ECON 303 – Law and Economics
Property Rights
Topic 1 – Property Rights – Introduction
Ø Economy Rights, Contracts, Crime and Torts
Ø Who is entitled to rights?
Ø Setting initial entitlements – who has the right to do what
Ø Provides with a legal framework for allocating resources and distributing wealth –
the economic goal is the efficient resource allocation
Ø Entitlements – first order decision – when there is scarcity there will be conflicting
interests – the law must decide whose rights will prevail
Ø After making the decision society must decide how to enforce the choice
Ø How do you protect those entitlements – Property rule – highest level of freedom of
exchange – your right is protected by a property rule – but I can buy that right from
you in a voluntary exchange
Ø Liability rule – if you own a house that’s in the path of a new motorway – they can
through legislation take your land – involuntary exchange – but you will be
compensated – the value of the land will be determined through some process
Ø Hold out – when someone chooses not to give up their property right
Ø Inalienable rule – legally not possible to trade – such as organ sale and rights of
women to work
Ø Economic efficiency
- Administrative efficiency – low transaction costs – we assume there are no
transaction costs – but in the real world there are many – such as hiring legal aid
to help with contract interpretation
- Pareto efficiency
- Dynamic efficiency – reward innovators by protecting their inventions which
benefit society
- If wealth comes into play, then negotiations could lead to different outcome –
this is because a person with deep pockets can influence decisions
st
Ø 1 welfare theorem – is that markets will eventually produce a pareto efficient
outcome
Ø Pareto efficiency is achieved when you cannot make one party better off without
making another worse off – the result you end at to achieve pareto efficiency
depends greatly on the initial endowment
Ø 2nd welfare theorem – you tell me what your initial endowment is and I can adjust
that to achieve efficiency
Ø Distribution goals – you tell me the initial endowment that is relevant – and I can
deliver that to you – government through tax and grants
Ø We all use access to space – it became a scarce resource in the digital age – the right
to use space is tradeable and companies compete to use that space
Ø When setting initial entitlements – there is a concern that some people in society do
not have the ability to compete due to wealth or cultural reasons – so you set aside
those rights to allow them to use it
Ø You do not have absolute rights – some of those rights are controlled by the
government
,Ø Attenuation is a dilution of rights
Ø Liability rules – we could simply enforce initial entitlements and enforce voluntary
contracts
Ø Inalienable entitlements – forbidding sale of certain goods and services – some
examples in NZ are Maori fishing quota, conservation land, body parts
Ø Harold Demsetz (1964) – the market provides a valuable and costly service
Ø The market facilitates exchange of goods and services – gives us information such as
price – P=MC also informs us of the costs
Ø Acceptable allocation mechanism we need it to provide us with the benefits and
costs – and you need people to take account of the information
Ø And you need individuals to be motivated to take on that information – by willing to
pay
Ø The value depends on the property rights – depends on how those rights are
enforced – for example, if anyone could use your property the value of it would be
zero because people a free riding on your investment
Ø Common pool resources – oil, water, fish, gas, geothermal – absence of property
rights results in too rapid depletion – prices reflect private costs and benefits
Ø Importance of exclusion – has a valuation function – ability to stop others from
utilizing the benefits that flow from your investment
Ø Public goods – non-excludability and non-rivalry in consumption – transaction costs
depend on technology
Ø Demsetz recommends that when transaction costs exceed value of information
received the price should be zero
Ø If you are maximizing your profit you produce at MVP=W – if there is
open access however, you will give hire labour until the point where
there is no extra profit to be made – this leads to depletion of
resources
Ø Evolution of property rights – as benefits-costs change due to technology as long as
there are net benefits the rights will continue
Ø For example, fur market – value of fur increased this resulted in over-hunting which
led to a negative externality
Ø This led to restriction on where and when you could hunt – so there were net
benefits so property rights would arise
Ø NZ example would be the kauri gum – all you needed was a spear and axe to get it
and it was the main export of Auckland between 1850-1900
Ø In 1890s there was resource depletion as people started cutting the trees to get the
gum – and new oil-based machines made the price of gum fall and by 1940s the
market came to end
Ø The land was owned by the crown – before 1888 it was open access and then
restrictions were placed – but a lot of costs associated with recovering the revenue
from those licenses
,Property Rights – Initial Entitlements
Ø Property rights occur as value of resource increases sufficiently to offset costs of
definition & enforcement
Ø Allocation mechanism
- First-possession: Assign ownership on first-come first-served basis
§ Advantages – those with experience with exploiting, recognizes innovations
supports risk takers and low-cost method
§ Disadvantages – discriminates new entrants and ring fence their innovation
- Uniform allocation – equal sharing rules – divide between everyone equally and
then allow people to trade
§ Advantages – if trade is allowed it will go to those who value it most,
avoids measuring claims and parties are homogenous
§ Disadvantages – opposition to re-allocation by existing users and could
involve costs of definition and enforcement
- Auction – directly allocate resource to those that attach high value to ownership
§ Advantages – avoid TC’s of reallocation, generates revenue and if rents
accrue to the state then avoid distributional arguments
§ Disadvantages – resistance from incumbents and obvious costs of running
an auction
Ø Roles of state and market
- Property rights are clear, secure and certain – so that you can trade
- Markets require clear assignment of initial entitlements and well-enforced rules
of contract
- Property rights are produced in response to market demand – government and
market has a role to make it work
Auctions
Ø First Price Auction – winner is the one that bids the highest
Ø Second Price Auction – the winner is the highest bidder but pays the second highest
price
Ø Floor Price –
§ Hard Floor minimum the seller is prepared to accept – will not accept anything
below
§ Soft Floor – if bids do not know the hard floor – soft floor could be used to
catch those bids that are below but close to the hard floor
Ø Auctioning similar items – Treasury bonds – Carbon emission permits
Ø Private value auctions – each bidder knows his/her own valuation. Value of painting
to me is $500, to you it is $300. My valuation does not depend on your information
Ø Art Auction – ascending bid start low and bid up – descending bid auction start high
and bids decline (first person to put their hand up gets the good)
Ø Ascending: Yes bidders reveal their true valuation – bidding up to your true valuation
is the dominant strategy
Ø Descending: No – each bidder “shades down” his bid
Ø Common value auctions – all bidders have the same valuation but they don’t know
what it is – most real world auctions have a mixture of private and common –
example can be price of a barrel of oil is $70
, Ø Winner’s curse – tendency to overbid due to the fact that bidder with highest
estimate (or signal) will win
Ø The optimal strategy in this case is to bid less than your estimated value
Ø Common types of bids
§ Open outcry bid – ascending – auctioneer announces increasing prices
§ Descending – decreasing bids until someone puts up their hand
§ Sealed bid auction – people put their bid in an envelope and highest bid
wins
Ø Static bids are when you have a homogenous divisible product – and two pricing
is used the uniform price and pay as you bid
Ø In sealed bids – people will pay P* which is the market clearing rate – some
may shade their bid in order to influence the price to be lower
Ø Pay as you bid – bidders pay the amount they bid – the tendency is to stay
slightly above P* - this favors larger players
Ø Ascending bid auction with clock – as the clock runs out the bids will
automatically have a tendency to become higher – auctioneer announces price
& bidders respond
Ø More expensive than sealed-bid but considered transparent & possibly generates
more revenue
Ø Reverse auction – this is where the buyers and sellers’ roles are reversed – the buyer
can ask for a service such as installation of a machine – and sellers bid in order to get
the opportunity to provide that service – the lowest bid will usually win
Ø Sellers compete to obtain business from the buyer and prices will typically decrease
as the sellers undercut each other
Property Rights – Structure & Shape
Ø Something is sustainable when you use up to a certain amount of it – but if you go
past it the resource will deplete
Ø When exclusion is a=0 then anyone can come use it – a=1 is perfect exclusion so
only you can use it – this means you need to monitor the use of the resource
Ø Present value of individual gain from use is harvest is U (a) – the value to me would
be the value over time summed up and discounted to me right now – that would be
the utility I get from accessing the resource
Ø If there is no scarcity – then there are no gains from exclusion – and if exclusion is
imposed, then the sum of utility will fall
Ø When there is scarcity – if you don’t exclude then utility falls – energy in the field will
fall and we will get an unsustainable resource because of free
riding – if we increase the degree of exclusion it will create benefits
Ø From the graph if costs are at C1 then the degree of exclusion that
is beneficial is 0 – since costs of exclusion exceed the benefits
Ø An example of this was fisheries – it costs a lot to prevent someone
from fishing, so exclusion is left at 0
Ø The optimal level of exclusion is when the slope of the benefits U is equal to the
slope of the costs
Ø In microeconomics the costs are influenced by the technology – the level of labour
and capital – the costs some time ago would have been very high so it was difficult
to exclude others
Property Rights
Topic 1 – Property Rights – Introduction
Ø Economy Rights, Contracts, Crime and Torts
Ø Who is entitled to rights?
Ø Setting initial entitlements – who has the right to do what
Ø Provides with a legal framework for allocating resources and distributing wealth –
the economic goal is the efficient resource allocation
Ø Entitlements – first order decision – when there is scarcity there will be conflicting
interests – the law must decide whose rights will prevail
Ø After making the decision society must decide how to enforce the choice
Ø How do you protect those entitlements – Property rule – highest level of freedom of
exchange – your right is protected by a property rule – but I can buy that right from
you in a voluntary exchange
Ø Liability rule – if you own a house that’s in the path of a new motorway – they can
through legislation take your land – involuntary exchange – but you will be
compensated – the value of the land will be determined through some process
Ø Hold out – when someone chooses not to give up their property right
Ø Inalienable rule – legally not possible to trade – such as organ sale and rights of
women to work
Ø Economic efficiency
- Administrative efficiency – low transaction costs – we assume there are no
transaction costs – but in the real world there are many – such as hiring legal aid
to help with contract interpretation
- Pareto efficiency
- Dynamic efficiency – reward innovators by protecting their inventions which
benefit society
- If wealth comes into play, then negotiations could lead to different outcome –
this is because a person with deep pockets can influence decisions
st
Ø 1 welfare theorem – is that markets will eventually produce a pareto efficient
outcome
Ø Pareto efficiency is achieved when you cannot make one party better off without
making another worse off – the result you end at to achieve pareto efficiency
depends greatly on the initial endowment
Ø 2nd welfare theorem – you tell me what your initial endowment is and I can adjust
that to achieve efficiency
Ø Distribution goals – you tell me the initial endowment that is relevant – and I can
deliver that to you – government through tax and grants
Ø We all use access to space – it became a scarce resource in the digital age – the right
to use space is tradeable and companies compete to use that space
Ø When setting initial entitlements – there is a concern that some people in society do
not have the ability to compete due to wealth or cultural reasons – so you set aside
those rights to allow them to use it
Ø You do not have absolute rights – some of those rights are controlled by the
government
,Ø Attenuation is a dilution of rights
Ø Liability rules – we could simply enforce initial entitlements and enforce voluntary
contracts
Ø Inalienable entitlements – forbidding sale of certain goods and services – some
examples in NZ are Maori fishing quota, conservation land, body parts
Ø Harold Demsetz (1964) – the market provides a valuable and costly service
Ø The market facilitates exchange of goods and services – gives us information such as
price – P=MC also informs us of the costs
Ø Acceptable allocation mechanism we need it to provide us with the benefits and
costs – and you need people to take account of the information
Ø And you need individuals to be motivated to take on that information – by willing to
pay
Ø The value depends on the property rights – depends on how those rights are
enforced – for example, if anyone could use your property the value of it would be
zero because people a free riding on your investment
Ø Common pool resources – oil, water, fish, gas, geothermal – absence of property
rights results in too rapid depletion – prices reflect private costs and benefits
Ø Importance of exclusion – has a valuation function – ability to stop others from
utilizing the benefits that flow from your investment
Ø Public goods – non-excludability and non-rivalry in consumption – transaction costs
depend on technology
Ø Demsetz recommends that when transaction costs exceed value of information
received the price should be zero
Ø If you are maximizing your profit you produce at MVP=W – if there is
open access however, you will give hire labour until the point where
there is no extra profit to be made – this leads to depletion of
resources
Ø Evolution of property rights – as benefits-costs change due to technology as long as
there are net benefits the rights will continue
Ø For example, fur market – value of fur increased this resulted in over-hunting which
led to a negative externality
Ø This led to restriction on where and when you could hunt – so there were net
benefits so property rights would arise
Ø NZ example would be the kauri gum – all you needed was a spear and axe to get it
and it was the main export of Auckland between 1850-1900
Ø In 1890s there was resource depletion as people started cutting the trees to get the
gum – and new oil-based machines made the price of gum fall and by 1940s the
market came to end
Ø The land was owned by the crown – before 1888 it was open access and then
restrictions were placed – but a lot of costs associated with recovering the revenue
from those licenses
,Property Rights – Initial Entitlements
Ø Property rights occur as value of resource increases sufficiently to offset costs of
definition & enforcement
Ø Allocation mechanism
- First-possession: Assign ownership on first-come first-served basis
§ Advantages – those with experience with exploiting, recognizes innovations
supports risk takers and low-cost method
§ Disadvantages – discriminates new entrants and ring fence their innovation
- Uniform allocation – equal sharing rules – divide between everyone equally and
then allow people to trade
§ Advantages – if trade is allowed it will go to those who value it most,
avoids measuring claims and parties are homogenous
§ Disadvantages – opposition to re-allocation by existing users and could
involve costs of definition and enforcement
- Auction – directly allocate resource to those that attach high value to ownership
§ Advantages – avoid TC’s of reallocation, generates revenue and if rents
accrue to the state then avoid distributional arguments
§ Disadvantages – resistance from incumbents and obvious costs of running
an auction
Ø Roles of state and market
- Property rights are clear, secure and certain – so that you can trade
- Markets require clear assignment of initial entitlements and well-enforced rules
of contract
- Property rights are produced in response to market demand – government and
market has a role to make it work
Auctions
Ø First Price Auction – winner is the one that bids the highest
Ø Second Price Auction – the winner is the highest bidder but pays the second highest
price
Ø Floor Price –
§ Hard Floor minimum the seller is prepared to accept – will not accept anything
below
§ Soft Floor – if bids do not know the hard floor – soft floor could be used to
catch those bids that are below but close to the hard floor
Ø Auctioning similar items – Treasury bonds – Carbon emission permits
Ø Private value auctions – each bidder knows his/her own valuation. Value of painting
to me is $500, to you it is $300. My valuation does not depend on your information
Ø Art Auction – ascending bid start low and bid up – descending bid auction start high
and bids decline (first person to put their hand up gets the good)
Ø Ascending: Yes bidders reveal their true valuation – bidding up to your true valuation
is the dominant strategy
Ø Descending: No – each bidder “shades down” his bid
Ø Common value auctions – all bidders have the same valuation but they don’t know
what it is – most real world auctions have a mixture of private and common –
example can be price of a barrel of oil is $70
, Ø Winner’s curse – tendency to overbid due to the fact that bidder with highest
estimate (or signal) will win
Ø The optimal strategy in this case is to bid less than your estimated value
Ø Common types of bids
§ Open outcry bid – ascending – auctioneer announces increasing prices
§ Descending – decreasing bids until someone puts up their hand
§ Sealed bid auction – people put their bid in an envelope and highest bid
wins
Ø Static bids are when you have a homogenous divisible product – and two pricing
is used the uniform price and pay as you bid
Ø In sealed bids – people will pay P* which is the market clearing rate – some
may shade their bid in order to influence the price to be lower
Ø Pay as you bid – bidders pay the amount they bid – the tendency is to stay
slightly above P* - this favors larger players
Ø Ascending bid auction with clock – as the clock runs out the bids will
automatically have a tendency to become higher – auctioneer announces price
& bidders respond
Ø More expensive than sealed-bid but considered transparent & possibly generates
more revenue
Ø Reverse auction – this is where the buyers and sellers’ roles are reversed – the buyer
can ask for a service such as installation of a machine – and sellers bid in order to get
the opportunity to provide that service – the lowest bid will usually win
Ø Sellers compete to obtain business from the buyer and prices will typically decrease
as the sellers undercut each other
Property Rights – Structure & Shape
Ø Something is sustainable when you use up to a certain amount of it – but if you go
past it the resource will deplete
Ø When exclusion is a=0 then anyone can come use it – a=1 is perfect exclusion so
only you can use it – this means you need to monitor the use of the resource
Ø Present value of individual gain from use is harvest is U (a) – the value to me would
be the value over time summed up and discounted to me right now – that would be
the utility I get from accessing the resource
Ø If there is no scarcity – then there are no gains from exclusion – and if exclusion is
imposed, then the sum of utility will fall
Ø When there is scarcity – if you don’t exclude then utility falls – energy in the field will
fall and we will get an unsustainable resource because of free
riding – if we increase the degree of exclusion it will create benefits
Ø From the graph if costs are at C1 then the degree of exclusion that
is beneficial is 0 – since costs of exclusion exceed the benefits
Ø An example of this was fisheries – it costs a lot to prevent someone
from fishing, so exclusion is left at 0
Ø The optimal level of exclusion is when the slope of the benefits U is equal to the
slope of the costs
Ø In microeconomics the costs are influenced by the technology – the level of labour
and capital – the costs some time ago would have been very high so it was difficult
to exclude others
