ECON 383 D100 Law & Economics
Fall 2021
Homework Assignment 4
The assignment is due by Friday, November 26, 23:59.
Late submissions:
less than 24 hrs late = 4 points deducted
24-48 hrs late = 8 points deducted
more than 48 hrs late = 0 points awarded.
This homework is all about playing with the decision trees.
The decision tree for Plaintiff is given below, with the relevant payoffs. In the tree, CF is the cost of filing a suit, CS is the cost of out-of-court settling, CT is the cost of trial, CA is the cost of appeal, PW is the probability of winning the trial by Plaintiff, PA is the probability of winning the appeal by Plaintiff. The parties are perfectly aware of each other’s costs and evaluations of probabilities.
Assume the following:
Each party, Plaintiff and Defendant, pay their own costs. Both parties encounter the costs at every stage; the only difference is Plaintiff pays CF if she files the complaint, Defendant does not pay anything at the filing stage. Both parties perceive same probabilities PW and PA.
CF = $200.
CS = $80.
CT = $400.
CA = $800.
PW = 0.6.
PA = 0.6.
Calculate expected value of appeal EVA to Plaintiff. (2)
Calculate expected value of trial EVT to Plaintiff. (2)
Calculate expected value of trial EVTD to Defendant. (2)
Find the reasonable settlement S to Plaintiff. (2)
Calculate expected value of filing the complaint EVC to Plaintiff. (2)
What will happen in this case (will the complaint be filed, will it be settled or proceed to trial, will the appeal be filed if Plaintiff loses the trial)? (2)
Assume the following (“excessive relative optimism”):
Each party, Plaintiff and Defendant, pay their own costs. Both parties encounter the costs at every stage; the only difference is Plaintiff pays CF if she files the complaint, Defendant does not pay anything at the filing stage. Parties do not perceive same probability PW.
CF = $200.
CS = $80.
CT = $400.
CA = $800.
Plaintiff thinks that PW = 0.95 while Defendant thinks that PW = 0.05.
Both parties perceive same probability PA = 0.5 (because they are totally ignorant of how the appeals work).
The parties are unable to correct the excessive relative optimism at the settlement stage (i.e., possible bargaining during the settlement stage does not change their evaluations of probabilities PW and PA).
Calculate expected value of appeal EVA to Plaintiff. (2)
Calculate expected value of trial EVT to Plaintiff. (2)
Calculate expected value of trial EVTD to Defendant. (2)
Find the reasonable settlement S to Plaintiff. (2)
Calculate expected value of filing the complaint EVC to Plaintiff. (2)
What will happen in this case (will the complaint be filed, will it be settled or proceed to trial, will the appeal be filed if Plaintiff loses the trial)? (2)
You will have to properly trim the decision tree in order to evaluate the expected values. Hint: Figure 10.4a (p. 388) and Figure 10.4b (p. 391) may be quite helpful when you work on the homework questions.
EXTRA: question 3 below will not be marked for your grade. You may want to try and solve it anyway (in preparation for the final, and because you are a smart and curious student).
Assume the following (“European-style loser-pay-all”):
At every stage when the complaint is resolved by court (trial or appeal) the loser pays all the costs, her own and the winner’s (including the cost of filing a complaint if Defendant loses in court and cost of trial if Defendant loses on appeal). If the case is settled, each party, Plaintiff and Defendant, pay their own costs. Both parties encounter the costs at every stage; the only difference is Plaintiff pays CF if she files the complaint, Defendant does not pay anything at the filing stage. Both parties perceive same probabilities PW and PA.
CF = $200.
CS = $80.
CT = $400.
CA = $800.
PW = 0.4.
PA = 0.7.
Calculate expected value of appeal EVA to Plaintiff.
Calculate expected value of trial EVT to Plaintiff.
Calculate expected value of trial EVTD to Defendant.
Find the reasonable settlement S to Plaintiff.
Calculate expected value of filing the complaint EVC to Plaintiff.
What will happen in this case (will the complaint be filed, will it be settled or proceed to trial, will the appeal be filed if Plaintiff loses the trial)?
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