Prices and Sanctions?

Prices compel decision makers to consider the monetary costs of their acts, whereas sanctions deter people from doing what is wrong.

We get tickets for illegal parking and also for drunk driving. Both activities are illegal, but somehow most of us think that the fines we pay for each of these violations are different in nature. To many, the fines for illegal parking are more like prices for the purchase for a convenience while fines for drunk driving represent a sanction against an act which should not be committed at all. Since both acts involve a payment, what is the difference between prices and sanctions?

In general, a sanction is a punishment imposed for doing what is forbidden, and a price is a cost for doing what is permitted. When a sanction is imposed, the forbidden act is not allowed at all. Individuals are not supposed to determine the level of compliance by treating the sanction as a financial cost of doing business. On the other hand, when a price is charged, an actor can freely choose that level of activity which equates his marginal cost with his marginal benefit. To determine whether a law prices or sanctions an activity, it is useful to remember that a price does not vary with the actor's intent or frequency of violations and varies with only the harm caused by his action, while a sanction varies with the actor's intent and the frequency of violations for the sake of deterring repeated and intentional violations.

Since an additional penalty on repeated parking violations is rare, most judges treat fines for parking violations as prices. Individual motorists are thus allowed to choose their level of compliance with parking regulations by balancing the costs of compliance against the benefits of non-compliance. In contrast, most judges treat a penalty for drunk driving as a sanction, by readily increasing it for repeated violations.

When is it efficient to use sanctions rather than prices, or vice versa? The answer depends on who has the lowest cost of obtaining information on costs and benefits of an activity.

When private persons are the best observers of the social costs and the social benefits of an activity because they could easily be either victims or injurers in such an occurrence, a community standard usually exists. This standard could be used as a socially optimal norm with sanctions for deviations. An advantage of an obligation-backed sanction is that individuals are relieved from each trying to balance the costs of compliance against the benefits of non-compliance.

When officials are the best observers of the social costs and private persons the best observers of the social benefits of an activity, it is more efficient to price the activity. Individuals are then free to balance their own costs and benefits. Pricing is particularly efficient when compliance costs and non-compliance benefits differ substantially among actors.

Some individuals may be tempted to treat sanctions as prices and choose their level of compliance by discounting the penalty with the chance of being caught. Hence the concern over the appropriate severity of the penalty in the absence of perfect enforcement. But since most people will obey a reasonable legal standard backed by a reasonable sanction, the level of penalty is perhaps less important than choosing the correct standard. This law-abiding tendency is reinforced by the sudden jump in an individual's costs when he enters the forbidden zone where behavior is sanctioned. This sudden jump in costs is absent if sanctions are replaced by prices.