Econ 522 Economics of Law

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Econ 522 Economics of Law. Dan Quint Fall 2011 Lecture 4. Last week, we…. …defined some important tools defined efficiency, and gave reasons for why we might want the law to be designed to be efficient showed how externalities (among other things) lead to inefficiency - PowerPoint PPT Presentation

Text of Econ 522 Economics of Law

  • Econ 522Economics of LawDan QuintFall 2011Lecture 4

  • Last week, we

    defined some important toolsdefined efficiency, and gave reasons for why we might want the law to be designed to be efficientshowed how externalities (among other things) lead to inefficiencyintroduced static games, the matrix representation of payoffs, and how to find equilibria

    showed two ways in which a lack of clear property rights can lead to severe inefficienciesoverfishing examplefarming/stealing game

  • Once we have private property rights, well have conflicts between mine and yours

    My neighbor likes tall treescan he plant a tree on his property if it shades my pool, or blocks my view?

    You want to have a partydo you have the right to make noise in your house?or do I have the right to a good nights sleep in my house?

    I own a small power plant located on a riverdo I have a right to use water from the river for cooling?do I have a right to pollute as much as I want?

  • *

    Cooter and Ulen: property isA bundle of legal rights over resources that the owner is free to exercise and whose exercise is protected from interference by others

    Doesnt tell us how property law should be designed

    Need to answer four fundamental questions:What things can be privately owned?What can (and cant) an owner do with his property?How are property rights established?What remedies are given when property rights are violated?

    Today: wild animals and CoaseUp next: how should we design property rights to achieve efficiency?

  • Foxes

  • *

    Pierson v. Post (NY Supreme Court, 1805)Lodowick Post organized a fox hunt, was chasing a foxJesse Pierson appeared out of nowhere, killed the fox and took itPost sued to get the fox backLower court sided with Post; Pierson appealed to NY Supreme Court

    Question: when do you own an animal?One early, classic property law case

  • *

    Court ruled for Pierson (the one who killed the fox)If the first seeing, starting, or pursuing such animals should afford the basis of actions against others for intercepting and killing them, it would prove a fertile source of quarrels and litigation(Also: just because an action is uncourteous or unkind does not make it illegal)

    Dissenting opinion: a fox is a wild and noxious beast, and killing foxes is meritorious and of public benefitPost should own the fox, in order to encourage fox huntingOne early, classic property law case

  • *Pierson gets the fox

    simpler rule (finders keepers)

    easier to implement

    fewer disputesSame tradeoff we saw earlier:Post gets the fox

    more efficient incentives

    (stronger incentive to pursue animals that may be hard to catch)

    Just like Fast Fish/Loose Fish vs Iron Holds The WhaleFast Fish/Loose Fish is the simpler rule, leads to fewer disputesIron Holds the Whale is more complicated, but is necessary with whales where hunting them the old-fashioned way is too dangerous

  • Coase

  • How should property rights be allocated?

    More specifically, under certain conditions, it doesnt matter for efficiency(Although it does matter for distribution)

    Coase Theorem: in the absence of transaction costs, if property rights are well-defined and tradable, then voluntary negotiations will lead to efficiencyIt doesnt matter how rights are allocated initiallybecause if theyre allocated inefficiently, they can be sold/traded until theyre allocated efficiently

    Coases surprising answer: it doesnt matter

  • Example of Coase: you have a car worth $3,000 to you, $4,000 to meObviously, efficient for me to own itbut we dont need the law to give me the carIf I start out owning the car:no reason for you to buy it, I end up with it efficientIf you start out owning the car:clear incentive for me to buy it, I end up with it efficientRegardless of who owns the car at first, we get to the efficient outcomeId rather start out with the car so I dont have to pay you for itYoud rather start out with it so you end up with more moneyEfficiency doesnt care about distribution how much money we each end up with just who ends up with the car at the end.And that doesnt depend on who starts with it.The key: lack of transaction costs

  • Another example: you want to have a party in the house next door to mineIf its efficient for you to have the partyYour benefit from having the party is greater than my benefit from a good nights sleepIf you start out with the right to have the party, no problemIf I start out with the right to quiet, you can pay me for the right to have the partyIf its efficient for you not to have the partyGood night sleep is worth more to meIf I have right to silence, no problemIf you have right to party, I can pay you not to have itThe point: either way, we achieve efficiencyIf its efficient to have the party, you have the partyIf its efficient not to, you dontRegardless of who started off with the right

  • The conditions for this to hold

    Property rights have to be well-definedWe need to be clear on who has what rights, so we know the starting point for negotiations

    and tradableWe need to be allowed to sell/transfer/reallocate rights if we want

    and there cant be transaction costsIt cant be difficult or costly for us to buy/sell the right

  • The Coase TheoremRonald Coase (1960), The Problem of Social Cost

    In the absence of transaction costs, if property rights are well-defined and tradable, voluntary negotiations will lead to efficiency.So the initial allocation of rights doesnt matter for efficiency

    However, it does matter for distributionAnd if there are transaction costs, it may matter for efficiency too

  • Coases example: a rancher and a farmer

  • Ranchers versus farmers rights

    English common law: closed range or fencing-in (or farmers rights)Ranchers have responsibility to control their cattleRancher must pay for any damage done by his herd

    Much of the U.S. at various times: open range or fencing-out (or ranchers rights)Rancher can let his cattle roam freeNot liable for damage they do to farmers crops(unless farmer had a good fence and they broke through anyway)

    Which rule is more efficient?

  • Open range versus closed range

  • Coase: either law will lead to efficiency

    If its cheaper for the farmer to protect his crops than for the rancher to control his herdUnder open range law, thats what hell doUnder closed range law, rancher can pay farmer to build fence

    If smaller herd is more efficient, farmer can pay rancher to keep fewer cattle

    Coase:Whatever is the efficient combination of cattle, crops, fences, etc.the rancher and farmer will negotiate to that efficient outcome, regardless of which law is in placeas long as the rights are well-defined and tradable and there are no transaction costs

  • Rancher and farmer: numerical example

    Three possibilities:Rancher builds fence around herd costs $400Farmer builds fence around crops costs $200Do nothing, live with damage costs nothing

    If expected crop damage = $100Open range: farmer lives with damage rather than building fenceClosed range: rancher pays for damage rather than fence

    If expected crop damage = $500Open range: farmer builds fence efficientCoase: closed range: rancher pays farmer to build fenceSo efficient outcome under either rule

  • Other examples from Coase

    Lots of examples from case lawa building that blocked air currents from turning a windmilla building which cast a shadow over the swimming pool and sunbathing area of a hotel next doora doctor next door to a confectionera chemical manufacturera house whose chimney no longer worked well after the neighbors rebuilt their house to be taller

    In each case, regardless of who is initially held liable, the parties can negotiate with each other and take whichever remedy is cheapest to fix (or endure) the situation

  • Quoting from Coase (p. 13):Judges have to decide on legal liability but this should not confuse economists about the nature of the economic problem involved.

    In the case of the cattle and the crops, it is true that there would be no crop damage without the cattle. It is equally true that there would be no crop damage without the crops.The doctors work would not have been disturbed if the confectioner had not worked his machinery; but the machinery would have disturbed no one if the doctor had not set up his consulting room in that particular place

  • Quoting from Coase (p. 13):If we are to discuss the problem in terms of causation, both parties cause the damage.

    If we are to attain an optimum allocation of resources, it is therefore desirable that both parties should take the harmful effects into account when deciding on their course of action.

    It is one of the beauties of a smoothly operating pricing system that the fall in the value of production due to the harmful effect would be a cost for both parties.

  • What does Coase mean by a cost for both parties?

    If the cheapest alternative is for the farmer to build a fence for $200The cost to build a fence is $200But the cost to not build a fence is more than $200 since under a closed-range law, the farmer could ask the rancher for more than $200 to build the fence

    Opportunity cost

  • So, summing up

    Coase Theorem: In the absence of transaction costs,if property rights are well-defined and tradeable,voluntary negotiations will lead to efficiency.

    The initial allocation of property rights therefore does not matter for achieving efficiency

    although it does matter for distribution

    and it only works if there are no transaction costs

    If there are transaction costs, then th