01:220:395 Lecture Notes - Lecture 2: Private Good, Patent Office, Bear Stearns

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2 Nov 2016
Department
Law and Economics Exam 2 Review
Chapter 5
Asymmetric information the unequal knowledge that each party in a transaction
has about the other party
Adverse selection the problem created before the transaction. The people who are
most undesirable, from the other party’ points of view, are the ones who are most
likely to want to engage in financial transactions.
Moral Hazard the risk that one party to a transaction will engage in a behavior that
is undesirable from the other party’s point of view
Public good everyone obtains benefits, cannot exclude anyone, one’s use does not
exclude benefit to others
Private good - one person’s consumption makes it unavailable to others, only
consumers obtain benefit
Coase Theorem the economic efficiency of an economic outcome or allocation in
the presence of externalities
Conditions externalities exist, there are no transaction costs, bargaining is possible
Dr. Ronald H. Coase born in England in Dec 29, 1910, professor emeritus of
economics, university of Chicago law school, noble memorial prize in economics in
1991
Publications - the nature of the firm 1937,(Nobel Prize Winner) the problem of
social cost 1960, the federal communications commission 1959, working on a book
concerning economies of china 2010.
Criticisms of Coase Theorem
Transaction costs are often costly
Externalities many times effect large number of the population
Bargaining is hindered by free riders and poorly defined property rights
Both sides often lack perfect information
Inside Job by Charles Ferguson
Revolving Door Policy
Financial executives receive government appointments
Results:
o Deregulation
o Oligopolies
o Collusion
o Criminal behavior
Oligopolies
Investment banking
o Merrill lynch
o Goldman Sachs
o Morgan Stanley
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o Lehman brothers
o Bear Stearns
Securities Ratings Companies
o Moody’s
o Standard and Poor’s
o Fitch
The Bubble
Make toxic loans
Earn commission on loans
Bundle and sell loans
Bet against loans
Insure against loan default
Bet against firm collapse
Avoid criminal prosecution
Result
Deregulated industry
Housing market collapse
Home foreclosures
Financial market collapse
Government bailout
Recession
Behavior continues
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