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Two Definitions of Efficiency in Law and Economics

THE efficiency paradigm of wealth maximization has provided a coherent framework for understanding many aspects of the law. Unfortunately, that understanding can be hampered by a failure to specify precisely what is meant by efficiency. In the absence of a clear definition, confusion is likely. This confusion is important. A faulty definition of efficiency will lead to a faulty analysis, which could exclude key features of the social situation that must be accounted for in any assessment of the legal setting. In this paper, I seek to identify two closely related definitions of wealth maximization. I show how they differ and why the second definition is superior in connection with a number of plausible illustrations where the choice between the definitions leads to a difference in outcome. To the extent that writers in this field state explicitly what they mean by wealth maximization, they usually echo the definition that Posner offers in his textbook: "Efficiency means exploiting economic resources in such a way that value-human satisfaction as measured by aggregate willingness to pay for goods and services-is maximized."' There is, however, an ambiguity in considering willingness to pay: what shall we assume about the cost of expressing that willingness? For example, suppose I have a neighbor who keeps a messy yard, and suppose further that I would be willing to pay $200 to have him clean up his property. Unfortunately, the cost of expressing this concern and specifying a contract is