ECO320H1 Chapter Notes - Chapter 4: The Surplus, Public Administration, Progressive Tax

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23 Nov 2014
ECO 320
Textbook Notes
Chapter 4: An Economic Theory of Property
Law of property supplies the legal framework for allocating resources and
distributing wealth.
Economic theories about property try to predict the effects of alternative forms of
Rule of first possession: the first party to use an unowned resource acquires claim
to it.
Incompatible uses: the law deals with this problem by trying to prevent property
owners from interfering with each other (there is a trade-off, however, between
competing activities – who is interfering with who?).
oLegal outcome of a case depends on whether the issue at hand constitutes
a “nuisance”.
Injunction: a court order not to do something (or to do something).
Fundamental questions of property law:
oHow are ownership rights established
oWhat can be privately owned?
oWhat may owners do with their property?
oWhat are the remedies for violation of property rights?
Property: a bundle of rights.
oThese rights describe what people may/may not do with the resources they
They may change from generation to generation.
Three facts about property rights:
oThe rights are impersonal in the sense they attach to property, not persons.
The ownership of the property gives the rights to the owner.
oThe owner is free to exercise the rights over his property (no law forbids
or requires the owner to exercise those rights).
oOthers are forbidden to interfere with the owner’s exercise of his rights.
If they do, the court will enjoin them to stop.
Summary of facts above
property gives owners liberty over things.
In a bargaining game whereby one person values a resource at less than the other
person, both can benefit from cooperating (i.e. car worth $3000 to the seller and
$4000 to the buyer; $3,000 < p < $4,000).
oThe person who values it less can move it to the person who values it
The price will be bargained between the two parties and will be
between the price the person who values it less at and the price the
person who values it more at.
Negotiation is an advantage of bargaining games.
oCooperative surplus: the value created by moving the resource to a more
valuable use (the share enjoyed by each party will depend on the ultimate
price the resource is sold at).
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oA noncooperative solution is whereby the two parties cannot negotiate a
price successfully and the resource is never transferred.
The total value of the solution would be the sum of the threat
values of each party.
Threat value: the value of keeping the resource for the
seller and the amount of cash the buyer has.
oThe value of the cooperative solution will be the sum of the value of the
resource to the buyer and the amount of cash retained of the original
amount and the amount received by the seller.
The surplus from cooperation is the difference in value between
the cooperative and noncooperative solutions.
In a society where no government protects property, individuals are forced to
allocate certain resources to defending their property while the rest go towards
other productive means.
oThe allocation of the resources will be in such a way that at the chosen
point, the value of resources used to protect the land (MB) equals their
value when used for other productive means (marginal opportunity cost).
I.e. MB = MC
oIf law could protect the property of all peoples at a lower cost than the
sum of all individuals protecting themselves, there is an inefficiency in the
Governments will enjoy economies of scale since the more people
they protect, the less costly it is on each person to provide the
Social contract: the bargain reached through negotiations of
individuals regarding the terms for establishing a government to
recognize/enforce their property rights.
It establishes the basic terms for social life.
oThe threat value in this would be the individual costs to each person of
protecting their own land.
oThe social surplus = sum of individual costs of protecting their own land –
total cost of operating a property-rights system in civil society.
Also is the cooperative surplus.
oThe advantages of cooperation arise from the social contract that includes
the fundamental laws of property.
New forms of property arise continually (creates the need to establish and enforce
rights to those new forms).
oI.e. in the last decade
MP3s, computer software etc.
Societies created property as a legal right to encourage production, discourage
theft, and reduce the costs of protecting goods.
Law is unnecessary and undesirable where bargaining succeeds.
oTerms bargained are often more efficient when people agree on them
themselves than when a lawmaker imposes them.
Basis of the Coase Theorem.
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Law is necessary and desirable where bargaining fails.
When one activity interferes with another, the law must decide whether one party
has the right to interfere (“ranchers’ rights” or “open range”) or whether the other
party has the right to be free from interference (“farmers rights” or “closed
oFairness apparently requires the party who causes harm to pay for it.
This may not be the efficient outcome.
I.e. farmer and ranger example where the farmer can build
a fence at a lower cost than the ranger (ranger is causing the
harm); by cooperating, the ranger can agree to pay the cost
the farmer would pay to build the fence and the two can
split the savings achieved by the ranger.
oIn this case bargaining has led to an efficient use of
resources as opposed to law since law would require
the ranger to pay (at a higher cost) to build the
Transaction costs: all impediments to bargaining (as defined by Coase).
Summary of the Coase Theorem:
oWhen transaction costs are zero, an efficient use of resources results from
private bargaining, regardless of the legal assignment of property rights.
Coase Corollary
oWhen transaction costs are high enough to prevent bargaining, the
efficient use of resources will depend on how property rights are assigned.
I.e. case with the farmer and rancher, if transaction costs are too
high, the law would have to rule in favour of the rancher so that the
farmer has to pay the lower amount to fence in his property for
there to be an efficient use of resources.
Three forms of transaction costs:
oSearch costs
Tend to be high for unique goods/services and low for standardized
oBargaining costs
When information is “private” (i.e. parties do not all know each
other’s threat values), bargaining costs are higher.
The element of private information of one party impedes
bargaining because much of it must be converted into public
information before computing reasonable terms for cooperation.
Each party will try to extract information from the other
and this is time consuming.
All information won’t become public since the share of the
cooperative surplus each party gets depends, in part, on
keeping some information quiet.
oI.e. not saying all the defects that a house has so that
a higher price is received from the buyer.
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