# ECONOMIC ANALYSIS OF PROPERTY LAW September 26, 2006.

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ECONOMIC ANALYSIS OF PROPERTY LAW September 26, 2006

ECONOMIC ANALYSIS OF PROPERTY LAW September 26, 2006 ANNOUNCEMENTS

ECONOMIC ANALYSIS OF PROPERTY LAW September 26, 2006 TUTOR FOR ECO320 Kui (Calvin) Hu hukuiwlu@gmail.com Every second Friday(10:30 AM to 12:30PM) »October 6, 2006 »October 20, 2006 »November 3, 2006 »November 15, 2006 »November 29, 2006

ECONOMIC ANALYSIS OF PROPERTY LAW September 26, 2006 http://www.cooter-ulen.com Answers to End of Chapter - Problems

ECONOMIC ANALYSIS OF PROPERTY LAW September 26, 2006 Recall the “legal” solution to the “two” agent problem was obtained by solving: dL/d a 1 = F 1 - 1 + 1  F 11 + 2 (1-  )F 12 = 0 dL/d a 2 = F 2 - 1 + 1  F 12 + 2 (1-  )F 22 = 0 dL/d  = 1 F 1 - 2 F 2 = 0  /(1-  ) = (F 22 /F 11 )^ 1/4

ECONOMIC ANALYSIS OF PROPERTY LAW September 26, 2006 Is there a solution to this?: dL/d a 1 = F 1 - 1 + 1  1 F 11 + 2  2 F 12 + 3 (1-  1 -  2 )F 13 = 0 dL/da 2 = F 2 - 1+ 1  1 F 12 + 2  2 F 22 + 3 (1-  1 -  2 )F 23 = 0 dL/da 3 = F 3 – 1 + 1  1 F 13 + 2  2 F 23 + 3 (1-  1 -  2 )F 33 = 0 dL/d  1 = 1 F 1 - 3 F 3 = 0 dL/d  2 = 2 F 2 - 3 F 3 = 0

ECONOMIC ANALYSIS OF PROPERTY LAW PROPERTY RIGHTS (EXPLICIT AGENCIES)

ECONOMIC ANALYSIS OF PROPERTY LAW Types of Property Real Property – land, buildings Personal Property - cars, clothes, securities Intellectual Property – patents, copyright, trade-marks

ECONOMIC ANALYSIS OF PROPERTY LAW At common law The source of all property rights was the sovereign What rights one had were determined by who one was and in which social class one belonged

ECONOMIC ANALYSIS OF PROPERTY LAW MedievalModern (Canada) King (Queen) Absolute title Dukes Counts Earls Barons FreemenFreehold title Peasants Serfs Slaves

ECONOMIC ANALYSIS OF PROPERTY LAW The sovereign or “Crown” is the absolute owner of land in Canada. This is “symbolic”, not personal

ECONOMIC ANALYSIS OF PROPERTY LAW Who or what takes the place of the “Crown” in the United States? A concept known as “eminent domain”

ECONOMIC ANALYSIS OF PROPERTY LAW In both Canada and the United States, freehold interests (land) and personal property have two major components »Title »Possession

ECONOMIC ANALYSIS OF PROPERTY LAW Title (Owner) Legally significant Includes possession May transfer possession to a third party May transfer or sell title May bequeath title to an heir

ECONOMIC ANALYSIS OF PROPERTY LAW Possession Economically significant Exclusivity Enjoyment of the property (especially the economic benefits) Cannot transfer or share possession without the owner’s consent Cannot bequeath possession – after death usually reverts back to the owner or joint holder of possession

ECONOMIC ANALYSIS OF PROPERTY LAW Posner explains that the creation of individual property rights is a necessary rather than a sufficient precondition for the efficient use of resources (Ch. 3, 3.1)

ECONOMIC ANALYSIS OF PROPERTY LAW. Exclusive Agent

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership The costs of enforcing property rights cannot exceed the benefits to social surplus of having those rights? Why or why not? (Posner - Ch. 3, 3.2)

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership Starting with Demsetz, there has to be “value in use” before a group will incur the costs of property enforcement or property recognition

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership How is “property ” established? First, by a “rule of capture” – most common one? Right of First Possession – Cooter, c. 4:I, c. 5:IA

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership First possession under “the rule of capture” can vary. In the famous case of Pierson v. Post the New York Supreme Court was divided over whether possession of a wild fox was determined by “hot pursuit” or physical capture. Pierson v. Post, 1805, 3 Cal. R. 175, 2 Am. Dec. 264 (Sup. Ct. of N.Y. 1805), Cooter, c. 5:IA

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership What is wrong with a “rule of capture”? Encourages squatters – This may not be bad if the possessors enhance the economic use of the property Statutes in most jurisdictions allow for the eventual transfer of title if the possession remains unchallenged for a set period of time

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership How is “property ” established? Second, by “root of title” Cooter, c. 5:II Domesday Book

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership Enforcing property rights Domesday Book Collection of Deeds To Show Root of Title Registry Land Titles Polaris (Cooter - Ch. 5-II)

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership Enforcing property rights Domesday Book Collection of Deeds To Show Root of Title Registry Land Titles Polaris (Cooter - Ch. 5-II) 1638 – Deed

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership Can title fraud be avoided? - Two situations Prior Title (Cooter, c. 5-II) »Lawyers search title »Malpractice actions can be costly »Buyers and mortgagees buy “title” insurance Current Title »Identity thieves can “pretend” they are the owners, sell and mortgage the property right from under the owners »Malpractice actions and “title” insurance usually does not apply

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership Let “a” be the effort or investment a puts into his or her property U(a) = aUTILITY c(a) = a COST OF EFFORT The first order condition or A’s incentive compatibility constraint is: dU/da = 1

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership Exclusivity Of Property (Taking vs. sharing) Surplus at Zero Cost = Value of Property Exclusive Possession a U(a) = Social Surplus

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership. Exclusive Agent Trespasser

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership Supposing A loses  of his or her surplus to the trespasser So A keeps (1-  ) of his or her surplus U((1-  )a) - aUTILITY Now the first order condition or A’s incentive compatibility constraint is: dU/da = 1/(1-  )

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership Exclusivity Of Property a (1- a)U(a) = SS

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership. Agent 2 Trespasser Trespassing Agent

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership So A loses  of his or her surplus One way to recoup this loss? Steal it from another A 2 ? U(  a 2 + (1-  )a) - aUTILITY Now the first order condition or A’s incentive compatibility constraint is: dU(  a 2 + (1-  )a)/da = 1/(1-  )

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusive Ownership Is there any point to A “bargaining” with the trespasser? Yes. If transaction costs are low as will be demonstrated with Coase Cooter – c. 4-III

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership CONCURRENT OWNERSHIP

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership. Explicit Bilateral AgencyProperty Horizontal Explicit Agency Example – Joint Asset Vertical Explicit Agency Example – Landlord and Tenant

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership Both title and possession can be held concurrently – by more than one owner Joint »Owners share an undivided interest in the property »In the case of title, the interest falls to the survivor(s) when one dies Tenants in common »Owners share a divided interest in the property »In the case of title, the divided interest falls to the estate of the deceased when the deceased dies

Horizontal Concurrent Interests ( Cournot-like ) ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership AGENT 1 AGENT 2

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership Can Joint Ownership be optimal?: Recall Professor Cooter defined Nash equilibrium and distinguished it from Pareto efficiency – (4th ed., 2004, c. 2., VII, p. 41) Equilibrium occurs where these “self- interested” actions intersect – Nash Equilibrium – Pareto inferior to the “exclusivity” optimum

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership Joint Ownership: SS(a 1,a 2 )=  F(a 1,a 2 )+  F 2 (a 1, a 2 )– a 1 –a 2 Assume constant returns to scale SS(a 1,a 2 )=  F(a 1 + a 2 ) – a 1 – a 2

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership Optimal Joint Ownership: SS(a 1,a 2 )=  F(a 1 + a 2 )+  F 2 (a 1 + a 2 )– a 1 –a 2 The “best use” or “most valuable use” satisfies:  F 1 (a 1 ) – 1 = 0  F 2 (a 2 ) – 1 = 0

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership Optimal Joint Ownership: Contracting to form joint property effectively creates a group that has exclusive rights to the resource pertains only to the group's size and the joint effort to exclude outsiders.

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership Optimal Joint Ownership: If there are two or more concurrent or joint owners of the same property, will the joint surplus be as optimal as exclusive ownership? Winter and Neary model – suggests “yes” Lueck - “No” – Why?

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership Optimal Joint Ownership: Implicit in the Winter- Neary model is the implicit assumption of homogeneity – everybody is the same.

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership Optimal Joint Ownership: If people are not the same a form of the adverse selection problem applies and some will apply more effort than others resulting in what Lueck calls an “internal rule of capture” (p. 406)

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership Optimal Joint Ownership: Dissipation from internal capture can be limited by maintaining a homogeneous membership. With equal sharing rules, a homogeneous membership maximizes the present value of a common property resource (Lueck, p. 399)

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership Optimal Joint Ownership: Once a group chooses an equal sharing rule there is an incentive to maintain homogeneity. Why? With heterogeneous members and equal shares, highly productive individuals will supply too little effort and the less productive will supply too much.

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership Optimal Joint Ownership: Dissipation of surplus will occur. In effect, equal-sharing rules increase group wealth with homogeneity among group members. What Luecks is referring to is the “tragedy of the commons (Luecks, p. 404)

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership This provides an economic rationale for preserving homogeneity. Screen potential members, by indoctrination, or by restricting the transfer of memberships.

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership Optimal Joint Ownership: In one important respect these problems are different: There is a “solution” to the “joint property” problem – discrimination »Condominiums »Co-ops »Gated Communities »Mandatory Activity Clubs

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership Optimal Joint Ownership: So the solution to the first order conditions that generated the optimal “sharing rule”  /(1-  ) = (F 22 /F 11 )^ 1/4 is no longer sufficient unless a further “rule” that “homogenizes” the owners is “imposed”

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership Optimal Joint Ownership: So notice how the “joint property” problem is analogous to the “collusive contract” problem because of the following issues: Overcoming the Prisoners dilemna Overcoming the inability to observe each others effort

ECONOMIC ANALYSIS OF PROPERTY LAW Joint Ownership Can Joint Ownership be optimal?: The preceding have explored ways that “avoid” the tragedy of the commons?

ECONOMIC ANALYSIS OF PROPERTY LAW Commons COMMON PROPERTY

ECONOMIC ANALYSIS OF PROPERTY LAW Commons Open Access: The absence of property rights leads to overuse of the asset and complete dissipation of surplus. If users are heterogeneous, low cost) users will earn rents. Rent under open access may be an important factor in preventing the establishment of private property rights.

ECONOMIC ANALYSIS OF PROPERTY LAW Commons Open Access – Demsetz Thesis: Demsetz argues that property rights emerge to internalize the externalities present in open access. Caution: Demsetz uses the term ‘common property’ to describe what is now called “open access”.

ECONOMIC ANALYSIS OF PROPERTY LAW Commons Open Access: The “actual use” or “overuse” satisfies:  F(a 1 ) – 1 = 0  F(a 2 ) – 1 = 0 The “rule” here is not the optimal “sharing” rule – but what Lueck called an “external rule of capture”

ECONOMIC ANALYSIS OF PROPERTY LAW Commons This leads to the Tragedy of the Commons: What is the “tragedy of the commons”? Mathematically, it is the Prisoners dilemna game played by a large number of agents What happens? The Nash equilibrium is the extinction of the resource do to over-use or exploitation by the agents

ECONOMIC ANALYSIS OF PROPERTY LAW HIERARCHIAL OWNERSHIP

Horizontal Interests ( Cournot-like ) Vertical Interests ( Stackelberg-like ) ECONOMIC ANALYSIS OF PROPERTY LAW AGENT 1 AGENT 2 PRINCIPAL AGENT

ECONOMIC ANALYSIS OF PROPERTY LAW Vertical Interests ( Stackelberg-like ) » Two parties agree on a ranking and order of conduct Principal – first mover Agent – second mover » Example: Landlord and tenant

ECONOMIC ANALYSIS OF PROPERTY LAW Exclusivity Sole recipient of the profit or surplus generated by the property In this capacity, tenant acts as a “principal” of the property with the owner acting as “agent” Owner as “agent” receives a fixed rent, with the tenant as “principal” receiving the residual or profit remaining

ECONOMIC ANALYSIS OF PROPERTY LAW Enjoyment of the property (especially the economic benefits) Tenant acts as a “principal” of the property with the owner acting as “agent” In the case of “tenant” farmers, a huge motivator in agricultural innovation and productivity Thought by Adam Smith and others why England surpassed other countries in agrarian output in spite of climactic and other geographical disadvantages

ECONOMIC ANALYSIS OF PROPERTY LAW A principal agency relationship may exist between the owner (agent) and tenant (principal) even in the absence of an express or explicit contract It would not be difficult to imagine landlord and tenant arrangements following either a vertical or horizontal pattern

ECONOMIC ANALYSIS OF PROPERTY LAW Horizontal Concurrent Interest ( Cournot-like ) Vertical Concurrent Interest ( Stackelberg-like )

ECONOMIC ANALYSIS OF PROPERTY LAW ( Cournot-like ) Both Landlord and Tenant are risk neutral Both share in the profits Cropsharing ( Stackelberg-like ) Landlord is risk averse Tenant is risk neutral Franchises Landlord is risk neutral Tenant is risk averse Shopping centres

ECONOMIC ANALYSIS OF PROPERTY LAW PROPERTY RIGHTS (IMPLICIT AGENCIES)

ECONOMIC ANALYSIS OF PROPERTY LAW. McKie v. KVP Background

PROPERTY RIGHTS McKie v. KVP By 1946, KVP had adopted "kraft" technology, manufacturing kraft paper by the sulphate process. This process began to take its toll on the river. Pollution was discharged into the river by KVP from its mill.

PROPERTY RIGHTS McKie v. KVP In 1946, six downstream landowners sued. The court granted them damages and an injunction, rejecting the defendant's argument that the social benefits created by the paper industry outweighed the plaintiffs' riparian rights. Sellick, Karen, http://oldfraser.lexi.net/publications/forum/1997/april/FF-04-97.html

PROPERTY RIGHTS McKie v. KVP The Plaintiffs claimed damages and asked for an injunction on the grounds that: (1) Their comfort and the enjoyment of their land was interfered with by reason of foul odours given off from the water. (2) The water had been rendered unfit for human consumption either in its raw state or after it has been boiled. (3) The ice taken from the river for domestic use was unfit for the purposes for which it is used.

PROPERTY RIGHTS McKie v. KVP (4) The water was repulsive to farm animals and milking cows would not drink it in sufficient quantities to maintain normal milk supply. (5) The water was unfit to bathe in. (6) The fish in the river were being either killed or driven therefrom. (7) Wild rice, which was formerly grown in abundance in the waters of the river, forming a feeding ground for wild ducks, was destroyed.

PROPERTY RIGHTS McKie v. KVP Alfred Huerter, an engineering expert called by KVP testified at trial that it was not economically efficient for KVP to recover the estimated 2% to 2.65% of pulp loss that got discharged into the river.

PROPERTY RIGHTS McKie vs. KVP Note as well the testimony of one of the plaintiffs who had raised with KVP the possibility of applying technology to reduce if not eliminate the water pollution.

PROPERTY RIGHTS McKie v. KVP Chief Justice McRuer, the trial judge, made a finding of fact that the KVP pollution did kill the river fish.

PROPERTY RIGHTS McKie vs. KVP Note the comment by McRuer that the pollution was endemic to kraft pulp producers. This suggests he knew that in a competitive economy, directing that it change its technology under threat of an injunction might put K.V.P. out of business.

PROPERTY RIGHTS McKie vs. KVP McRuer granted relief to the plaintiff, James B. Vance in the action of trespass, which carried with it both damages and an independent right to an injunction against KVP.

PROPERTY RIGHTS McKie vs. KVP The other plaintiffs were granted both damages and injunctive relief on the grounds that their riparian rights had been breached and that nuisance had been proved.

PROPERTY RIGHTS McKie vs. KVP This judgment begs some important questions. Was KVP found liable because it operated at a socially optimal level or because it chose to “ignore” the law and operate at a private level of efficiency?

PROPERTY RIGHTS McKie vs. KVP Was it because KVP thought it was “protected by its Crown lease” or because it thought the technology was neither socially optimal nor privately optimal that inspired the manager to dismiss the plaintiff's advice?

PROPERTY RIGHTS McKie vs. KVP However, McRuer J. dismisses the “Crown lease” argument on the grounds that any contract permitting harm to the Plaintiffs' property must be done by way of an express contract among all the parties.

PROPERTY RIGHTS No Liability Rule – McKie v. K.V.P. While KVP appealed McRuer's decision, the Ontario government passed a law, named The Lakes and Rivers Improvement Act. This permitted courts to deny an injunction against polluters if such would cause adverse economic results to the community.

PROPERTY RIGHTS No Liability Rule – McKie v. K.V.P. The case of Boomer v. Atlantic Cement Co., 122 26 N.Y.2d 219, 309 N.Y.S.2d 312, 257 N.E.2d 870 (Court of Appeals of New York, 1970) involved a group of landowners who sought an injunction against a large cement factory because of the dirt, smoke, and noise that it produced.

PROPERTY RIGHTS No Liability Rule – McKie v. K.V.P. That court denied the injunction and instead awarded money damages on the grounds that the injunction would have forced the factory to shut down, causing a loss of jobs and the company’s substantial capital investment.

PROPERTY RIGHTS No Liability Rule – McKie v. K.V.P. Some sections of the Public Health were also repealed. The Ontario Water Resources Commission was given authority over such matters as herbicides, water quantity and quality with the power to issue orders to municipalities and industries with respect to the establishment of sewage, water works and other types of water pollution.

PROPERTY RIGHTS No Liability Rule – McKie v. K.V.P. The Supreme Court of Canada upheld the trial judge, reasoning that he had decided correctly considering the state of the law at the time of his judgment.

PROPERTY RIGHTS No Liability Rule – McKie v. K.V.P. The Ontario Progressive Conservative government next passed the K.V.P. Company Limited Act in 1950 after KVP lost its appeals to the Court of Appeal and the Supreme Court of Canada. Ont. Stat. 1950 c. 33.

PROPERTY RIGHTS No Liability Rule – McKie v. K.V.P. This law specifically dissolved the injunction against KVP. Now the company and its successors were free to pollute. Sellick, Karen, http://oldfraser.lexi.net/publications/forum/1997/april/FF-04-97.html

PROPERTY RIGHTS No Liability Rule – McKie v. K.V.P. The Boomer v. Atlantic Cement Co decision seems correct in view of the high costs of contracting among the large number of effected homeowners that would have been necessary to keep the plant operating under an injunction.

ECONOMIC ANALYSIS OF PROPERTY LAW. TRESPASS

ECONOMIC ANALYSIS OF PROPERTY LAW TRESPASS. Exclusive Agent Trespasser

ECONOMIC ANALYSIS OF PROPERTY LAW TRESPASS In the case of land, externalities arise because of conflicting uses of adjacent properties. The primary common law actions (lawsuits) applicable to unwanted invasions are trespass and nuisance.

ECONOMIC ANALYSIS OF PROPERTY LAW TRESPASS The primary remedy under trespass is an injunction against the unwanted intrusion. The landowner’s right to exclude is protected by a property rule. Examples of trespass are squatters and boundary encroachment

ECONOMIC ANALYSIS OF PROPERTY LAW TRESPASS Protection of Exclusivity of Possession Common law – through the remedy of the action for trespass Historically, had to be launched by the owner (title holder) on behalf of the tenant Now the tenant can sue directly Who is it aimed at »Squatters »Encroaching neighbours

ECONOMIC ANALYSIS OF PROPERTY LAW TRESPASS Cases of trespass ordinarily involve a small number of parties where the intruder is easily identifiable. Contracting costs among the parties tend to be low, and property rules are the preferred remedy.

ECONOMIC ANALYSIS OF PROPERTY LAW TRESPASS Lueck argues that the "rule of first possession" emerged as an efficient rule to clarify ownership. (Lueck, p. 412) Squatter's rights were determined in accordance with the rules of first possession bring abandoned or unused assets back into production. (Lueck, p. 416)

ECONOMIC ANALYSIS OF PROPERTY LAW NUISANCE

ECONOMIC ANALYSIS OF PROPERTY LAW NUISANCE. Exclusive Agent Nuisance

ECONOMIC ANALYSIS OF PROPERTY LAW NUISANCE Protection of the enjoyment of property Common law – through the remedy of the action for nuisance Had to be a “private” harm Bamford v. Turnley (1860) 3 B. & S. 62 at 63 (Ex. Ct.) “Public harms” effecting private property had to be prosecuted through the Crown attorney or criminal courts Who is it aimed at »Polluting neighbours

ECONOMIC ANALYSIS OF PROPERTY LAW NUISANCE The remedy under nuisance more complicated. First, the landowner can only obtain relief if the invasion is substantial, even then, he may have to be satisfied with money damages (a liability rule). Examples of nuisance are air, water, and noise pollution.

ECONOMIC ANALYSIS OF PROPERTY LAW NUISANCE Cases of nuisance often involve large numbers or sources of harm that are difficult to identify. Transaction costs are high and contracting is unlikely to lead to the efficient outcome. In cases like this liability rules are preferred.

ECONOMIC ANALYSIS OF PROPERTY LAW NUISANCE If the landowner wishes the harm to be enjoined, he must meet the further legal standard of showing that outweighs the benefit of the nuisance-creating activity Posner argues that the damages and injunction remedies applied in cases like KVP follow an economic pattern? Damages – High Transaction Costs Injunctions – Low Transaction Costs (Ch 3 – X)

ECONOMIC ANALYSIS OF PROPERTY LAW NUISANCE The common law nuisance action carried with it the right of the person to “shut-down” a defendant as of right – so a “defendant” is not compensated for its loss making this remedy optimal for plaintiffs but not necessarily anyone else. (Posner, 6th ed., c. 1, p. 16)

PROPERTY RIGHTS NUISANCE Aldred's Case (1610), 9 Co. Rep. 57b, 59a, 77 E.R. 816 is the earliest case establishing the “strict liability rule” for property damages for nuisance law

PROPERTY RIGHTS NUISANCE Protection of Possession Common law actions for trespass and nuisance were governed by the “strict liability” property rule for damages until the industrial revolution encouraged its replacement by a different rule in pollution cases (Horwitz Thesis) [18] Horwitz, Morton, "The Transformation in the Conception of Property in American Law 1780 - 1860', (1980) 40 U. of Chi. L. Rev. 248-290 [19] Schwartz, Gary, "Tort Law and the Economy in Ninteenth-Century America: A Reinterpretation', (1981) 90 Yale L. J. 1717 - 1775

PROPERTY RIGHTS Socially Optimal Strict Liability Rule Agents operate two firms: a 1 = output of Agent 1 a 2 = output of Agent 2

PROPERTY RIGHTS Socially Optimal Strict Liability Rule These agents have the following profit functions  1 (a 1,a 2 ) = 5a 1 – 3(a 1 )^ 2  2 (a 1,a 2 ) = 5a 2 - (a 1 )^ 2

PROPERTY RIGHTS Socially Optimal Strict Liability Rule The output of Agent 1 is jointly produced with pollution which imposes damages on on Agent 2 according to the damage function D(a 1 ) = (a 1 )^ 2 Suppose that a rule of law makes Agent 1 liable for all pollution damages to Agent 2.

PROPERTY RIGHTS Socially Optimal Strict Liability Rule If Agent 1 (i)knows it is strictly liable for damages (ii)knows the rule can be costlessly enforced against it (iii)acts rationally (is a cost minimizer or a profit maximizer)

PROPERTY RIGHTS Socially Optimal Strict Liability Rule Finding the socially optimal level of Agent 1’s production in the local economy involves the Agent assuming it will be sued: MAX [pa 1 – C(a 1 ) – D(a 1 )] d[5a 1 – 4 ( a 1 ) ^ 2 ]/da 1 = 0 (a 1 )* = 5/8

PROPERTY RIGHTS Socially Optimal Strict Liability Rule Competitive Firm – Perfect Information Strict Liabilty Rule

PROPERTY RIGHTS Socially Optimal Strict Liability Rule Profit for Agent 1:  = p(5/8) – C(5/8) – D(5/8) = 25/16

PROPERTY RIGHTS Socially Optimal Strict Liability Rule AGENT 1 - Competitive Firm - SR SATC = 4(a 1 ) ^ 2 PROFIT a1a1 SMC = 8a 1 p = 5

PROPERTY RIGHTS Socially Optimal Strict Liability Rule AGENT 1 - Competitive Firm - LR LATC P = MR = LSMC = 5 PROFIT = 0

PROPERTY RIGHTS Socially Optimal Strict Liability Rule The strict liability damages rule is socially optimal provided AGENT 1: (i)knows the rule (ii)knows the rule can be costlessly enforced against it

PROPERTY RIGHTS Socially Optimal Strict Liability Rule Property damages Agent 1 still imposes on Agent 2: D = (5/8)(5/8) = 25/64 How can this happen under a strict liability rule?

PROPERTY RIGHTS Socially Optimal Strict Liability Rule Reaction Curves a 1 = a 1, a 2 = a 2 Agent 2 cannot strategically interact with Agent 1’s “imposed” externality  * 1 = G 1 (a 1, a 2 )  * 2 = G 2 (a 1, a 2 )

PROPERTY RIGHTS Socially Optimal Strict Liability Rule Externality – Pareto Equilibrium – Agent 2 trades rights for profits Externality – Nash Equilibrium a2a2 Iso-Profit Curve For Agent 2 a1a1 a2a2 a1a1 Iso-Profit Curve For Agent 1

PROPERTY RIGHTS Socially Optimal Strict Liability Rule Although Agent 2 can produce more and Agent 1 will produce less under the strict liability law, Agent 2 might be persuaded to also produce less in exchange for a transfer payment that might allow Agent 1 to produce more – in this sense the externality creates strategic substitutes

PROPERTY RIGHTS Socially Optimal Strict Liability Rule Externality – Nash Equilibrium Agents’ Joint Surplus Externality – Pareto Equilibrium [1,0] Agents’ Joint Surplus

PROPERTY RIGHTS Model No Liability Rule

PROPERTY RIGHTS No Liability Rule What happens if AGENT 1 (i)is NOT liable for pollution damages or (ii)thinks it is not liable for pollution damages

PROPERTY RIGHTS No Liability Rule AGENT 1 sets its production at a privately optimal level, which is socially sub-optimal: MAX [5a 1 – 3 ( a 1 ) ^ 2 ] d[5a 1 – 3 ( a 1 ) ^ 2 ]/da 1 = 0 ( a 1 ) P = 5/6 > 5/8

PROPERTY RIGHTS No Liability Rule Constant Cost – Constant Returns To Scale AGENT 1 - Competitive Firm - SR SATC = 4(a 1 ) ^ 2 SATC = 3(a 1 ) ^ 2 y SMC = 8a 1 SMC = 6a 1 p = 5

PROPERTY RIGHTS No Liability Rule Constant Cost – Constant Returns To Scale Competitive Firm - LR LATC P = MR = LSMC = 5 PROFIT > 0

PROPERTY RIGHTS No Liability Rule Profit for Agent 1:  = p(5/6) – C(5/6) = 25/12 > 25/16

PROPERTY RIGHTS No Liability Rule Property damages Agent 1 still imposes on Agent 2: D = (5/6)(5/6) = 25/36 > 25/64 What will Agent 2 do if it cannot sue?

PROPERTY RIGHTS No Liability Rule Externality – Pareto Equilibrium – Agent 1 trades rights for profits Externality – Nash Equilibrium a2a2 Iso-Profit Curve For Agent 2 a1a1 a2a2 a1a1 Iso-Profit Curve For Agent 1

PROPERTY RIGHTS No Liability Rule Although Agent 1 can produce more and Agent 2 will produce less under the no liability law, Agent 1 might be persuaded to also produce less in exchange for a transfer payment that might allow Agent 2 to produce more – in this sense the externality still creates strategic substitutes

PROPERTY RIGHTS No Liability Rule Externality – Nash Equilibrium Agents’ Surplus Externality – Pareto Equilibrium [1,0] Agents’ Surplus

PROPERTY RIGHTS Does one see an analogy to the duopoly problem? Could the polluter and victim collude to maximize social surplus? If there were a Pareto superior position, would it be stable? If not, what would the pattern of defection be?

PROPERTY RIGHTS Under either the strict liability rule or no liability rule, at least one of the parties is favoured (unlike the duopoly situation, where the rule favoured consumers) How do these two (2) alternative regimes differ from the “strategic complementarity” of antitrust regulation of duopolies?

PROPERTY RIGHTS If the parties were to collude would either the “no liability rule”(which favours Agent 1) or the “strict liability rule” (which favours Agent 2) “stabilize” any collusive agreement that arose? Why or why not?

PROPERTY RIGHTS Prisoners dilemna works against a collusive duopoly Prisoners dilemna could be “solved” in a collusive externality agency? P.O.E N.E P.O.E and N. E

ECONOMIC ANALYSIS OF PROPERTY LAW ADDITIONAL SOURCES

ECONOMIC ANALYSIS OF PROPERTY LAW Boyer, Patrick, A Passion For Justice: the legacy of James Chalmers McRuer (Toronto: University of Toronto for the Osgoode Society for Canadian Legal History, 1994) http://www.osgoodesociety.ca/books/book- 19941.html

ECONOMIC ANALYSIS OF PROPERTY LAW McKie v. K.V.P. Co.. [19481 Ont. W.N. 386. 119481 3 D.L.R. 201 (High Ct.) See also http://www.archives.gov.on.ca/ENGLIS H/exhibits/paper/profiles.htmhttp://www.archives.gov.on.ca/ENGLIS H/exhibits/paper/profiles.htm Right Wing Perspective http://www.karenselick.com/CL9611.ht mlhttp://www.karenselick.com/CL9611.ht ml

ECONOMIC ANALYSIS OF PROPERTY LAW Left Wing Perspective http://www.utpjournals.com/product/ctr/99/ 99_Beveridge.html

ECONOMIC ANALYSIS OF PROPERTY LAW Demsetz, Harold, "Towards a Theory of Property Rights", (1967) Am. Econ. Rev. Papers & Proceedings 347 Ellickson, R., "Alternatives To Zoning", (1973) 40 U. Chi. L. Rev. 681 Brenner, Joel, "Nuisance Law and the Industrial Revolution", (1974) 3 J. of Leg. Stud. 403 Campbell, David, "Of Coase and Corn: A Defence of Private Nuisance", (2000) 63 Mod. L. Rev 197 Epstein, Richard A., "Holdouts, Externalities, and the Single Owner", (1993) 36 Journal of Law & Econ. 553