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Property Law Economic Theory of Property


Property Law Economic Theory of Property The Economic Theory of Property The law of property is closely linked to the process of resource allocation and wealth ... – PowerPoint PPT presentation

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Title: Property Law Economic Theory of Property

Property LawEconomic Theory of Property
The Economic Theory of Property
  • The law of property is closely linked to the
    process of resource allocation and wealth
    distribution in a society.
  • Societies differ on matters relating to resource
    allocation and wealth distribution, implying the
    property law differs across societies.
  • Individuals within our own society have very
    different views on property (private vs public)
  • Nonetheless, every civil society must has a
    system of property law the notion of property
    cannot simply be ignored

Four basic questions of property law
  • 1 How are ownership rights established?
  • 2 What can be privately owned?
  • 3 What may owners do with their property?
  • 4 What are the remedies for the violation of
    property rights?

  • The following are some examples of the types of
    practical problems that arise with respect to
    each of these four basic questions of property

How are ownership rights established?
  • EXAMPLE In the early days of the Internet John
    begins using the address
  • As the Internet becomes better established as a
    commercial forum, the Coca Cola company wants to
    establish a website.
  • It realizes that John is already using its most
    obvious address name to provide a
    bulletin board for users of illicit drugs.
  • Can Coca Cola sue John to gain the use of the
    website address name?

  • John used the term coke as part of a website
    address first, perhaps long before anyone could
    have realized that it would have commercial value
    to Coca Cola.
  • Coca Cola would like to extend it registered
    trade mark ownership of the symbol COKE to its
    use on the Internet.
  • The rule of first possession implies that the
    first individual to use a resource has ownership.
    The rule of tied ownership would say that the
    ownership of a website address name could be tied
    to the ownership of the name itself. What should
    we do?

What can be privately owned?
  • EXAMPLE Narrow Passage Ferry Services has been
  • operating a ferry service between the mainland
    and Resort
  • Island each summer for the past 25 years.
  • This year it finds that the Seadoo Rental Company
    is renting jet boats, seadoos and water ski craft
    for use in Narrow Passage, which is a public
  • The resulting proliferation of recreational craft
    has disrupted the ferry service, making it much
    more hazardous, resulting in fewer trips per day
    and lower profits.
  • The Narrow Passage Ferry Service sues the Seadoo
    Rental Company for lost profits.

  • Does the rule of first possession apply?
  • Narrow Passage Ferry Company was there first but
    it is a public waterway?
  • Seadoo Rentals will likely argue that anyone,
    including its customers, should be allowed use of
    the waterway.
  • Should someone own the right to use the public

What may owners do with their property?
  • EXAMPLE Hidden Glen Golf and Country Club was
    built in 1930, in what was then a rustic area on
    the outskirts of the city.
  • Over the years, the city grew and now the club
    finds that the land it occupies is much more
    valuable as a housing subdivision than as a golf
  • Local residents are upset. The course is a
    natural green area and increases the value of
    their property.
  • The residents successfully argue that City
    Council should pass a motion banning the
    subdivision of the property.
  • The Golf Club sues the City demanding that it be
    allowed to proceed, or be fully compensated.

  • This is a dispute between the private golf club
    and the government.
  • What is a private individual or group allowed to
    do with their property?
  • Can a government place any restriction it finds
    convenient on private property use simply because
    it is politically expedient?

What are the remedies for the violation of
property rights?
  • EXAMPLE The Greens have owned their house for
    over 30 years. About 20 years ago they built a
    stone fence across their back yard. Their
    backyard neighbours, the Blues, moved in about 10
    years ago.
  • Recently the Blues noticed that the Greens stone
    fence extended about six inches onto their
  • The Blues complain to the Greens. The Greens
    agreed to either pay annual rental fees for the
    land or to simply buy the six inches of land from
    the Blues.

  • The Blues point out that this is trespass and sue
    the Greens to have them move the stone fence.
  • This situation has existed for 10 years why even
    consider it a trespass?
  • If it is trespass, should the court force the
    Greens to move their fence or simply make
    financial compensation?

  • How would Canadian courts rule in the above
  • Fortunately, this is not a problem for us as
  • We are interested in what economic theory
    suggests would be appropriate answers to the
    above questions.
  • The above questions represent both fundamental
    questions in property law and interesting
    economic problems.
  • (It is very easy to create interesting legal
    questions. It requires years of legal training
    and practice to develop sound legal answers.
    Luckily, it requires only some microeconomic
    theory to decide on what is an efficient

The legal concept of property
  • Property is a bundle of rights that describe
    what an individual may and may not do with the
    things they own (material or immaterial) the
    extent to which they may possess, use, transform,
    transfer or exclude others from their property.
  • There are two fundamental legal rights that are
    essential to any notion of ownership
  • 1 The owner is free to exercise the rights over
    his/her property. No law forbids, or requires
    the owner to exercise the rights.
  • 2 Others are forbidden from interfering with the
    owners exercise of her rights.

  • For example, the Forestry Company can cut down
    the trees they own or leave them standing. It is
    their decision. But environmentalists have no
    right to interfere in the harvesting of the trees
    if the Forestry Company decides to cut them down.
  • Ownership is at times described as a zone of
    privacy or as having liberty over things.
  • The concept of property, as a bundle of rights,
    is very general. It is consistent with the
    inclusion or exclusion of a very wide range
    specific rights in the bundle and also with a
    wide range of responsibilities imposed on the

This bundle of rights might change over time
  • Consider the owner of an apartment building on
    Riverside Drive in Windsor, Ontario.
  • What bundle of rights does she possess with
    respect to her building?
  • What bundle of rights did she create for
    herself when she first built the building in
  • How have these rights evolved over time and how
    has this affected the value of what she owns?
  • Consider, rent controls, zoning by-laws, sign
    posting by-laws, parking by-laws, fire
    regulations, etc.

Why does private property exist?
  • Is the concept of property a basic - primary
    human concept?
  • Like a parents care for a child, or the urge to
  • There might be some pretty deep evolutionary
    source for the human desire for ownership but we
    probably need other socio-economic theorys to
    explain the existence of private property rights.
  • Efficiency, greed, power, etc?
  • Economist like to believe that the institutions
    we see around us (social institutions that have
    existed for a very long time) are there for a
    reason and that the reason is generally
    consistent with our notion of efficiency.
  • Social institutions that have existed for a long
    time exist because they work! When they stop
    working they tend to disappear.

The origins of the institution of property a
thought experiment
  • Consider a primitive, or initial, state of the
    world in which
  • - there are people banded together in families or
  • - there is land, simple farm tools (sticks) and
    simple weapons (sticks).
  • - no laws, courts, police or government of any
  • Each family grows crops and steals crops from
    other families, and attempts to protect its crops
    from being stolen by others.
  • How much of each activity will each family do?

  • It depends on their productive abilities,
    including the quality of their tools, weapons and
  • Welfare maximizing rule for individual families
  • Contribute resources to each activity up to the
    point that the marginal benefit derived from the
    resources in the given activity is equal to the
    marginal benefit of devoting the same resources
    to any other activity (MRTSGK,L MRTSF K,L)
  • It would make no sense to devote all of the
    familys resources to building the most secure
    defence. It would make no sense to devote all of
    the familys resources to growing food.
  • Some families might specialize in (in the sense
    that they would tend to do more of) growing,
    defending or stealing. It would depend on their
    initial factor endowments.

An example
  • Consider the allocation of labour for a given
  • Current situation 10 units of labour for growing
  • 5 units of labour for fighting
  • MP of last unit of labour in growing 100 units
    of food
  • MP of last unit of labour in fighting 150
    units of food
  • The above is not a food maximizing allocation of
    family labour.
  • Consider the following
  • food available
  • to the family
  • Take 1 unit of labour out of growing falls by
    100 units
  • Put the 1 unit of labour into fighting
    increases by 150 units
  • Net gain 50 units of food
  • This process continues until MP of labour is
    equal in both activities
  • (recall diminishing marginal returns)

  • In this world farming and fighting are rational
    (maximizing) activities.
  • Is this social arrangement efficient? Maybe it
    is, but maybe it isnt. The society could
    certainly reached a Pareto Optimum in this state.
    Can the society get to a better Pareto
    Optimum? Can the PPF be pushed outwards?
  • Suppose that families really only enjoy eating
    and that they get no innate satisfaction from
    stealing or defending (fighting).
  • If we could find a mechanism which would limit
    the need to devote resources to fighting and
    thereby allow more food to be grown, families
    would be better off

  • A system of law which granted property rights,
    enforced by a government might do just that.
  • If it requires fewer resources to agree upon a
    set of property rights and organize a central
    authority to enforce those rights, then resources
    would be freed up for use in agriculture. (A
    natural monopoly in policing might exist.)
  • The families would have to agree on a social
    contract, which would include the bundle of
    rights to be included in property, how the
    government (authority) is selected, organized and
    financed, etc.
  • Such a social contract is said to take the
    families from a state of nature to a civil

  • To see how such a social contract might arise we
    need to understand when and how individuals might
    successfully co-operate
  • Intro_EE_Prop and Intro_FF_Prop slide sets which
    introduce Game Theory and the Bargaining Model

In terms of a bargaining game we can think of
  • The state of nature, or primitive society as
    the non-cooperative solution.
  • The threat values associated with this
    non-cooperative solution are the quantities of
    food consumption available to each family in a
    world in which they must each grow, steal and
    protect a world in which they cannot agree on a
    social contract.
  • A social surplus, or cooperative surplus, arises
    from a cooperative solution in which a set of
    property rights is agreed upon and a government
    is put in place to enforce those rights (no
    individual family need expend resources on
    stealing or protecting).

  • Will there be a cooperative surplus (social
    surplus) from organizing a civil society?
  • Only if it is more efficient to centralize
    fighting (enforcement of property rights).
  • The society must then decide on a mechanism to
    share the surplus. How much each family will
    contribute to the cost of the government and army
    (a system of taxes).
  • What is a reasonable division of the tax

  • Suppose the families currently devote resources
    that could grow 200 units of wheat to fighting
    (stealing and defending), and suppose that
  • - it will cost resource equivalent to 50 units
    of wheat to negotiate an agreement among the
  • - it will cost the equivalent of 50 units of
  • to run the government
  • Conclusion if the combined cost of negotiating
    an agreement and enforcing it - the cost of
    organizing and running the government
    (transaction costs) is less than the current
    expenditure of resources on fighting, then there
    will be a social surplus from cooperation
    (organizing a civil society).

EXAMPLE from textbook (changed slightly)
  • State of Nature (non-Cooperative Solution)
  • Family Corn Corn gained Corn lost Net Corn
  • Grown (theft) (theft) Consumed
  • Smiths 100 60 -20 140
  • Jones 200 20 -60 160
  • Total for
  • Society 300 80 -80 300

  • Note that the total corn consumed equals the
    total corn grown.
  • Theft simply re-distributes the corn.
  • Now suppose that by not having to devote
    resources to stealing and preventing theft, the
    Smiths and Jones could grow an additional 200
    bushels of corn (i.e. by transferring time, tools
    and other resources from stealing and defending
    to growing), use 100 bushels to organize and run
    the government and have 100 bushels left over.
  • This additional 100 bushels represents the
    cooperative surplus.

  • Civil Society (Cooperative Solution) assuming a
    reasonable solution - 50/50 split
  • Family Threat Share of Net corn
  • value surplus consumed
  • Smiths 140 50 190
  • Jones 160 50 210
  • Total for
  • Society 300 100 400

  • Note
  • The threat values are determined by the state of
    nature even if the reasonable solution
    applies, the income distribution is not uniform
    after a civil society is introduced.
  • All of this will only work if the cost of
    introducing a government is less than 200 bushels
    of corn (recall they will need to pay for the
  • Is this really how property rights originated? I
    dont know.
  • Economist do not like institutional explanations
    for anything!

  • Would Alberta or Quebec be more believable if
    they threatened to secede from Canada?
  • What if the United States invited Alberta to
    become the 51st state?
  • QUESTION Can we interpret the ending of the Cold
    War and the resulting peace dividend as the
    outcome of a cooperative solution among nations?

  • We do know that there is a strong tendency for
    modern society to avoid chaos and to try to
    establish property rights.
  • We do know that property rights evolve over time
    is part of the reason for this change that the
    threat values of individual groups change over
  • Maybe property rights are a form of technical
  • This is really just a more dynamic notion of
    efficiency in that a new social arrangement must
    be developed as threat values change.
  • We can think of a set of enforceable property
    laws as a kind of technology.
  • As an historical process, the development of
    property rights is an evolutionary process.

  • It might have began with a few rudimentary
    agreements among marauding bands of primitives,
    but it has continued on through the centuries and
    continues today.
  • Ownership of land has been long established. But
    what about the right to fish certain waters?
  • The right to oil or gas resources which flow
    under land owned by many owners?
  • The right to use a certain segment of the radio
    frequency, television frequency, cellular
    telephone frequency?
  • The right to a particular name for an Internet
  • These items, along with inventions, brand names,
    songs, poems, books, computer software, new forms
    of life and many other unique forms of property
    require an evolving and growing body of property

  • COMMENT In a modern society this social
    contract and related system of private property
    rights is fairly complex.
  • It has developed slowly over hundreds of years.
  • Consider the former Soviet Union
  • How quickly can a society which was more or less
    a feudal society under the Tsars, and had very
    limited private property rights under Communism,
    create a set of enforceable private property
  • The exercise which the former Soviet Union is
    undertaking is much more complex than our simple
    thought experiment applied to a primitive
  • Why bother? Because, the payoffs are enormous.

What comes first organized society (the law) or
property rights
  • Example in notes
  • There are four groups (families) of criminals,
    each of which supplies illegal goods and services
    (drugs, gambling, prostitution, etc.) throughout
  • Each gains revenue from supplying these goods and
    each steals from other crime families whenever
    possible (after all who is going to complain to
    the police).
  • As a result each family must spend resources
    (family members time, bullets, etc.) in
    protecting its operation from other criminals.
  • Is there a better solution? See on of the
    examples in Lecture notes Econ230bii.pdf