Hi, everybody. Welcome. In earlier talks, I've tossed the words retribution and deterrence around informally to describe some concepts that were useful at the time. What I'd like to do know is to investigate those two terms a little bit more closely to see exactly what they mean. And to show how these two concepts can connect the realm of economic exchange to the realm of liability. Economists are not used to using words like retribution and deterrence. They're not part of the typical economist vocabulary. The words come from the domain of moral philosophy and criminal law. And retribu-, retribution and deterrence are the first two of the four traditional moral justifications for criminal punishment. These four justifications are retribution, and deterrence. These were for a long time the only moral justifications for punishment. But I think the harshness of the implications of retribution and deterrence when seen in the context of punishment, has been softened a little bit in our century. And we felt that criminal punishment also has aspects of rehabilitation to it. And an aspect of incapacitation, of isolating dangerous offenders from the rest of society and thereby protecting us from them. But retribution and deterrence remain the two principle justifications for the imposition of criminal punishment. And most legal scholars, most moral philosophers understand retribution and deterrence to be rather different things. Indeed, objectives of a criminal justice system that might at times even be at odds with on another. Retribution, in the vocabulary of the moral philosophers and the legal scholars, retribution looks backward in time. It stresses measured vengeance and expiation . Offenders owe their victims compensation for their wrongs, that's the vengeance part, and they pay this debt through suffering of their own. That's the expiation part. But vengeance and expiation in this sense are simply different ways to express the same idea. You do a wrong to somebody and thus it is your just desert that that wrong be visited back upon you in terms of the suffering that matches the suffering that you've imposed on somebody else by your criminal act. Our ordinary language about criminal justice sometimes suggests this notion of retribution when we say that criminals have to pay a debt to their society for their crime. Or when we say to potential criminals that if they want to do the ti-, do the crime, they have to do the time. So, that crime and punishment are linked in this way as a kind of compensation. Deterrence on the other hand looks forward in time and stresses the efficient reduction of product. This is obviously looks backward to Jeremy Bentham. Offenders are punished under the theory of deterrence only as much as it's necessary to effectively deter them and others from committing crimes in the future. In this view, punishment is a pure bad. As Bentham put it, punishment is absolutely nothing but evil and therefore there ought to be as little of it in the world as possible. And so for the advocates of deterrence, the principal role of criminal punishment is to provide the minimum punishment necessary in every crime. To deter both that individual from committing that crime again and by example, to send a message to other potential criminals to show what will happen to them if they commit the crime in the future. As I've said, moral philosophers and legal scholars tend to treat retribution and deterrence as distinct objectives of criminal justice. As objectives that may even be in contradiction with one another. But seen from an economic perspective, retribution and deterrence are very closely related to one another. Indeed, they're two sides of the same coin represented by the notion of prices. Like competitive prices, liability prices serve both to compensate the bearers of external cost for the costs that they've already borne. And in that sense, liability prices look backward, and are a form of retribution. But at the same time, they serve to inform potential ceasers of entitlements, potential purchasers of those entitlements through the liability system, what they will have to pay in order to impose these costs into the future. And so, as a result of this, we can say that liability systems, as I said very early in the course, are not like economic systems. They are economic systems. Indeed, the system of competitive free exchange is a way to organize transactions in a certain transactional environment. Where the costs of bargaining are very low. Where the costs of bargaining are low, as we've seen, property rules are sufficient to protect entitlements, and free exchange allocates resources. And indeed, all property rights, to their highest value and owners. In this view, liability systems try to perform much the same set of tasks, but in a different economic environment. Where free exchange works in an environment of low tranasctions cost, it doesn't work in an environment of high transactions cost. And if efficient exchange is to be facilitated in a regime of high transaction costs, then a liability rules system is the only way to go. And in this sense, a liability rules system is a system of exchange that operates in an environment of high transactions cost. Where the ordinary system of free exchange operates in an environment of low transactions cost. Let's take a closer look at the operation of competitive prices and see what it means to say that they are simultaneously instruments of retribution and deterrence. In the discussion, we'll start with a qualification as we frequently do. And we'll assume that competitive exchange is working perfectly. That is, every single one of the many buyers and many sellers of the identical goods in question are all perfectly informed about their own preferences. About the prices of the goods that they will be trading for, about how much income they have to spend on goods and so on and all transactions costs are zero. Here, the two key aspects of the assumption are the homogenaity or identicality of all the goods that are being traded. And the level of transactions costs low enough to enable all mutually beneficial exchanges could take place. And we'll call these conditions the conditions of perfect competitive exchange. If exchange works perfectly, and here's a key proposition, the price of every good would be driven by competition down to an equilibrium value. That is, a value on which there is no pressure to rise or fall. That represents the smallest possible sum of all the costs that have had to be borne in order to produce that good. Because goods are homogeneous, every buyer looks at every seleer and sees each seller selling exactly the same good. So the only way the buyer has to distinguish between the many sellers of this identical good, is the price at which the seller is offering the good. If any seller attempts to offer the good at a price which is higher than the full cost of producing that good Including the payment for risk taking that we call profits, paid typically at a market rate of exchange. If exchange is working perfectly the price of every good will be driven down to the value that represents the lowest possible cost of production of that particular good. As I began to say, if any firm tries to sell a good for a price above the cost of producing that good. Including the profit that I have described, then competing sellers will undercut that price and drive the price lower. This means that the first seller will have to reduce his price as well; otherwise he won't be able to sell any goods. This process goes on until it can't go on any more. No seller will sell a good for less than it costs to make that good, at least under ordinary conditions. And so, sellers will reduce the price of their goods under the pressure of competition until the price of the good exactly matches the cost of producing that good. Where it will stay because it can't fall any lower and firms remain in business and, by selling those particular goods. So when the system of competitive exchange has worked perfectly, at the end of the day, when prices have reached their equilibrium value. The op-, output price, the price at which any particular good is being sold, represents the full cost of producing that unit of output. And making it available to consumers to purchase in the marketplace. Economists summarize this argument by saying that firms expand their production of goods until the marginal cost of producing the next unit of the good. That is, the full cost of all of the resources that have had to be employed to produce that single unit of output. When that marginal cost is exactly equal to the output price, then the firm is operating at it's profit maximizing point, and that's where it will stay. And so, output prices in this sense, represent the cost of producing goods. So that the price of any output, of any output, unit of any output represents the sum of all of the sacrifices that have had to be made by all of the people around the world who have contributed to the production of this good. And the price represents the sum of all of those costs, and not a penny more or a penny less under ideal conditions. When prices have this quality of reflecting costs of production. Then every buyer must pay the full cost of producing the good he wants to consume before he may consume it. So, he only consumes those goods whose consumption by him pays for itself. That is to say, the price forces every consumer to ask him or herself a question. And that is, do I value the consumption of this good more than the sum of all the costs that it took to produce this good, and make it available for me to consume. If the answer is yes, the consumer will purchase it and pay the price. If the answer is no, then the requirement that the consumer has to pay the price before he can consume the good will deter him from consuming the good. And thus, having the costs of production imposed on his or her behalf. This leads to an efficient amount of cost imposition. That is, the only goods that are are made. And thus the only costs of production that are incurred. Are those goods which pay for themselves. Such that the cost of production is smaller than the economic value of that good to some consumer who will purchase it. So in this efficient amount of cost in position the total value of all goods to their holders is maximized. Just a result that we've seen earlier in the course. And as we've seen this generally does not deter cost in position absolutely. Every act of production is an act of cost imposition. You can't make anything without using something else in order to make it. And therefore, again, every aspect of production imposes costs on the people who have to sacrifice in order to produce that particular good. But the exchange system does not contemplate that no cost will ever be inflicted upon anyone. Instead, it provides a mechanism that allows people to distinguish efficient from inefficient cost imposition. And through the mechanism of competitive prices, it makes people who perform an efficient act of cost imposition compensate those who have borne their costs. And if they decided that the act of cost imposition is not worth it to them in terms of the benefit that they'll receive from compensate from consuming. Then the requirement that they pay the price will in fact deter them from consuming the goods. Let me illustrate all of this with a simple example That is illustrated in the picture by oranges for sale at your local grocery store. The oranges sit out in a bin. Customers come and look at the oranges and decide whether they want to purchase them. As you can see in the picture, prices cost, excuse me, oranges cost $1.00 a piece. And in terms of the conversation that we've just had, we can interpret this $1.00 purchase price for the orange as follows. That the sum total of all of the costs that have had to be borne by all of the input owners who have contributed inputs to the production of this orange is $1.00. Laborers have contributed their labor. Raw material owners have contributed their raw materials. Land owners have contributed their land. Transportation owners have contributed their services to move the oranges from the farm to distribution points, and so on. Each of these participants in the production of oranges has had to bear some costs so that the oranges that we see in the picture are made available to consumers in the store. And because we're assuming that the orange market is perfectly competitive, that $1.00 price tag means that the sum total of all the costs borne by all of these input owners to produce each of those oranges is $1.00. So as we've said, that $1.00 price tag confronts our consumer with a question. Do you value your consumption of the orange sufficiently to justify the imposition of the cost of production on all of the people who must bear them to produce the orange? Do you value consumption of this orange more than the $1.00 that it costs in sum for the orange to be made? If you do, then paying the purchase price will compensate all of these people for the costs that they've borne give you the orange and leave you some value left over. But if you don't value the o-, orange more then the sum of the cost of producing it, the the requirement that you pay the purchase price will deter you from purchasing the orange. So as you can see, the price tag suggest two possible courses of action for the consumer. For those who decide that the cost of producing the orange exceeds the value that they will derive from consuming it, two things are true. Obviously, they are not the highest valuing owners of the orange because the people who have already contributed costs to the production of that orange, value the resources that are represented in the orange more than the potential consumer values those resources. And so, the owners of the resources taken together are the higher valuing owners of the orange. They are represented by the owner of the store who has purchased the orange from them. So the consumer, if he's not willing to pay the purchase price, is not the highest valuing owner of the orange. And therefore, too, he will be deterred from buying it, and thus from imposing the cost of production on his behalf by the requirement that he pay the price equal to the cost of production. On the other hand, those who decide that the value of the orange to them is greater then the cost of producing it, well they're the highest valuing owners or so they claim. But they're required to prove that they're the highest valuing owners by being willing to pay the purchase price that represents the value placed on those resources by all of the people who have produced the orange and made it available for his consumption. So in order to show that he values the orange more than they do, he's asked to put up or shut up by paying the purchase price. But once he does pay the purchase price through the exchange system, the value of that purchase price is then distributed to each and every one of the people who have borne costs in the production of this orange in perfect proportion to the cost that each has borne. And thus, payment of that competitive purchase price exacts perfect ret-, retribution from the consumer for the costs of production that have been imposed on others on behalf of the consumer. By paying the p-, purchase price, the consumer repays the cost of production so that those who are borne the cost of production are in this sense, made whole by the payment of the purchase price. And the reception by them of the compensation that it represents. So, simultaneously, competitive prices are perfect in-, instruments of retribution and deterrence, and they look both backward to the costs of production and forward to the provision of incentives for the efficient allocation of goods. It's a beautiful system, which is one of the reasons that economists are so attracted to it, and spend so much time studying it's operation under otherwordly ideal condition, conditions. But as it allocates every good to it's highest valuing owner through free exchange. The exchange system does not deter cost imposition absolutely. Oranges are still made and the costs of producing them are still imposed on the producers of those oranges for the benefit of other people, for the people who will ultimately consume the oranges. And by setting the price of each good equal to the cost of producing it, the exchange system allows consumers in their own interest to see which acts of compa-, of, of consumption will be efficient. And which acts of consumption will be inefficient in terms of the relative value of the resources to the consumers and to the producers. And the exchange system, through competitive prices, provides strong incentives to undertake efficient transactions, efficient, efficient cost imposition and to compensate for the cost their consumption imposes. And where they are not the highest valuing owners of the good, where their consumption would not be an act of efficient cost imposition. The purchase price encourages them to refrain from inefficiently purchasing the good or inefficiently imposing the costs so that the costs are not in fact imposed on their behalf.
