it seems a stretch to claim that law as an institution is best
completely described in economic terms. It seems counterintuitive to view all
law as based upon market principles. What the economic analysis of law
manages, though, is to see such disparate areas as contract, tort and criminal
law as all based upon economic aims, therefore giving law a more coherent
basis than other theories can offer. Richard Posner argues that tort cases -
those involving private harm - can be seen as contractual by looking for the
hypothetical terms that the parties to an accident would have agreed to in
advance in order to bring about the accident voluntarily. Also that criminal are
deterred by the threat of punishment only if the likelihood of punishment
multiplied by the quantity of punishment exceeds the gain offered by the
criminal act. Scholars have been quite effective in extending the tools of
economic analysis into areas that seem to be anything but economic in nature.
Even rules of evidence and legal ethics have proved amenable to economic
analysis. However, it may be argued that an economic explanation of law fails
on two counts. Firstly as a descriptive analysis it doesn’t do justice to everyday
legal conceptions. Secondly as an analytical analysis of the necessary
conditions for the practice of law it may not be able to account for the internal
point of view which Hart thought so central to a proper understanding of law..
This may be mistakenly importing traditional philosophical aims into a
drastically different project, but the truth is that it is often hard to tell what
types of theoretical claims are being made within law and economics. If the
claims are of exhaustive descriptive accuracy or of the necessary and sufficient
conceptual foundations of law then it is more than likely a failure. But whether
or not law and economics is an accurate or even conceptually necessary
description of law as a social institution, and whether or not it suffices as a
complete analysis of law, it could be argued that law should in any case adopt
economic efficiency as the central aim guiding judicial decision-making. [6]

[6]. Posner, Richard A., Economic Analysis of Law (New York: Aspen, 5th ed., 1998)
3. Economics and Normative Jurisprudence

Though analytically incomplete, economic analysis models the actual results of

legal institutions better than any other theory. This does not entail, however,
that law ought to be consciously used for such an aim. Might not law be better
used to consider issues related to justice, duty and the like? Advocates of law
and economics have argued against such a conclusion. The arguments usually
are of two types. First, it is claimed that meanings of words such as justice or
duty are so vague and in dispute that the use of such concepts for a basis of
judicial decisions offers no guidance whatsoever. It is argued that while such
concepts are unhelpfully complex, the tools of economic analysis and the
concept of economic efficiency are sufficiently clear to provide the judge a
solid and predictable basis of decision. Law is better able to decide according
to efficiency rather than justice or duty due to limitations of institutional
competence. This might be so if issues of justice are so complex as to involve
information that courts are structurally unable to process. Second, it has been
argued that because the paradigm case of justice is the freely entered in to
contract, law is best seen as a tool to optimize contractual arrangements. If
this is so, then where law can help is in situations where transaction costs are
so high as to prohibit efficient contractual relationships. Here Posner argues
that law can encourage economic efficiency by assigning property rights to
those parties who would have secured them through market exchange if
transaction costs were lower. In other words law should bring about
allocations that mimic the results of a properly functioning market. [7]

4. Later Developments
Another argument for the fertility of the economic analysis of law is that it has
spawned a number of further tools that seem helpful in understanding legal
institutions. Three of the most important of these are the results of
behavioural economics, game theory and public choice theory.

[7]. Posner, Richard A., The Economics of Justice (Cambridge: Harvard University Press, 1983)
a. Behavioural Economics and Law

Practitioners of behavioural law and economics examine human limits to

means-end rationality. One of the outcomes of behavioural economics is the
concept of bounded rationality. Bounded rationality means that information is
not processed according to a model of perfect means-end rationality but, to
the contrary, is distorted due to limits of our cognitive abilities. For instance
the endowment effect is thought to be a behavioural limit that distorts the
proper valuation of property, an important aspect of bargaining to efficient
outcomes. According to the effect, the ownership of objects creates an
irrational cognitive overvaluation of them. Another claim is that our cognitive
abilities are distorted by the availability heuristic. According to this the
availability of strong imagery may induce us to over or underestimate the
actual probability of events associated with the image. For instance, graphic
representations of highly improbable harms might be more influential on
behaviour and demand unjustified use of resources than statistical analysis
showing another equally undesirable harm to be more common and easier to
avoid. Jurisprudential practices could be significantly influenced by such
results. For instance, judges might be as irrationally influenced by the
availability heuristic as other human beings. Therefore victim impact
statements might be important correctives to proceedings if a well-presented
defendant’s presence in the court skews judge or jury's decisions. An
awareness of such a cognitive failure could help adjust legal reasoning and its
conclusions accordingly.

b. Game Theory

Game theory adds to economic modelling the phenomenon of strategic action.

Strategic actions are those adopted because of the competitive nature of many
social transactions. They are adopted due to how one individual expects
another to act in response. For example, a person who wishes to buy an item
cheap would act disinterest so as not to signal his or her actual desires to the
seller. Addition of analytic tools dealing with strategic action greatly
strengthens the economic analysis of law.
For instance, the Coase theorem, to function properly, necessarily excludes
strategic action; cooperation is just assumed. But it seems apparent that legal
actions often are deeply implicated in and animated by strategic motives.
Common sense tells us that full open cooperation is not always the best path
to bringing about one’s desired results. In fact much of the bargaining invested
in designing an effective contract seems to be done in the shadow of potential
strategic action on the part of the contracting parties. Designing legal rules
with an eye to the possibility of strategic action helps ensure that the rules will
not create perverse outcomes. For instance, if a defendant’s privilege against
self-incrimination could also encourage an inference of guilt from the silence
the privilege would be all but useless. Therefore, courts have not only barred
comment on the refusal to testify but also have required that juries, on
defendant’s request. Further, the understanding that legislators might have
adopted specific wording for a law based upon strategic motives may help
direct the proper aims of judicial interpretation. This type of claim, though, is
often better analyzed by the tools offered in public choice theory. [8]

c. Public Choice Theory

Public choice theory is centered upon how the nature of the legislative process
and collective decision making influence the nature of law. It is the application
of economic models of decision-making and their results to the issues that
traditionally occupy political science, for example Arrow's Theorem. One claim
made within public choice theory is that a proper understanding of collective
decision processes will help judges understand their position within the
system. If all collective decisions are unavoidably influenced by those who get
to frame the questions debated and the order of voting - the agenda-setters -
public legislation will need to be interpreted differently than if it were a more
neutral recording of collective wishes. Such a theoretical result makes
problematic a court’s reference to the intent of the legislature.

[8]. Coase, Ronald, "The Problem of Social Cost," 3 Journal of Law and Economics 1 (1960)
Marxist Theory of Law

Karl Marx and Friedrich Engels

Both of them are considered to be the founders of the greatest social and
political movement which began in 19th century and flourished in 20th century
as a political philosophy in Eastern Europe which is the erstwhile Soviet Union
and influenced all the decolonized colonies of the world. Tenets of their
ideology are practised in China’s Political Philosophy.

Marx’s view of state and law was co-terminus with the understanding of
society and social process. Marx’s originality of thought lies in the fact that he
synthesized almost entire philosophical thought from Aristotle to Hegel.

Marx’s ideas about law were expressed mainly in the Communist Manifesto,
which he published in collaboration with his friend Friedrich Engels in 1848. In
that paper Marx contends that “law, morality, religion, are so many bourgeois
prejudices, behind which lurk in ambush just as many bourgeois interests.”
Then he goes on to criticise the whole tradition of government under the rule
of law as nothing more than a mere expression of “bourgeois” aspirations: [9]

“Your very ideas are but the outgrowth of the conditions of your bourgeois
production and bourgeois property, just as your jurisprudence is but the will of
your class made into a law for all; a will, whose essential character and
direction are determined by the economic conditions of existence of your class
The selfish misconception that induces you to transform into eternal laws of
nature and of reason, the social forms springing from your present mode of
production and form of property—this misconception you share with every
ruling class that has preceded you.”

[9]. Marx, K. and Engels, F., Manifesto of the Communist Party, ch. 2; cited in Kelly, ref. 22, p. 329
According to Marx, the final advent of revolutionary communism necessarily
requires “a period in which the state can be nothing but the revolutionary
dictatorship of the proletariat. “In other words, he contended that dictatorship
is the only way in which the ideal of communism can be advanced. On the
basis of such a radical premise, V.I. Lenin argued that Marxist law does not
seek to protect any human right, but that Marxism regards law only as a
mechanism “for holding the other subordinated classes obedient to the one
class”. [10]

The sociological understanding of the society led Marx to pronounce that the
desired system should be a Communist Society based on rational planning, co-
operative production and equality of distribution and most importantly,
liberated from all forms of political and bureaucratic hierarchy.

Marx condemned and rejected the state and money as Bourgeois concept. He
believed that the proletariat has a historical mission of emancipating the
society as a whole. For him, law seemed to be nothing more than a function of
economy without any independent existence.

Following is his classification of society into various classes:

1. The capitalists

2. The Wage Labourers

3. The land owners

He said that the conflict between various classes of the society will eventually
have to be resolved. The resolution of the conflict will take place in the shape
of a Proletarian revolution. Once this revolution takes place, it will seize the
power of the state and transform the means of production in the first instance
into State property. The earlier state of exploitation and representative of class
antagonism will be replaced by a state truly representative of society as a
whole which means taking possession of means of production in the name of
society. This would be at the same the last independent act of the State.

[10]. Karl, M., Critique of the Gotha Programme; cited in Cain, M. and Hunt, A., Marx and Engels on Law,
Academic Press, London p. 163, 1979
The interference of the State in social relations becomes superfluous in one’s
sphere after a point of time and then ceases off itself. The government of
persons is to be replaced by a different administration that would direct the
process of production. However, the Proletarian revolution in order to reach
the stage of Communism shall have to pass through various stages.

1. Establishment of a Proletarian Dictatorship which is essential to convert the

capitalist modes of production into the Proletariat mode of production.

2. Stage of Nationalization of the property and all the capital modes of

production.

3. Stage of Socialism as the property is in common ownership, the society at

large shall be responsible for the production and distribution of goods.

The production of goods in common ownership, the distribution of

commodities will have to follow “from each according to his ability to each
according to his needs”.

However, inequalities will remain and hence, the need to distribute the goods
will become inevitable. The ultimate stage is that of Communism and this state
he imagined in his work called “Critique of the Gotha Program”. He said that
the Communist society will have to develop and emerge from capitalist society
and in respects, it is bound to carry with it some marks of capitalist society.
Since the idea of law was interpreted by Marx as invariably an instrument of
class domination, he argued that the coming of a classless society implied that
all laws would have to disappear. Hence in his seminal work, The Communist
Theory of Law (1955), legal philosopher Hans Kelsen contends that the “anti-
normative approach to social phenomena is an essential element of the
Marxian theory in general and of the Marxian theory of law in particular.
“Because Marx believed that law arises from class conflicts, he concluded that
the need for law would cease to exist with the advent of classless communism.
Such a promise of lawlessness that leads to “perfect justice” was correctly
interpreted by Kelsen as being “a utopian prophecy”. [11]

[11]. Cited in Kelsen, H., The Communist Theory of Law, Stevens & Sons, London, p. 54, 1955.
“Accordingly the individual producer will receive back what he gives to society,
after deductions for government, education, and other social charges. He will
give society his individual quota of labour. For example: the social working day
consists in the sum total of individual working days; the individual labour time
of the individual producer is the part of the social working day which he
contributes; his share thereof. He will receive from society a certificate that he
has performed so much work (after deducting his work for social funds), and
with this certificate he will draw from the social provision of articles of
consumption as much as a similar quantity of labour costs. The same quantity
of labour as he will give to society in one form he will receive back in
another.... The right of producers will be proportionate to the work they will
perform: the equality will consist in the application of the same measure:
labour." Higher Communist State- Concept of power and labour gets vanished.
After production force increases, then there will be all round development of
individual. This we get from “Communist Manifesto”. In higher form of
communist state after enslaving subordination of the individual to the division
of labour and anti-thesis between mental and physical labour has vanished
after labour has become not only a means of life but life’s prime want, after
the productive forces have also increased with the all-round development of
individual. And all the springs of the co-operative wealth flows more
abundantly”. [12]

He further believed that the concept of state is a super structure in a capitalist

state to organize and uphold class oppression. The bureaucracy and the
executive in a state are for the managing common class and struggle waged by
the society against each other. Law is not based on will but once the bourgeois
state is overthrown by a proletariat, the proletariat state would come into
existence. This state would be representative of social will of all the classes.
The nexus between safeguarding the private property by a capitalist state will
be replaced by a proletariat state which has nationalized all the private
property. However, it is interesting to note that the state and statecraft
remains an important and integral in the proletarian society.

[12]. Marx, K., A Contribution to the Critique of Political Economy, tr. N.I. Stone, Chicago, 1904, preface
Evgeny Pashukanis

He tried to remove the gloss on law and Marxism as experimented by the

Marxist state. He believed that proletariat law practised in erstwhile Soviet
Union needed alternative general concepts to reinforce Marxist theory of law.
He believed that power is collective will as the ‘rule of law’ realized in the
bourgeois society is to the extent that the society is represented by a market.
[13]

Karl Renner
He authored “The institutions of private law and their social functions”. This
work of his utilized the Marxist theory of sociology to develop a separate
theory of law. He believed that the Socialists and Marxists have failed to
understand that new society as such societies have pre-formed in the womb of
the old and that is equally true for law as well. According to him, the process of
change from one given order to another is automatic.

Renner confessed that the concept of property in terms of Marx has not
remained the same today. The property whether in socialism and capitalism
has not remained an instrument of exploitation rather the natural forces of
change have put property into various restrictions be it tenants, employees or
consumers. However, he also said that the power of property remains
whatsoever the political character of the state may be. [14]

[13]. Head, Michael (2004). "The Rise and Fall of a Soviet Jurist: Evgeny Pashukanis and Stalinism". Canadian
Journal of Law and Jurisprudence 17 (2): 269–294.

[14]. Chisholm, Hugh, ed. (1922). "Renner, Karl". Encyclopædia Britannica (12th ed.). London & NewYork.
Economic Analysis of Tort Law
Tort Law is the name given to a body of law that creates and provides
remedies for civil wrongs. Generally speaking, it defines what constitutes a
legal injury and establishes the circumstances under which one person maybe
held liable for another’s injury. Deliberate torts causing bodily harm, property
harm etc. is ruled as crimes in the court system. For example, if X throws a ball
and accidentally hits another person Y in the eye. Now Y may sue the ball
thrower for losses occasioned by the accident like the cost of medical
treatment or loss of income during the time he is off from work. In this case,
whether Y will win or not will depend upon whether he can prove that X
engaged in tortious conduct in injuring him. The main substance of tort law is
determining the “standard of care”, i.e., distinguishing between when conduct
is or is not tortious.

Tort law may also be used to compensate injuries that are intangible, such as
an interest in freedom from emotional distress, privacy interests and
reputation. These are protected by a number of torts such as infliction, privacy
torts and defamation. For example, defamation and privacy torts may allow a
celebrity to sue a newspaper for publishing an untrue and harmful statement
about him. Economic torts are torts that provide the common law rules on
liability for the infliction of economic loss, such as interference with economic
or business relationships. These protect people from interference with their
trade or business. The principal torts can be listed as passing off, injurious
falsehood and trade libel, conspiracy, inducement of breach of contract,
tortuous interference and watching and besetting. [15]

In the modern world, tort liability has been expanded to include intangibles,
probabilistic connections and liability without fault. Before developing our
economic analysis of tort law we need to make some assumptions. Firstly, in
economic theory, we consider the “rational man”. It implies that a person, who
takes reasonable care, is stable and tries to maximize his satisfaction. Here it
also implies that he can calculate the cost and benefits of the alternatives
available to him and can minimize his liability by taking precautionary actions.

[15]. THEORETICAL FOUNDATIONS OF LAW AND ECONOMICS, Mark D. White ed., Cambridge U. Press, 2009
Secondly, we assume that there are no regulations designed to reduce external
costs. If we compare liability regulation sometimes one is more efficient than
the other and sometimes both together are more efficient than either one by
itself. Regulation is ex-ante enforcement by administrators and liability is ex-
post enforcement by victims.

For instance, if a store is required to have a fire extinguisher, the inspectors

will check it from time to time that the store complies with the regulation. But
suppose, if the store complies with the regulation, and a fire injures a
customer, then the store maybe held liable. In this case, the store is subject to
regulation and liability. Thirdly, we assume that there is no insurance.
Insurance transfers the risk from the insured party to the insurer, i.e., it
externalizes. This gives the insured an incentive to reduce precaution, which is
known as moral hazard. For example, a person who insures his bike against
theft may not be so careful about locking it every time. Lawyers do not agree
that insurance interferers with the goals of tort law but rather they favour
insurance for accidents and liability. But there may be some cases where this is
not so, such as in case of punitive damages . Insurance allocates the cost of
accidents according to private contracts and it also regulates.

For instance, under fire regulations, the insured may be required to maintain
sprinklers and submit to inspections. In this case, insurance privatizes liability
and regulates precaution. A change in tort law may increase or decrease the
costs of insurance against accidents and liability. Thus, tort law provides the
restrictions within which the private insurers operate. Fourthly, it is assumed
that all the injurers are solvent and pay the damages in full. Lastly, it is
assumed that there are no litigation costs. But in real life, litigation is expensive
and it has different effects on potential victims and potential injurers. For
instance, it may induce the potential victims not to file actions or induce
potential injurers to take more care.[16]

[16]. Posner, Richard A., "Gary Becker's Contributions to Law and Economics," 22 Journal of Legal Studies
211 (1993)
Economic Analysis of Contract Law

Contract Law helps the people to cooperate with each other by enforcing,
interpreting and regulating promises. Contracts facilitate trade and economize
the costs of making transactions. It lays out guidelines for information that
must be revealed and that maybe kept secret in a contractual relationship.

In real world people are not economically equal or equally knowledgeable.

Thus, many times, contract between two unequal’s results in favour of
economically stronger men. But in economics, we assume the people are
economically equal and can trade with each other on equal footing. Contract
Law regulates the terms and conditions of the contracts between people of
different economic backgrounds. In Bombay Labour Union v. M/S.
International Franchise (P) Ltd., the Supreme Court in India gave a blow to the
so-called sanctity of contract. The Court observed, “It is too late in the day now
to stress the absolute freedom of an employer to impose any condition, which
he likes on labour. It is always open to industrial adjudication to consider the
conditions of employment of labour and to vary them if it is found necessary,
unless the employer can justify it by convincing reasons”.[17]

Obeying the legal rules and trying to cover all the issues arising from a contract
would be time-consuming and expensive. Hence, the contracting parties have
found certain ways to reduce the costs involved in forming contracting parties.
These are: Normally, the contracting parties depend on the custom and trade
practice to determine the profits and losses that may commonly result in their
particular line of business; or Well-known principles can be relied upon by the
contracting parties to find out the results of certain contingencies that are not
itself covered by the contract; or Standard form of contracts maybe used by
the contracting parties to help them to economize the costs, which can be
used for many trading purposes, rather than having a custom-designed form
for a single deal.

[17] Polinsky, A. Mitchell, An Introduction to Law and Economics (Boston: Little, Brown & Company, 1989)
The empirical investigations by the economists and legal economists came to
the conclusion that resort to legal remedies by the parties to the contract is
minimal due to heavy litigation costs or due to the reputation of a person in
the trading community. For instance, if a person ‘X’ resorts to litigation with
many of the contracting parties, he would be putting them to higher costs both
in time and money. His own reputation that he is a litigant and a ‘court bird’,
may isolate him from the trading community resulting in reduced contracts
with others. Thus, if the contracting parties resolve their disputes by
compromise, traditional business and morality points of view, then the
mediation by the trading community will work efficiently and will also reduce
the transaction costs to a large extent.

However, these might fail as the markets expand and become complex.
Sometimes, it may also be possible that a breach of contract is economically
efficient. For example, ‘X’ contracts with ‘Y’, the seller, to buy a machine for Rs.
25000. Just before the delivery, the demand rises unexpectedly and the price
of that machine increases. Another buyer ‘Z’ approaches ‘Y’ and offers to pay
him Rs.35000 for the same machine. Due to the disequilibrium in the demand
and supply, the market price of the machine is Rs.27000. Suppose, ‘X’ goes to
the court for special performance or may compel “Y’ to pay him some profit
that “Y’ would make from breaching the contract. ‘X’ may insist on receiving
Rs.3000 from ‘Y’ as damages. If ‘Y’ agrees, ‘X’ can recover at Rs.27000 and be
better off by Rs.2000, than he would have been under the damage remedy,
which would have given him only the difference between the cover price and
the contract price.

Thus, wherever, seller’s better offer is higher than the new market price, the
seller has an incentive to breach and the first buyer has an incentive to
threaten specific performance to capture some of the sellers’ gains from the
breach. Therefore, under economic analysis of contract law, we have to
analyse the case laws from the economic efficiency point of view.
 CONCLUSION

The development of an economic approach to law has been

the most important jurisprudential development of the
twentieth century. Economic analysis has been offered as
both a positive and a normative jurisprudence: as an analysis
of important features of existing legal practices and as an
ideal against which these practices ought to be evaluated. For
some, economic analysis has a narrow explanatory range (in
various fields of private law, corporations and taxation, and
anti-trust law, for example), while others make broader
claims for its ability to illuminate any area of law. Finally,
there is a difference between those who focus on one
explanation and those who focus on prediction, but all offer
positive economic analysis of law based on the concept of
economic efficiency as defined in welfare economics.
BIBLIOGRAPHY

1. Economic analysis of law by RICHARD POSNER

2. Markets, Morals, and the Law by JULES COLEMAN
3. The Firm, the Market, and the Law by RONALD COASE