01:220:395 Lecture 4: Chapter 4

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7 Nov 2018
CHAPTER FOUR: An Economic Theory of Property
I. The Legal Concept of Property
- From a legal viewpoint, property is a bundle of rights
- These rights describe what people may/may not do with the resources
they own, the extent to which they may…
Possess, use, develop, improve, consume, deplete, destroy, sell,
donate, transfer, etc.
- These rights are impersonal in the sense that they attach to property, not
This is in contrast to contract rights, which are personal in the
sense that one person owes something to another person
- The owner is free to exercise the rights over his/her property, no law
forbids or requires the owner to exercise those rights
- Others are forbidden to interfere with the owner’s exercise of rights
If others interfere, the court will enjoin them to stop, issue an order
- Property creates a zone of privacy in which owners can exercise will
without being answerable to others
II. Bargaining Theory
- Economic theory of bargaining games is the foundation of the economic
theory of property
- Example: Adam lives in a small town & has a 1957 Chevy convertible in
good repair. The pleasure of owning/driving the car is worth $3000 to
Adam. Blair, who has been coveting the car for years, inherits $5000 and
decides to try to buy the car from Adam. After inspecting the car, Blair
decides the pleasure of owning/driving the car is worth $4000 to her
The potential seller values the car less than the potential buyer, so
there is a scope for a bargain
Adam will not accept less than $3000 and Blair will not pay more
than $4000, so the sale price is between those two values (a
reasonable price would be $3500)
Reinstate Game Theory (both parties can benefit from cooperating
with each other)
Moving the resource (the car) from someone who values it less
(Adam) to someone who values it more (Blair) will create $1000 in
Cooperative Surplus: the value created by moving the resource to
a more valuable use
Share of this surplus depends on price car is sold ($3500 causes
each to have $500 of the value created by the exchange)
If the price is set at $3800, value will be divided unequally, Adam
will get of the value or $800 while Blair only gets or $200
(and if $3200, Adam gets $200 and Blair gets $800)
Cooperative solution: they agree and exchange, Noncooperative
solution: fail to agree on price and fail to exchange
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Threat Values: the payoffs to the parties in the noncooperative
solution (would be $3000 for Adam, the value of keeping his car
and $5000 for Blair, the value for keeping her cash)
The value of the non cooperative solution is the sum of the threat
values $3000 + $5000 = $8000
The value of the cooperative solution, if they agree on $3500, is
$4000 (the value of the car to Blair) + $1500 (the amount hat Blair
retains of her original $5000) + $3500 (the amount received by
Adam for the car) = $9000
The surplus from cooperation is the difference in value between
cooperation and noncooperation ($9000 - $8000 = $1000)
- Summary: process of bargaining has 3 steps (establishing the threat
values, determining the cooperative surplus, and agreeing on terms for
distributing the surplus from cooperation)
III. The Origins of the Institution of Property: A Thought Experiment
- Law is a mechanism that uses fewer resources to achieve the same level
of protection for property claims (similar to finding a mechanism for
efficient production)
- The bargain eventually reached by such negotiations is called the social
- First you describe the State of Nature: a situation that corresponds to the
threat values of the non-cooperative solution, which prevails if the parties
cannot agree
- Second you describe the advantages, the game’s cooperative solution,
which prevails if the parties can agree
- The social surplus is the difference between the amount spent in the state
of nature and the total cost of the cooperative surplus
IV. The Economic Theory of Property
A. The Coase Theorem
- Example: Farmer and cattle rancher live next to each other and cattle
keeps running from the rancher’s land to the farmer’s land, damaging the
- Two specific rules the law could adopt...
The farmer is responsible for keeping the cattle off his property,
and he must pay for the damages when they get in (“ranchers’
rights” or “open range”)
The rancher is responsible for keeping the cattle on her property,
and she must pay for the damage when they get out (“farmers’
rights” or “closed range”)
- Coase responds in terms of efficiency: we would like a legal rule to
encourage efficiency in both ranching and farming
- By bargaining to an agreement rather than following the law non-
cooperatively, the rancher and farmer can save money
- The first legal rule’s efficiency is apparent
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