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UW-Madison ECON 522 - Lecture 15

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Econ 522 – Lecture 15 (March 24 2009)- Welcome back- Reminder: homework on contract law due next Tuesday- Who would like to move second midterm from Tues April 7 to Thurs April 9?Let’s begin with a little review.- We started this class by defining the notion of efficiency- Basically: the idea of maximizing the total surplus realized by everyone in societyo Efficiency requires that scarce resources be owned by whoever values them the mosto And that any action should be if its total social benefit exceeds its total social cost- We made the claim that we’re interested in designing a legal system that leads to efficient outcomes- What makes this hard?o Once we set up the rules, we don’t expect individuals to act based on what’s efficiento We expect individuals to do whatever is in their own best interest- So the goal is to set up the rules in such a way that people acting in their own best interest will naturally lead to efficiency- Coase gives us one way to do thiso Efficiency requires things to be owned by whoever values them the mosto Suppose we set up a legal system where things can be bought and soldo If I value something more than you, I can buy it from youo As long as property rights are clearly defined and tradeable, and there are no transaction costs, people have an incentive to trade until each resource is owned by whoever values it mosto This argument doesn’t depend on who starts with what – so Coase tells us that the initial allocation of rights doesn’t matter for efficiency, only for distribution- On the other hand, when there are transaction costs – impediments to private bargaining – we may not get to efficiency this way- This led us to two different normative views of the legal system:o One, that the legal system should aim to minimize transaction costs (“lubricate” private exchange, the normative Coase), since if we make transaction costs low enough, efficiency will follow- 1 -o Or two, that the legal system should aim to allocate rights efficiently (the normative Hobbes), so that less is lost when private exchange fails- 2 -We then looked in more detail at four questions a property system needs to address:1. What things can be privately owned?- One of the motivations for property rights was that without them, common resources would be overused- We distinguished between public and private goods- General principle: private goods should be privately owned- While public goods should be publicly owned/provided/regulated- We pointed out that society has an incentive to privatize a resource when the costsof boundary maintenance are smaller than losses due to overuse of common resourceso Demsetz: fur trade made furs more valuable and caused overhuntingo Loss due to overuse went up, leading Native Americans to develop privateland rightso Another neat theory is mentioned in the Friedman book: “we owe civilization to the dogs”o When dogs were domesticated, they could be trained to recognize their owner’s land and guard it, and so private ownership of farmland became feasible because the cost of boundary maintenance went down- Property rights over information – patents (to create incentive to innovate), copyrights (to encourage the supply of a public good)- Different types of public ownership (common access vs regulation vs unanimous consent)2. What can (or can’t) an owner do with their property?- General principle: maximum libertyo You can do whatever you want with your property, as long as it doesn’t infringe on anyone else’s rights or property- Nuisances, public and private nuisances- Other limitations on property rights, and economic rationale for eacho Rules against perpetuities – an owner can’t restrict heirs indefinitely (but can for one generation)o Emergency exception to rules against trespasso Inalienability –some entitlements can’t be sold (or even given away)o Unbundling – can’t always unbundle property rights But in some instances, you can – for example, with land in Pennsylvania, and with conservation easements in some locations- 3 -3. How are property rights established?- Fugitive property – paradigms of first possession and tied ownershipo first possession tends to be simpler to implemento but causes resources to be wasted in trying to gain possessiono example of this: Friedman on Homestead Act, saying that the resources wasted in starting to farm before it was efficient basically wasted much of the value of the land (p. 120 in Law’s Order)- First possession versus tied ownership is one example of the general tradeoff between simple, “bright line” rules versus more complex rules that might be morecostly to implement but create better incentiveso Pierson v Posto Fast Fish/Loose Fish versus Iron Holds The Whale- Verifying legal ownership (property deeds and car titles), acquiring title- Losing property rights – adverse possession, estray rules- Government’s rights to claim private property – eminent domain/takings, limitations (public use, just compensation); regulatory takings, abuse of takings4. What remedies are available when property rights are violated?- injunctions vs damageso injunctions simpler (cheaper) to implement, create bright-line property rights to encourage bargainingo damages more efficient when transaction costs are high (bargaining unlikely to succeed)- temporary versus permanent damageso temporary damages more efficient when damages are easy to calculate and technology is changingo permanent damages are more efficient when damages are hard to calculate and technology is stableand we called all that “property law”- 4 -Part of what makes property law straightforward is that trade tends to be simultaneous- I give you an apple, you give me $1- However, in some situations, efficient trade can’t be done simultaneouslyo It might be efficient for me to build you an airplaneo But it would be very complicated/costly for you to pay me each day for that day’s work- Contract law gives us a way to transact when one of us has to depend on a promise by the other- We motivated contract law by looking at the agency gameo if you can’t trust me to return your money, we miss out on a valuable investment opportunity- Contracts give a way for a promise to be legally binding, allowing us to cooperate in instances where we could not have otherwise- The first purpose of contract law: to enable cooperation- We introduced the Bargain Theory of contractso A promise is binding if it was


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UW-Madison ECON 522 - Lecture 15

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