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The normative approach to legal decision making

Courts as efficiency maximisers

Chapter 1 examined the invisible hand theorem and discussed some of the implications that may follow if the assumptions of that result do not hold. One of the main conclusions to emerge there was that if there is an inefficient allocation of economic resources, then it must be because one or more of the assumptions of the theorem do not hold. For example, economic resource allocation might be observed to be inefficient because private property rights over assets are not well defined, which may lead to greater risk, underinvestment and resource underexploitation.

One important approach to justifying and explaining the role of courts and legal decision making is that in such situations, legal rules and decisions can enhance the efficiency of resource allocation. Thus, continuing our property rights example, if private property rights are not well defined, courts and legal rules may assist by better defining these private property rights.2 This general approach to legal decision making, in which courts and/or legal rules should aim to improve economic outcomes, is broadly known as the normative or public interest approach. Under this view, the existence of an inefficiency (which may be due to a market failure or the existence of inefficient legal rules) justifies intervention and a change in current legal rules by governments, regulators or courts. The only remaining question is: which interventions or rules should be chosen?

The normative approach proceeds by applying a test of market failure and the tools of cost-benefit analysis. The approach is usually comprised of the following five elements: [1]

5. Weigh up the incremental benefits and costs of the change (relative to an appropriately specified baseline) and show that the expected benefits of the proposed rule outweigh the expected costs. The direct costs associated with rule are the expenditures associated with the proposed rule (for example, the costs to firms and consumers in the market under consideration, etc.). The indirect costs include rule-induced inefficiencies (that is, possible misallocations in other markets and other general equilibrium effects).

  • [1] Define some suitable efficiency criterion. 2. Analyse the market, and determine whether inefficiencies exist. 3. Determine the magnitude and extent of the inefficiency. 4. Determine which interventions are appropriate and which are feasible.This entails identifying possible legal rules that directly or indirectlyaddress the alleged market failure. Such appropriate, feasible rules maynot actually exist.
 
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