Econ 522 economics of law l.jpg
This presentation is the property of its rightful owner.
Sponsored Links
1 / 35

Econ 522 Economics of Law PowerPoint PPT Presentation


  • 96 Views
  • Uploaded on
  • Presentation posted in: General

Econ 522 Economics of Law. Dan Quint Spring 2010 Lecture 4. Outline. Last lecture, we… introduced static games, the matrix representation of payoffs, and how to find equilibria motivated the need for property law (“anarchy is inefficient”) Today… the Coase Theorem. Coase.

Download Presentation

Econ 522 Economics of Law

An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -

Presentation Transcript


Econ 522 economics of law l.jpg

Econ 522Economics of Law

Dan Quint

Spring 2010

Lecture 4


Outline l.jpg

Outline

  • Last lecture, we…

    • introduced static games, the matrix representation of payoffs, and how to find equilibria

    • motivated the need for property law (“anarchy is inefficient”)

  • Today…

    • the Coase Theorem


Slide3 l.jpg

Coase


The coase theorem l.jpg

The Coase Theorem

  • Ronald Coase (1960), “The Problem of Social Cost”

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

    • So the initial allocation of rights doesn’t matter for efficiency

  • However, it does matter for distribution

    • And if there are transaction costs, it may matter for efficiency too


An example of the coase theorem l.jpg

An example of the Coase Theorem

  • Your car – worth $3,000 to you, $4,000 to me

    • If I start out owning the car:

      no reason for you to buy it, I end up with it  efficient

    • If you start out owning the car:

      clear incentive for me to buy it, I end up with it  efficient

    • I’d rather start with it, you’d rather start with it…

    • …but either way, we get to the efficient outcome

  • The key: lack of transaction costs


Coase l.jpg

Coase

  • “In the absence of transaction costs, if property rights are well-defined and tradeable, voluntary negotiations will lead to efficiency”

  • You want to have a party next door to my apartment

    • Think of “party rights” like an object

    • I start off with “party rights” (right to be undisturbed):

      You can buy them if they’re worth more to you (and your guests)

    • You start off with party rights (right to have party):

      I can buy them if quiet is worth more to me than party is to you

    • Whoever starts with them, we still get to efficiency


Example coase uses a rancher and a farmer l.jpg

Example Coase uses: a rancher and a farmer


Example coase uses a rancher and a farmer8 l.jpg

Example Coase uses: a rancher and a farmer


Example rancher and farmer l.jpg

Example: rancher and farmer

  • Three possibilities:

    • Rancher builds fence around herd… $400

    • Farmer builds fence around crops… $200

    • Do nothing, live with damage… $0

  • If expected damage = $100…

  • If expected damage = $500…


Other examples from coase l.jpg

Other examples from Coase

  • Lots of examples from case law

    • a building that blocked air currents from turning a windmill

    • a building which cast a shadow over the swimming pool and sunbathing area of a hotel next door

    • a doctor next door to a confectioner

    • a chemical manufacturer

    • a 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 l.jpg

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 doctor’s 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 1312 l.jpg

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.


So summing up l.jpg

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 may matter for efficiency if there are transaction costs


Slide14 l.jpg

Bargaining


Some vocabulary about bargaining l.jpg

Some vocabulary about bargaining

  • Example from before:

    • Your car is worth $3,000 to you, and $4,000 to me

    • Suppose I have $10,000

  • $10,000 is my threat point

    • the payoff I can get on my own, by refusing to cooperate with you

    • also called reservation utility, or outside option

  • $3,000 is your threat point

  • Any outcome we both agree to must make us both at least as well-off as our threat point


Some vocabulary about bargaining16 l.jpg

Some vocabulary about bargaining

  • If I don’t buy the car from you…

    • my payoff is 10,000 (my threat point)

    • your payoff is 3,000

    • combined payoffs are 13,000

  • If I buy the car for some price P

    • my payoff is 4,000 + 10,000 – P = 14,000 – P

    • your payoff is P

    • combined payoffs are 14,000 – P + P = 14,000

  • $1,000 are the gains from trade (or gains from cooperation)

    • no trade  combined payoffs of $13,000

    • I buy car  combined payoffs of $14,000

    • if we cooperate, our combined payoffs increase by $1,000


Some vocabulary about bargaining17 l.jpg

Some vocabulary about bargaining

  • Threat points: 10,000 and 3,000

  • Gains from cooperation: 1,000

  • If gains from cooperation were divided equally…

    • we’d each get 500 more than threat point

    • my payoff would be 10,500, yours 3,500

    • Which means P = $3,500

  • (Coase doesn’t say gains will be divided equally, just that they’ll be divided in some way)


Let s go back to the rancher and farmer l.jpg

Let’s go back to the rancher and farmer

  • Cows do $500 damage; fence around herd costs $400; fence around crops costs $200

Rancher’s Rights

Farmer’s Rights

Rancher’s Threat Point

0

-400

Farmer’s Threat Point

-200

0

Gains From Cooperation

0

200

Rancher’s Payoff (IF…)

0

-300

Farmer’s Payoff

-200

100

Combined Payoffs

-200

-200


Relating coase to general equilibrium first welfare theorem l.jpg

Relating Coase to general equilibrium/first welfare theorem

  • General equilibrium

    • given prices, consumers maximize utility

    • given prices, firms maximize profits

    • prices are such that all markets clear

  • First Welfare Theorem: general equilibrium is efficient

  • But not when there are externalities, or “missing markets”

  • Allowing the consumer to negotiate with the firm is like introducing a “missing market” in air rights


Relating coase to general equilibrium first welfare theorem20 l.jpg

Relating Coase to general equilibrium/first welfare theorem

  • General equilibrium

    • given prices, consumers maximize utility

    • given prices, firms maximize profits

    • prices are such that all markets clear

  • First Welfare Theorem: general equilibrium is efficient

  • But not when there are externalities, or “missing markets”

  • Allowing the consumer to negotiate with the firm is like introducing a “missing market” in air rights


Slide21 l.jpg

Demsetz


We motivated property law by looking at a game between two neighboring farmers l.jpg

We motivated property law by looking at a game between two neighboring farmers

ORIGINAL GAME

MODIFIED GAME

Player 2

Player 2

Farm

Steal

Farm

Steal

10, 10

-5, 12

10 – c, 10 – c

-5 – c, 12 – P

Farm

Farm

Player 1

Player 1

12, -5

0, 0

12 – P, -5 – c

-P, -P

Steal

Steal

  • Changing the game had two effects:

    • Allowed us to cooperate by not stealing from each other

    • Introduced a cost c of administering a property rights system

21


Harold demsetz 1967 toward a theory of property rights l.jpg

Harold Demsetz (1967), “Toward a Theory of Property Rights”

  • “A primary function of property rights is that of guiding incentives to achieve a greater internalization of externalities”

  • “[ In order for an externality to persist, ] The cost of a transaction in the rights between the parties… must exceed the gains from internalization.”

  • “Property rights develop to internalize externalities when the gains from internalization become larger than the cost of internalization.”


Harold demsetz 1967 toward a theory of property rights24 l.jpg

Harold Demsetz (1967), “Toward a Theory of Property Rights”

  • “Property rights develop to internalize externalities when the gains from internalization become larger than the cost of internalization.”

  • Private ownership of land among Native Americans

    • Cost of administering private ownership: medium

    • Before fur trade…

      • externality was small, so gains from internalization were small

      • gains < costs  no private ownership of land


Harold demsetz 1967 toward a theory of property rights25 l.jpg

Harold Demsetz (1967), “Toward a Theory of Property Rights”

  • “Property rights develop to internalize externalities when the gains from internalization become larger than the cost of internalization.”

  • Private ownership of land among Native Americans

    • Cost of administering private ownership: medium

    • Before fur trade…

      • externality was small, so gains from internalization were small

      • gains < costs  no private ownership of land

    • As fur trading developed…

      • externality grew, so gains from internalization grew

      • gains > costs  private property rights developed


Friedman tells a similar story we owe civilization to the dogs l.jpg

Friedman tells a similar story: “we owe civilization to the dogs”

The date is 10,000 or 11,000 B.C. You are a member of a primitive tribe that farms its land in common. Farming land in common is a pain; you spend almost as much time watching each other and arguing about who is or is not doing his share as you do scratching the ground with pointed sticks and pulling weeds.

…It has occurred to several of you that the problem would disappear if you converted the common land to private property. Each person would farm his own land; if your neighbor chose not to work very hard, it would be he and his children, not you and yours, that would go hungry.


Friedman tells a similar story we owe civilization to the dogs27 l.jpg

Friedman tells a similar story: “we owe civilization to the dogs”

There is a problem with this solution… Private property does not enforce itself. Someone has to make sure that the lazy neighbor doesn’t solve his food shortage at your expense.

[Now] you will have to spend your nights making sure they are not working hard harvesting your fields. All things considered, you conclude that communal farming is the least bad solution.


Friedman tells a similar story we owe civilization to the dogs28 l.jpg

Friedman tells a similar story: “we owe civilization to the dogs”

Agricultural land continues to be treated as a commons for another thousand years, until somebody makes a radical technological innovation: the domestication of the dog.

Dogs, being territorial animals, can be taught to identify their owner’s property as their territory and respond appropriately to trespassers. Now you can convert to private property in agricultural land and sleep soundly. Think of it as the bionic burglar alarm.

-Friedman, Law’s Order, p. 118


Slide29 l.jpg

So…

  • Coase: if property rights are complete and tradeable, we’ll always get efficiency

  • Demsetz:

    • yes, but this comes at a cost

    • property rights will expand when the benefits outweigh the costs

    • either because the benefits rise…

    • …or because the costs fall

  • Of course, Coase wasn’t completely ignoring costs…


Slide30 l.jpg

TransactionCosts


Slide31 l.jpg

So…

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

  • This suggests that if there are transaction costs, voluntary negotiations may not lead to efficiency

  • Car example (yet again)

    • If transactions are costly, we may not trade

    • And if we do trade, we incur that cost


Quoting coase l.jpg

Quoting Coase…

“If market transactions were costless, all that matters (questions of equity apart) is that the rights of the various parties should be well-defined and the results of legal actions easy to forecast.

But as we have seen, the situation is quite different when market transactions are so costly as to make it difficult to change the arrangement of rights established by the law.

In such cases, the courts directly influence economic activity.

…Even when it is possible to change the legal delimitation of rights through market transactions, it is obviously desirable to reduce the need for such transactions and thus reduce the employment of resources in carrying them out.


We can see the coase theorem as either a positive or negative result l.jpg

We can see the Coase Theorem as either a positive or negative result

  • “In the absence of transaction costs, if property rights are well-defined and tradeable, voluntary negotiations will lead to efficiency.”

  • We can read this as…

    • “As long as transaction costs aren’t a big deal, we’ll get efficiency”

    • Or as, “we’ll only get efficiency automatically if there are no transaction costs”

  • Coase also gives two examples of institutions that may emerge in response to high transaction costs:

    • Firms

    • Government regulation


Slide34 l.jpg

What AreTransaction Costs?


Up next l.jpg

Up next:

  • What are transaction costs?

  • What do we do about them?


  • Login