What are limits on freedom of contract? Conspiracy, force, cartels, and rate regulation [No. 86]
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What are limits on freedom of contract? Conspiracy, force, cartels, and rate regulation [No. 86]


Thus far what we’ve done is to talk about
how it is that contracts produce gains from trade to the parties, positive externalities. The benefits are not just between the two
parties, they also radiate out to the rest of the legal system. The more difficult case has to deal with the
problem of negative externalities. If it turns out that it is wrong for A to
hit B or for C to hit B or then if it turns out that A and C get together, it’s a situation
in which the synergies between A and C essentially make the likelihood of force against the third
person more likely, so the legal response is to render these contracts unenforceable
in an effort to dissipate the gains and in fact, in many cases you not only render them
unenforceable, you make them conspiracies and essentially you can then punish them under
the criminal law because the gains to the two parties are inversely correlated with
social welfare given the huge losses that are suffered by victims of force and fraud. In the simplest case in which multiple parties
get together, they agree essentially to raise prices and to reduce assets or they decide
that each of them will have a separate territory on which they sell. These are not contracts that deal with force
but it’s pretty clear that if you do the standard economic analysis uh, the social
welfare under a monopoly situation is always lower than that under a competitive situation,
because transactions that would take place at the competitor’s price are excluded when
the monopolist raises the price in question. So what the antitrust law does essentially
is to make it impossible for you to enter into these contracts by treating them as illegal
contracts and restraints of trade. This is a very old common law category and
it receives its modern formation in the statutory law starting with the Sherman Act in 1890. And the history of rate regulation begins
roughly at the same time as the Sherman act around the 1880s and in the old days of public
utilities where the official form of supply requires that you have a single provider for
the entire network. Ah so you could build only one railroad between
two towns, ah, but once the railroad is built, ah, the owner of that particular railroad
might be able to exact the monopoly price. But the customers have to pay you sufficient
amount so that an aggregate you can remain in business and earn a risk-adjusted competitive
return and so what you then do is develop rate of return regulation which forces the
obligation and then requires you to sell these services on reasonable i.e. you get a competitive
rate of return but no more, non-discriminatory, i.e. you have a situation where you can’t
pick favors and so the so-called RAND obligations – reasonable and non-discriminatory – become
the hallmark of rate regulation as the third major limitation on freedom of contract.

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