1. Econ 522 Economics of Law Dan Quint Fall 2011 Lecture 9

2. 1  Second homework due tomorrow night  First midterm next Wednesday (Oct 12) Reminders

3. 2  What things can be privately owned?  Intellectual Property – patents, copyrights, trademarks, trade secrets  What can/can’t an owner do with his/her property?  Restraints on alienation, unbundling, inalienability  How are property rights established?  First Possession versus Tied Ownership  Adverse Possession  What remedies are given?  Injunctions vs damages; temporary vs permanent damages  Private necessity (emergency) as exception to property protection Recently: applications/examples of property law…

4. 3  Government can limit how you use your property  Regulation  The government can take your property  “Eminent domain” Today: two important limitations on property rights imposed by government

5. 4 Takings

6. 5  Public goods privately provided  undersupply  One role of government: provide public goods  Defense, roads and infrastructure, public parks, art, science…  To do this, government may need land  …which might already belong to someone else  In most countries, government has right of eminent domain  Right to seize private property when the owner doesn’t want to sell  This type of seizure also called a taking Takings

7. 6  U.S. Constitution, Fifth Amendment: “…nor shall private property be taken for public use, without just compensation.”  Government can only seize private property for public use  And only with just compensation  Consistently interpreted to mean fair market value – what the owner would likely have been able to sell the property for Takings

8. 7  Why allow takings? Takings

9. 8  Why allow takings?  Why these limitations?  why require compensation? Takings

10. 9  Why allow takings?  Why these limitations?  why require compensation? Takings $3 MM$1 MM $9 MM $10 MM

11. 10  Why allow takings?  Why these limitations?  why require compensation?  why only for public use? Takings

12. 11  Why allow takings?  Why these limitations?  why require compensation?  why only for public use?  The government should only take private property (with compensation) to provide a public good when transaction costs preclude purchasing the necessary property through voluntary negotiations Takings

13. 12  1981: GM was threatening to close Detroit plant  Would cost city 6,000 jobs, millions in tax revenue  City used eminent domain to condemn entire neighborhood  1,000 homeowners and 100 businesses forced to sell  land then used for upgraded plant for GM  city claimed employment and tax revenues were public goods, which justified use of eminent domain  Mich Sup Ct: “Alleviating unemployment and revitalizing the economic base of the community” valid public purposes; “the benefit to a private interest is merely incidental”  Overturned in 2004 ruling (Wayne v Hathcock)  Similar case, Kelo v. City of New London (2005 US Sup Ct) Poletown Neighborhood Council v Detroit

14. 13  1981: GM was threatening to close Detroit plant  Would cost city 6,000 jobs, millions in tax revenue  City used eminent domain to condemn entire neighborhood  1,000 homeowners and 100 businesses forced to sell  land then used for upgraded plant for GM  city claimed employment and tax revenues were public goods, which justified use of eminent domain  Mich Sup Ct: “Alleviating unemployment and revitalizing the economic base of the community” valid public purposes; “the benefit to a private interest is merely incidental”  Overturned in 2004 ruling (Wayne v Hathcock)  Similar case, Kelo v. City of New London (2005 US Sup Ct) Poletown Neighborhood Council v Detroit

15. 14 Regulation

16. 15  Open Access  Anyone free to use the resource  Leads to overutilization (Tragedy of the Commons)  Example: oyster beds  Unanimous Consent  Opposite of open access – multiple owners must all agree to any use of the resource  Leads to underutilization  Example: empty storefronts in post-Communist Moscow  Political Control/Regulation Multiple forms of public ownership

17. 16 Dividing the mountain pasture among individual owners would require fencing it, which is prohibitively expensive. Instead, the highland pasture is held in common, with each village owning different pastures that are separated by natural features such as lakes and mountain peaks. If each person in the village could place as many sheep as he or she wanted in the common pasture, the meadows might be destroyed and eroded by overuse. Third form of public ownership: political control/regulation

18. 17 In fact, the common pastures in the mountains of Iceland have not been overused and destroyed, because the villages have effective systems of governance. They have adopted rules to protect and preserve the common pasture. The sheep are grazed in common pasture in the mountains during the summer and then returned to individual farms in the valleys during the winter. The total number of sheep allowed in the mountain pasture during the summer is adjusted to its carrying capacity. Each member of the village receives a share of the total in proportion to the amount of farmland where he or she raises hay to feed the sheep in the winter. Third form of public ownership: political control/regulation

19. 18  Open access would lead to overfishing, deplete fishing stock  Government of Iceland decides how much fish should be caught in total each year  People own permits which are right to catch a fixed fraction of each year’s total  Permits are property – can be bought, sold, etc. Similar to how Iceland maintains fishing stock

20. 19 Regulation

21. 20  1800s: PA Coal purchased mineral and support estates, Mahon owned surface  1921: Kohler Act prohibited “mining of anthracite coal in such a way as to cause the subsidence of, among other things, any structure used as a human habitation.”  PA Coal sued government, claiming the regulation was same as seizing their land (without compensation)  “…While property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.” Regulation: Pennsylvania Coal v. Mahon surface estate support estate mineral estate

22. 21  1800s: PA Coal purchased mineral and support estates, Mahon owned surface  1921: Kohler Act prohibited “mining of anthracite coal in such a way as to cause the subsidence of, among other things, any structure used as a human habitation.”  PA Coal sued government, claiming the regulation was same as seizing their land (without compensation)  “…While property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.” Regulation: Pennsylvania Coal v. Mahon surface estate support estate mineral estate

23. 22  1800s: PA Coal purchased mineral and support estates, Mahon owned surface  1921: Kohler Act prohibited “mining of anthracite coal in such a way as to cause the subsidence of, among other things, any structure used as a human habitation.”  PA Coal sued government, claiming the regulation was same as seizing their land (without compensation)  “…While property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.” Regulation: Pennsylvania Coal v. Mahon surface estate support estate mineral estate

24. 23  1800s: PA Coal purchased mineral and support estates, Mahon owned surface  1921: Kohler Act prohibited “mining of anthracite coal in such a way as to cause the subsidence of, among other things, any structure used as a human habitation.”  PA Coal sued government, claiming the regulation was same as seizing their land (without compensation)  “…While property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.” Regulation: Pennsylvania Coal v. Mahon surface estate support estate mineral estate

25. 24  Support compensation for regulatory takings  Shifting burden of regulation from owners of affected property to all taxpayers  Equivalent to selling everyone insurance against harmful regulation  If such insurance were available, people would buy it  But it’s not available, for usual reasons insurance markets may fail  adverse selection  moral hazard  So government should provide it instead…  …by paying compensation for regulatory takings Blume and Rubinfeld, “Compensation for Takings: An Economic Analysis”

26. 25  Support compensation for regulatory takings  Shifting burden of regulation from owners of affected property to all taxpayers  Equivalent to selling everyone insurance against harmful regulation  If such insurance were available, people would buy it  But it’s not available, for usual reasons insurance markets may fail  adverse selection  moral hazard  So government should provide it instead…  …by paying compensation for regulatory takings Blume and Rubinfeld, “Compensation for Takings: An Economic Analysis”

27. 26  Recent ruling by a Dane County judge  Plaintiffs argued they had “a fundamental right to own a cow, and to use their cows in a manner that does not cause harm to a third party”  Judge responded:  “Plaintiffs do not have a fundamental right to own and use a dairy cow or a dairy herd  Plaintiffs do not have a fundamental right to consume the milk from their own cow  Plaintiffs do not have a fundamental right to board their cow at the farm of a farmer  The private contract does not fall outside the scope of the States’ police power  Plaintiffs do not have a fundamental right to produce and consume the foods of their choice  DATCP has jurisdiction to regulate the Plaintiffs’ conduct” “Maximum liberty” vs. government’s right to regulate

28. 27  Zoning laws  Distinguish industrial areas from residential areas Zoning

29. 28  Zoning laws  Distinguish industrial areas from residential areas  Nollan v California Coastal Commission (US Sup Ct, 1987)  Nollans owned coastal property  Asked for permit to expand building, which would diminish view  Commission: donate a public walking path, and you get permit  Supreme Court: such a deal only legal if there is clear connection – a nexus – between the harm being done and the remedy Zoning

30. 29  Zoning laws  Distinguish industrial areas from residential areas  Nollan v California Coastal Commission (US Sup Ct, 1987)  Nollans owned coastal property  Asked for permit to expand building, which would diminish view  Commission: donate a public walking path, and you get permit  Supreme Court: such a deal only legal if there is clear connection – a nexus – between the harm being done and the remedy Zoning

31. 30  What are benefits and costs of…  having property rights at all?  expanding property rights to cover more things?  introducing an exception/limitation to property rights?  When will benefits outweigh the costs? Property law: the big-picture question End of material on first midterm  Up next: contract law

32. 31  Some transactions don’t occur all at once  I’m flying to Boston for Thanksgiving…  …or I hire someone to paint my house… Why do we need contracts?

33. 32  Some transactions don’t occur all at once  I’m flying to Boston for Thanksgiving…  …or I hire someone to paint my house…  …or you can get $10 for a purple poker chip, but don’t have any cash on you right now to buy it from someone with a lower number  A contract is a promise…  …which enables trade when transactions aren’t concluded immediately Why do we need contracts?

34. 33  Subgame perfect equilibrium: I’ll keep all the money; so you don’t trust me  Inefficient outcome (100 < 200)  And we’re both worse off Example: the agency (trust) game Player 1 (you) Trust meDon’t Player 2 (me) Share profitsKeep all the money (150, 50)(0, 200) (100, 0)

35. 34 (One solution: reputation)

36. 35  Now we get cooperation (and efficiency)  Purpose of contract law: to allow trade in situations where this requires credible promises Another solution: legally binding promises Player 1 (you) Trust meDon’t Player 2 (me) Share profitsKeep all the money (150, 50)(125, 25) (100, 0)

37. 36  “The rich uncle of a struggling college student learns at the graduation party that his nephew graduated with honors. Swept away by good feeling, the uncle promises the nephew a trip around the world. Later the uncle reneges on his promise. The student sues his uncle, asking the court to compel the uncle to pay for a trip around the world.”  “One neighbor offers to sell a used car to another for $1000. The buyer gives the money to the seller, and the seller gives the car keys to the buyer. To her great surprise, the buyer discovers that the keys fit the rusting Chevrolet in the back yard, not the shiny Cadillac in the driveway. The seller is equally surprised to learn that the buyer expected the Cadillac. The buyer asks the court to order the seller to turn over the Cadillac.”  “A farmer, in response to a magazine ad for “a sure means to kill grasshoppers,” mails $25 and receives in the mail two wooden blocks with the instructions, “Place grasshopper on Block A and smash with Block B.” The buyer asks the court to require the seller to return the $25 and pay $500 in punitive damages.” So… what types of promises should be enforced by the law?

38. 37 The Bargain Theory of Contracts

39. 38  Developed in the late 1800s/early 1900s  A promise should be enforced if it was given as part of a bargain, otherwise it should not  Bargains were taken to have three elements  Offer  Acceptance  Consideration The bargain theory of contracts

40. 39  Promisor: person who gives a promise  Promisee: person who receives it  In a bargain, both sides must give up something  reciprocal inducement  Consideration is what the promisee gives to the promisor, in exchange for the promise  Under the bargain theory, a contract becomes enforceable once consideration is given What is consideration?

41. 40  Promisor: person who gives a promise  Promisee: person who receives it  In a bargain, both sides must give up something  reciprocal inducement  Consideration is what the promisee gives to the promisor, in exchange for the promise  Under the bargain theory, a contract becomes enforceable once consideration is given What is consideration?

42. 41  Hamer v Sidway (NY Appeals Ct, 1891)  Uncle offered nephew $5,000 to give up drinking and smoking until his 21 st birthday, then refused to pay “The promisee [previously] used tobacco, occasionally drank liquor, and he had a legal right to do so. That right he abandoned for a period of years upon the strength of the promise… We need not speculate on the effort which may have been required to give up the use of these stimulants. It is sufficient that he restricted his lawful freedom of action within certain prescribed limits upon the faith of his uncle’s agreement, and now, having fully performed the conditions imposed, it is of no moment whether such performance actually proved a benefit to the promisor, and the court will not inquire into it.” The bargain theory does not distinguish between fair and unfair bargains

43. 42  Expectation damages  the amount of benefit the promisee could reasonably expect from performance of the promise  meant to make the promisee as well of as he would have been, had the promise been fulfilled Under the bargain theory, what is the remedy?

44. 43 Problems with the bargain theory  Not that accurate a description of what modern courts actually do  Not always efficient  Does not enforce certain promises that both promisor and promisee might have wanted to be enforceable

45. 44 Problems with the bargain theory  Not that accurate a description of what modern courts actually do  Not always efficient  Does not enforce certain promises that both promisor and promisee might have wanted to be enforceable  Does enforce certain promises that maybe should not be enforced

46. 45 What does efficiency say about what promises should be enforced?

47. 46 What promises should be enforced?  In general, efficiency requires enforcing a promise if both the promisor and the promisee wanted it to be enforceable when it was made  different from wanting it to actually be enforced

48. 47 What promises should be enforced?  In general, efficiency requires enforcing a promise if both the promisor and the promisee wanted it to be enforceable when it was made  different from wanting it to actually be enforced  The first purpose of contract law is to enable people to cooperate by converting games with noncooperative solutions into games with cooperative solutions  or, enable people to convert games with inefficient equilibria into games with efficient equilibria

49. 48 What promises should be enforced?  In general, efficiency requires enforcing a promise if both the promisor and the promisee wanted it to be enforceable when it was made  different from wanting it to actually be enforced  The first purpose of contract law is to enable people to cooperate by converting games with noncooperative solutions into games with cooperative solutions  or, enable people to convert games with inefficient equilibria into games with efficient equilibria

50. 49 So now we know…  What promises should be enforceable?  For efficiency: enforce those which both promisor and promisee wanted to be enforceable when they were made  One purpose of contract law  Enable cooperation by changing a game to have a cooperative solution  Contract law can serve a number of other purposes as well  That’s where we’ll pick up Wednesday