Welfare analysis

One aspect of our market for lawyers that is very different from other markets is the welfare properties of the competitive equilibrium. The consumption of legal services in our model is a little unusual compared to the standard microeconomic model, in the following sense: the consumption of legal services simply redistributes existing resources between plaintiffs and defendants, rather than creating new resources.

Welfare analytics in such a world are very different from the usual microeconomic analysis. On the demand side, each individual's demand curve for lawyers is derived in the usual way, by equating marginal benefit with price - but the marginal benefit for each type of individual depends on the choice of legal services chosen by their opponent. Moreover, in an interior equilibrium, a lower price of lawyers makes no difference to the welfare of both individuals, even though they consume more legal services - this is clear from the payoffs in (11.23). Thus, in contrast to the usual conclusion of microeconomic analysis, the area to the left of the individual or aggregate demand curves is not a measure of consumer well-being. Why does this happen? A fall in P induces both types of individuals to consume more legal services in equilibrium. But expenditure on legal services remains the same. The net demand-side effect of a price fall is for both individuals to consume more legal services and to spend the same on those services. More economic activity is devoted to legal services on the supply side, but there is no offsetting benefit anywhere on the demand side. On the other hand, if the price of legal services rises, then both types consume fewer legal services. Spending remains the same, but resources devoted to redistributive activities fall.

In an interior equilibrium, the benefit of each type is given by BP and BD as above, and aggregate consumer benefits are simply

The producer surplus is:

and so aggregate welfare is simply

The change in welfare (dW) as Q* changes is simply:

Therefore, changes in the area under the long-run market supply curve can be used to measure aggregate welfare changes in this market. Intuitively, the purchase of legal services simply redistributes resources between plaintiffs and defendants. This redistribution itself has no overall direct welfare consequences for users since both value output equally at the margin. On the other hand, purchases of legal services by plaintiffs and defendants that are used to undertake this redistribution reduce each of their equilibrium benefits. But this loss is offset by an equal revenue gain accruing to the suppliers of legal services. The opportunity cost of producing legal services is therefore a pure social loss, since it is a cost that is not offset by a gain anywhere else in the economy.

These conclusions are illustrated in Figure 11.6.1 below. Consumers of legal services pay (A + B) to suppliers, gaining nothing as a whole, since legal services in this model simply shuffle resources among consumers. This amount of spending is equal to the producer's revenue, and the two payments exactly offset each other. The opportunity cost of supplying the quantity Q* of legal services, however, is not offset by a gain anywhere else in the economy - it is a pure social loss. We therefore have a result that is the exact opposite of one of the invisible hand result of standard welfare economics that was discussed in Chapter 1: In the

Competitive equilibrium in the market for legal services

Figure 11.6.1 Competitive equilibrium in the market for legal services

market for purely redistributive legal services, every competitive equilibrium allocation can be potentially Pareto improved upon by another allocation.

 
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