Economic Efficiency in Law and Economics

Economic Efficiency in Law and Economics

New Horizons in Law and Economics series

Richard O. Zerbe Jr.

In this path-breaking book, Richard Zerbe introduces a new way to think about the concept of economic efficiency that is both consistent with its historical derivation and more useful than concepts currently used. He establishes an expanded version of Kaldor–Hicks efficiency as an axiomatic system that performs the following tasks: the new approach obviates certain technical and ethical criticisms that have been made of economic efficiency; it answers critics of efficiency; it allows an expanded range for efficiency analysis; it establishes the conditions under which economists can reasonably say that some state of the world is inefficient. He then applies the new analysis to a number of hard and fascinating cases, including the economics of duelling, cannibalism and rape. He develops a new theory of common law efficiency and indicates the circumstances under which the common law will be inefficient.

Chapter 3: The Nature of Economic Efficiency

Richard O. Zerbe Jr.


3. The nature of economic efficiency 3.1 INTRODUCTION Chapter 2 outlined the axioms for KHZ efficiency. In a formal sense some of these are redundant. Here I pare down the axioms of Chapter 2 into the three essential axioms required to generate the results in the following chapters. I define an action or decision as efficient if (1) there is a positive sum for the willingness to pay (WTP) for gains and the willingness to accept (WTA) payment for losses; (2) gains and losses are measured from psychological reference points (Kahneman and Tversky 1979); (3) the transaction costs of operating in states of the world are included in costs for purposes of determining efficiency, but the transactions costs of changing to a new state of the world are not included. (To require economists to include the costs of persuasion in their pronouncements of what is efficient would be stupefying at best.) I call an approach based on these axioms KHZ. KHZ efficiency has the following characteristics: (1) it is not subject to preference reversals (Zerbe 2001); (2) it satisfies a compensation criterion (Zerbe 2001); (3) it defines all goods for which there is a WTP as economic goods (Zerbe 1998b); (4) it includes the income distribution, as well as the fact of compensation or its lack, as an economic good, so that a project that provides compensation may be valued differently in efficiency from one that does not (Zerbe 1998)...

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