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UW-Madison ECON 522 - Lecture 7

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Econ 522 – Lecture 7 (Sept 23 2008)Logistics- next week: no class Tuesday, no office hours Wednesday- working together on homework- reminder: homework is due when I start lecture on Thursday, anything after will be penalized (sorry)Last week- discussed some examples of what can be privately owned – information (through patents, copyrights, trademarks, trade secrets), corporations- and some ways property rights are established (fugitive property) and not established (sale by thief); and examples of how property rights are verified, as well as how they can be lost (through adverse possession and by losing the property itself)Next: some applications of What can owners do with their property?One thing owners can typically do with their property is to determine who gets it when they die.- This wasn’t always the case. In medieval England, land passed automatically to the owner’s eldest son, and changes to this could only be made under very particular circumstances- Feudal and tribal societies typically specified who inherited land, and restricted the sale of land, especially to outsiders- Over time, however, the trend in Western countries has been towards more freedom to specify of owners to specify who will inherit their property and what they may do with it.What effect do limitations like this have?- Suppose I own some large estate, which the law says I must pass on to my eldest son when I die, but I’d prefer to give it to my daughter- One thing I can do: look for ways to circumvent the rules- I might be able to sell her the property now, and rent it back from her while I’m still alive- There might be other technicalities that allow me to get around the intent of the law- But these are likely to be somewhat costly, so I would incur what the book refers to as Circumvention Costs.On the other hand, it may be too costly, or impossible, for me to give the property to my daughter; I may have to accept the fact that it will go to my lazy, worthless son- In this case, I’m likely to start caring much less about the value of my estate after I am gone, which creates an incentive for me to use the property inefficientlyo I may choose to overhunt now, not caring whether I wipe out the animals on my lando I might cut down trees prematurely, before they mature all the way, to get more use out of the land now (while I’m alive) at the expense of its future value (which I no longer care about)- The book refers to the loss due to these decisions as Depletion Costs – inefficiencies I bring on because I stop caring as much about the future value of the property.Circumvention costs and depletion costs seem to argue in favor of giving an owner more freedom in determining what happens to his property after he dies. However, there is also a danger when this freedom is made too absolute.- Suppose that the estate I own is my family’s ancestral home, and I specify in my will that nobody should ever use that land for purposes other than a residence- I die, and several years later, my heirs want to turn the land into a golf course, or sell it to a developer to turn into a mall. Should this be allowed, or should the restrictions in my will be upheld?o If my restrictions are routinely set aside by the law, then we return to the old problem – since I don’t have control over what will happen to my estate after I die, I have an incentive to circumvent the law or to deplete the value of the propertyo On the other hand, if the restrictions are typically upheld, it becomes difficult to maintain efficiency as circumstances change, since my heirs may not be able to put the land to its most valuable use (or sell it to an owner who values it more).- If I’m wealthy but don’t trust my childrens’ judgment, I may try to create a trust that will prevent them from accessing most of my wealth until they reach a certainage. Similarly, if I don’t trust them to use my estate wisely, I may try to put restrictions on what they can do with it.- Earlier, we used the term “inalienability” to define entitlements which you are notallowed by law to get rid of- Limitations on the use of property are sometimes called “restraints on alienation,” since among other things they limit an heir’s legal right to dispose ofthe property- English common law typically imposes a time limit on such restrictions, ruling out what is referred to as a perpetuity, a restriction that would last forevero Thus, I can legally restrict what happens to my property after I die for a certain length of time, but not forever.o The time limit is typically defined as “lives-in-being plus 21 years,” that is, they are binding for the lifetime of my heir plus an additional 21 years.- The effect of this time limit is basically to allow me to place restrictions on the next generation, but not the generation after thato If I pass my estate on to my daughter, with the restriction that it not be sold or developed into for commercial uses, this limits my daughtero But once she dies and passes the estate on to her children, after a certain length of time, they will be free to do what they want with it- Thus, this acts as a “generation-skipping rule” – I’m free to do what I want, and the second generation after me is once again free to do what they want, but the generation in between is not.This sort of law makes a lot of sense if you assume that “most” heirs will be prudent and well-behaved, but that every once in a while someone will come along whose judgment can’t be trusted. The law protects my estate from a single bad heir, since whoever passes the property on to them can restrict them; but it does not tie up the property forever in what might eventually be an inefficient way.Exceptions to Property RightsWe said before that property rights are typically protected by injunctive relief – using another owner’s property without permission is typically considered criminal trespass. When transaction costs are low, this leads to bargaining and through bargaining to efficient use of the property.However, these restrictions are not absolute. We already noted there are “fair use” exceptions to copyright protection – even though a copyright is a form of ownership, there are ways in which I can use others’ property legally, such as for educational purposes or in satire. There are also exceptions in general property law. The Supreme Court of Vermont decision established one such exception, in the case of Ploof


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UW-Madison ECON 522 - Lecture 7

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