L&E: Key Terms

Coase Theorem

A theory stating that if property rights are well-defined and transaction costs are zero, private parties can negotiate to resolve externalities efficiently.

Harmful side effects of an economic activity that affect third parties who are not involved in the transaction.

The total cost to society, including both private costs and externalities caused by a transaction or activity.

The costs of negotiating, enforcing, or monitoring an agreement between parties.

An allocation where no one can be made better off without making someone else worse off.

A change is efficient if the gainers could compensate the losers and still be better off (even if no actual compensation occurs).

Economic Naturalism

Shows the relationship between the price of a good and the quantity consumers are willing to buy. It typically slopes downward, reflecting that people buy less as prices rise.

Represents the relationship between the price of a good and the quantity producers are willing to sell. It generally slopes upward, as higher prices incentivize more production.

Refers to how strongly the quantity demanded or supplied responds to price changes. High sensitivity means consumers or producers react strongly to even small price shifts.

A market structure where many buyers and sellers exist, products are identical, and no single actor can influence the market price. Firms in perfect competition are price takers.

The point where the supply and demand curves intersect, determining the price and quantity at which the market clears. At this point, there is no excess supply or demand.

Limits on how much a firm can produce due to physical or resource limitations. When a firm hits capacity, it cannot increase output without expanding facilities or operations.

A supply curve with a "step" shape reflects fixed production capacities across producers. Each step represents the entry of a higher-cost producer as demand increases.

The producer whose costs are highest among those currently in the market. This producer sets the market price in competitive markets, as others must match or beat that cost.

Graphs showing a firm’s production costs at different output levels, including fixed, variable, and total costs. They help firms determine the most efficient scale of operation.

Cost advantages that firms experience as they increase production. Larger scale leads to lower per-unit costs due to factors like specialization and bulk purchasing.

The smallest production size at which a firm can achieve the lowest average cost. Below this scale, per-unit costs are higher due to underutilised resources.

A market where a single firm can supply the entire demand at a lower cost than multiple competing firms. This usually occurs when economies of scale are so large that competition is inefficient.

Economic Tort Law

The study of strategic interaction where the outcome for each participant depends on the actions of others.

A market situation where a few dominant firms set prices while considering the likely reactions of competitors.

A situation where one party in a transaction has more or better information than the other.

A market failure where buyers or sellers with better private information self-select, leading to poor market outcomes.

When one party takes greater risks because they do not bear the full consequences of their actions, often due to hidden actions.

A theory analyzing how public decisions are made and how self-interest and incentives affect government behavior.

A legal test balancing the cost of preventing harm against the probability and severity of that harm.

A game scenario where rational individuals choose to betray each other, even when cooperation would lead to a better outcome.

Insurance Contracts

If transaction costs are low and property rights are well-defined, parties can negotiate to resolve externalities without legal intervention.

A cost-benefit formula used to determine negligence: liability exists if the burden of prevention is less than the probability of harm multiplied by its severity.

One party in a transaction has more or better information than the other.

Relief is given if a knowing party fails to inform an unknowing party, but only when disclosure is low-cost and no substantial investment in information was made.

Contractual tool where the informed party assumes the risk of quality or performance, used to correct information asymmetry.

Occurs BEFORE contract; individuals with higher risks are more likely to seek insurance, leading to skewed risk pool.

Arises AFTER contract is signed; individuals may take more risks because they are insured , making it difficult for the insurer to verify care levels

The insured must stand to lose something from the event insured against; prevents gambling, moral hazard, and externalities to uninvolved third parties.

Insured may not profit from insurance; only actual losses are compensated. Exceptions include life insurance policies and agreed-sum policies

The insured must disclose ALL relevant information; strict sanctions apply for non-disclosure

Insurance does NOT cover deliberate or criminal actions to reduce incentives for harmful behaviour

Behavioural Law and Economics

People aren’t always purely self-interested; they may care about fairness or others’ wellbeing at a cost to themselves

Individuals often struggle to follow through on long-term goals, especially when facing short-term temptations or pressures

Humans make decisions with limited cognitive resources, time, and information, often settling for ‘good enough’ rather than optimal choices

People tend to give stronger weight to immediate rewards over future ones, often leading to procrastination or impulsive decisions

People often stick with pre-set option when it comes to making choices, choosing familiarity over change even though it may not be in their best self-interest

A game in which one player proposes how to divide a sum of money, and the other can accept or reject it; rejections (even of small unfair offers) highlight people’s concern for fairness.

People judge the likelihood of events based on how easily examples come to mind, which can lead to biased thinking when vivid or recent events dominate memory

Aims to steer people's choices in a way that improves their well-being while preserving their freedom to choose. It relies on "nudges"

Competition law

The idea that competition law should aim to benefit consumers, especially through lower prices and better products.

A method in competition law to define markets by asking if a Small but Significant Non-transitory Increase in Price would be profitable.

The regulation of mergers to prevent harmful effects on market competition.

When a dominant firm uses its power to exclude rivals or harm consumers.

A test used in market definition: would a monopoly raise prices profitably in this market?

A tool to evaluate how much demand would need to drop before a price increase becomes unprofitable.

A mistake in market definition caused by looking at pricing after a firm has already raised prices due to market power.

Evaluates rules or outcomes based on how well they maximise total welfare or allocate resources without waste.

Benefiting from someone else’s investment or effort without paying for it, potentially discouraging future investment.

A situation where a dominant firm prevents competitors from entering or competing effectively in a market.

Setting prices equal to the cost of producing one additional unit, promoting allocative efficiency and competitive entry.