Econ 522 – Lecture 7 (Sept 23 2008)
Logistics
 next week: no class Tuesday, no office hours Wednesday
 working together on homework
 reminder: homework is due when I start lecture on Thursday, anything after will
be penalized (sorry)
Last week
 discussed some examples of what can be privately owned – information (through
patents, copyrights, trademarks, trade secrets), corporations
 and some ways property rights are established (fugitive property) and not
established (sale by thief); and examples of how property rights are verified, as
well as how they can be lost (through adverse possession and by losing the
property itself)
Next: some applications of What can owners do with their property?
One thing owners can typically do with their property is to determine who gets it when
they die.
 This wasn’t always the case. In medieval England, land passed automatically to
the owner’s eldest son, and changes to this could only be made under very
particular circumstances
 Feudal and tribal societies typically specified who inherited land, and restricted
the sale of land, especially to outsiders
 Over time, however, the trend in Western countries has been towards more
freedom to specify of owners to specify who will inherit their property and what
they may do with it.
What effect do limitations like this have?
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Suppose I own some large estate, which the law says I must pass on to my eldest
son when I die, but I’d prefer to give it to my daughter
One thing I can do: look for ways to circumvent the rules
I might be able to sell her the property now, and rent it back from her while I’m
still alive
There might be other technicalities that allow me to get around the intent of the
law
But these are likely to be somewhat costly, so I would incur what the book refers
to as Circumvention Costs.
On the other hand, it may be too costly, or impossible, for me to give the property to my
daughter; I may have to accept the fact that it will go to my lazy, worthless son
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In this case, I’m likely to start caring much less about the value of my estate after
I am gone, which creates an incentive for me to use the property inefficiently
o I may choose to overhunt now, not caring whether I wipe out the animals
on my land
o I might cut down trees prematurely, before they mature all the way, to get
more use out of the land now (while I’m alive) at the expense of its future
value (which I no longer care about)
The book refers to the loss due to these decisions as Depletion Costs –
inefficiencies I bring on because I stop caring as much about the future value of
the property.
Circumvention costs and depletion costs seem to argue in favor of giving an owner more
freedom in determining what happens to his property after he dies. However, there is
also a danger when this freedom is made too absolute.
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Suppose that the estate I own is my family’s ancestral home, and I specify in my
will that nobody should ever use that land for purposes other than a residence
I die, and several years later, my heirs want to turn the land into a golf course, or
sell it to a developer to turn into a mall. Should this be allowed, or should the
restrictions in my will be upheld?
o If my restrictions are routinely set aside by the law, then we return to the
old problem – since I don’t have control over what will happen to my
estate after I die, I have an incentive to circumvent the law or to deplete
the value of the property
o On the other hand, if the restrictions are typically upheld, it becomes
difficult to maintain efficiency as circumstances change, since my heirs
may not be able to put the land to its most valuable use (or sell it to an
owner who values it more).
If I’m wealthy but don’t trust my childrens’ judgment, I may try to create a trust
that will prevent them from accessing most of my wealth until they reach a certain
age. Similarly, if I don’t trust them to use my estate wisely, I may try to put
restrictions on what they can do with it.
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Earlier, we used the term “inalienability” to define entitlements which you are not
allowed by law to get rid of
Limitations on the use of property are sometimes called “restraints on
alienation,” since among other things they limit an heir’s legal right to dispose of
the property
English common law typically imposes a time limit on such restrictions, ruling
out what is referred to as a perpetuity, a restriction that would last forever
o Thus, I can legally restrict what happens to my property after I die for a
certain length of time, but not forever.
o The time limit is typically defined as “lives-in-being plus 21 years,” that
is, they are binding for the lifetime of my heir plus an additional 21 years.
The effect of this time limit is basically to allow me to place restrictions on the
next generation, but not the generation after that
o If I pass my estate on to my daughter, with the restriction that it not be
sold or developed into for commercial uses, this limits my daughter
o But once she dies and passes the estate on to her children, after a certain
length of time, they will be free to do what they want with it
Thus, this acts as a “generation-skipping rule” – I’m free to do what I want, and
the second generation after me is once again free to do what they want, but the
generation in between is not.
This sort of law makes a lot of sense if you assume that “most” heirs will be prudent and
well-behaved, but that every once in a while someone will come along whose judgment
can’t be trusted. The law protects my estate from a single bad heir, since whoever passes
the property on to them can restrict them; but it does not tie up the property forever in
what might eventually be an inefficient way.
Exceptions to Property Rights
We said before that property rights are typically protected by injunctive relief – using
another owner’s property without permission is typically considered criminal trespass.
When transaction costs are low, this leads to bargaining and through bargaining to
efficient use of the property.
However, these restrictions are not absolute. We already noted there are “fair use”
exceptions to copyright protection – even though a copyright is a form of ownership,
there are ways in which I can use others’ property legally, such as for educational
purposes or in satire. There are also exceptions in general property law. The Supreme
Court of Vermont decision established one such exception, in the case of Ploof v Putnam,
decided in 1908.
Ploof was sailing on Lake Champlain with his wife and two children when a storm came
up very suddenly and they needed a safe harbor quickly. The nearest one was on an
island owned by Putnam. Ploof tied his boat to a pier on the island to wait out the storm.
But an employee of Putnam’s worried that the boat would bang against the pier and cause
damage, so he untied the boat (with Ploof and his family still aboard) and pushed it away.
Ploof sued, claiming that the eventual wreckage of his boat and injuries to his family
were the fault of Putnam (through his employee), saying that the emergency justified his
trespassing on the defendant’s property without permission; he asked for damages.
Putnam answered that property owners have the right to exclude trespassers, and claimed
that it was so obvious the case should not even go to trial. The Vermont Supreme Court
said that private necessity was an exception to the general rule of trespass.
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Thus, in an emergency, one person can use another’s property without permission,
but must then compensate the owner for the cost of use
For example, a lost hiker is allowed to break into a remote cabin for food and
shelter, but must pay for the damage to the cabin and whatever food he took.
The book gives other examples where private necessity justifies unauthorized use
of another owner’s property
o breaking into a pharmacy when someone is deathly ill and the owner
cannot be found
o using someone’s valuable vase as a weapon against a murderer.
This is also similar to the rule we saw in Demsetz as property rights over land
were being established among Native Americans – you could kill an animal for
food on someone else’s land if you were starving, but you could not keep its
valuable fur.
This type of exception to the general rule of property law makes perfect sense, if we see
property law as an attempt to encourage individuals to bargain over the most efficient use
of property. Clearly, in an emergency, there is no time for bargaining (or transaction
costs can be thought of as being prohibitively high); so a damages rule ensures that the
property will be put to its most efficient use.
(If Ploof had been able to find Putnam and had tried to bargain with him, Putnam would
have found himself in a very strong bargaining position, and might have demanded an
unreasonable amount of money. Ploof might have agreed to pay it, and then tried to get
out of it after the fact. Once we get to contract law, we’ll discuss, among other things,
the legality of contracts signed under duress.)
Inalienability
We mentioned earlier that entitlements can be protected in three ways:
 as property (through an injunction)
 by a liability rule (through damages)
 or through inalienability
There are lots of things that cannot legally be sold, and most of them strike us as creepy
to even think about in those terms:
 the book gives the examples of organs, sex, heroin, children, votes, atomic
weapons, and human rights
 In some cases, you can neither sell the entitlement nor give it away – as with the
right to vote. (You can choose not to vote, but you can’t transfer your right to
vote to another person.)
In most cases, there is not a clear economic argument for the rule, so much as an attempt
to rule out something that is seen as disgusting or immoral. The book does mention one
argument for outlawing the sale of blood: that it might undermine blood donations.
 Most (but not all) blood in the U.S. is provided by donations, and its safety is
protected by two means:
o a medical history given by the donor
o and a lab test for infections
 One could imagine that a person has no reason to lie about their history when
donating blood; if you were selling blood, you might choose to hide a condition
that made you an unfit donor
 So blood might be more safely supplied by donation rather than purchase
 But if some places paid for blood, nobody would want to donate for free
 So outlawing the sale of blood might end up being efficient.
(In the U.S., the sale of blood is legal, but the sale of organs is not. The supply of
transplantable kidneys – both from live donors and from cadavers – falls far short of the
demand. There has been lots of discussion about ways to improve the system…)
Unbundling
Earlier in the course, we defined property as “a bundle of rights,” that is, a collection of
rights that you have over the use of your property. In some instances, an owner may
want to unbundled these rights – that is, separate them, so that he could sell some of them
and hold onto others. In some instances, this is not allowed – an owner may be permitted
to sell the bundle as a whole, but not in pieces.
A great example of unbundling comes from Pennsylvania. Pennsylvania was largely
built on coal – lots of land has coal under it, and lots of money was made by mining this
coal.
In Pennsylvania, as of the late 1800s and early 1900s, land ownership consisted of three
separable pieces, referred to as “estates”. There was the surface estate – the rights to use
the surface of the land (build a house on it, grow corn on it, whatever). There was the
mineral estate – the rights to whatever coal lay underneath the surface. And most
interestingly, there was the support estate – the rights to whichever parts of the
underground structure were holding up the surface.
If I owned the surface and support estates, I could build a house on the land and live
there. If you owned the mineral estate, you could mine coal from my land, but if my
house began to sink, it was your fault and you owed me damages – that is, by owning the
support estate, I had the right to my house not falling in.
On the other hand, if you owned both the mineral and support rights, you could mine the
coal however you wanted. If I owned the surface, I could still build a house, but if the
surface fell in as a result of your mining operation, I had no recourse, since I owned the
surface but not the right to have it held up.
In this case, the “support estate” wasn’t necessarily tangible property, but it made it
completely clear who had the rights to do what with the property, and the three property
estates could be bought and sold separately. (I don’t think the support estate had any
value on its own.) There’s an interesting case from the 1920s, Pennsylvania Coal vs
Mahon, which is discussed on the textbook website – we’ll come back to that case on
Thursday, because it’s interesting for other reasons.
This is one example where an unbundling of rights was allowed. But there are also many
instances when unbundling is not permitted. We already saw one example where it
wasn’t permitted. Restrictions I place in my will about how my property can be used
have an expiration date; so I can’t pass on to my heirs (and their heirs, and theirs) the
rights to own and live on my property, but keep for myself the rights to turn it into a golf
course (or more generally to determine what to do with it). Similarly, the owner of a
vacant lot may be able to sell it whole, but zoning restrictions may prevent him from
dividing it up into smaller pieces and selling them separately.
In general, neither the common law nor the civil law allow free unbundling and
repackaging of property rights. The civil law tradition is the more restrictive of the two:
in the civil law, the rights which come with property ownership are attached to the
property itself, not to the owner, and so they typically cannot be separated at all.
The book gives an example of two brothers, one of whom inherits a watch that’s a family
heirloom. The other brother wants to be able to wear the watch at a family Christmas
party every year. If they sign a contract – one brother pays for a guarantee that he can
wear the watch every Christmas – this is binding on the brother who inherited the watch;
but if he decides to sell the watch, the buyer would be buying the whole watch, and
would not be bound by this contract. (Selling the watch might be a breach of the contract
with his brother, but the brother would have no claim against the watch’s new owner.)
On the other hand, if unbundling of property rights were allowed, the brother could buy
the “Christmas rights” to the watch, with the heir retaining all the other rights. Then if
the heir sold the watch, he could only sell the non-Christmas rights to it, since he did not
possess the Christmas rights, and the brother would have a legitimate claim against the
new owner to wear the watch on Christmas.
The example helps explain why property rights generally can’t be unbundled –
unbundling creates uncertainty that may hamper future trade. In this case, it might be
very hard for the owner of the 364-day rights to the watch to sell it, since buyers might
only be interested in buying a “whole” watch.
Of course, if rights could be unbundled, they could presumably be re-bundled; but if they
were unbundled and individual rights sold to lots of different owners, the transaction
costs of rebundling might be overly high.
Efficiency would generally suggest that unbundling should be allowed when it increases
the value of the property; but if rebundling the rights in the future would be costly, this
may argue against unbundling. One could also argue that unbundling leads to greater
uncertainty. In a world without unbundled rights, when I buy an apple, I know exactly
what I’m getting. In a world with total unbundling, before buying an apple, I would need
to verify that the seller owns the specific rights that I want to acquire – say, the eating
rights – and not just the right to carry the apple. Thus, excessive unbundling might
increase transaction costs in general.
Easements
Someone asked after class last week why, if unbundling was generally not permitted,
easements were.
 In rough terms, an easement is a right to use someone else’s property (almost
always their land) for a particular purpose
 The most common easements are right-to-pass easements – the right to cross
someone else’s property
 Easements can be private or public – they can allow everyone to cross (such as
from a public road to a beach), or they can apply to the owner of the adjacent
property (to get from a public road to “landlocked” property)
 Examples of other easements:
o the right to use the airspace over someone’s property (above a certain
altitude) for aviation
o the right to have a storm drain, sewer line, power line, phone line, or gas
line cross someone else’s property
o easements to prevent the adjacent property from blocking too much of the
sunlight, or blocking one’s existing view
o a shared driveway may cut through one property to get to another
o communications easement – I could let someone put up a cell phone tower
on my land without selling them the land
Easements can originate in a number of ways:
 “prescriptive easements” – similar to adverse possession – if I access my property
by cutting through yours, regularly, without your permission, over a long enough
period of time, then in many places, I acquire the right to keep doing that
o unlike adverse possession, you don’t own the land, you just have a right to
cross it
o generally established that this does not apply to views – if I enjoy my view
of a distant beach for long enough, that doesn’t give me a permanent right
to unblocked view
 “implied easements” – if a subdevelopment is planned in such a way as one plot is
landlocked, it is assumed its owner has a right to get to his property via others’
 and easements can be explicitly granted
So why are easements allowed, when unbundling is often not?
 one of the problems with unbundling was future uncertainty – if my brother has
Christmas rights to our grandfather’s watch, but I sell the watch to a stranger, he
has no reason to suspect that I don’t own the whole watch
 easements attach to property, and as we mentioned earlier, there are registries to
verify who owns what property, so it’s easier to document rights that are tied
directly to land
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in the example of someone wanting to protect his ancestral estate from being
turned into a golf course, once he set up a perpetuity and died, there would be
nobody who could renegotiate it as circumstances changed
but with an easement, on an ongoing basis, there are two sides – the owner of the
property, and the owner of the right
o the easement was presumably established because it is currently efficient
o if circumstances changed in the future, it could be renegotiated
Cooter and Ulen took the view that unbundling should be allowed when it increases the
value of the property; in the case of easements, this is typically the situation (the right is
worth more to the holder of the easement than it costs the property owner)
 a landlocked property is worthless if you can’t get to it
 but if one owner signed a contract with his neighbor allowing him to cross, it
wouldn’t apply to the new owner, so selling the landlocked property would be
hard due to uncertainty
 easement solves this problem
Friedman points out that, although the details of the law vary by jurisdiction and over
time, it is generally easier to pass a benefit on to future buyers than to pass on a burden.
 If I sign a contract (a covenant) with my neighbor promising not to use my
property in a particular way, that generally does not get passed on to a new owner
 But if I have the right to access the beach from my property by crossing a
neighbors, that typically would transfer to the new owners
 If I’m trying to sell property, there’s a strong incentive to mention benefits to
potential buyers, and to hide burdens – the law basically lines up so that there
won’t be many surprises
However, this is not always the case. In some areas where overdevelopment is a fear,
conservation easements are being introduced to ensure that some farmland remains
farmland. (This includes two towns, Dunn and Baraboo Hills, in Wisconsin.)
Basically, government and foundation money is paid to farmers, in exchange for placing
a long-term or permanent easement on their land, preventing it from being used for any
other purpose. This is exactly unbundling – the rights to develop the land for another
purpose are unbundled from the ownership of the land, and sold off separately to a
nonprofit that then “retires” those rights.
If farmland is seen as a public good – natural beauty, less congestion/pollution than if it
were developed into something else, etc. – it’s a way to internalize the positive
externality
But less clear what will happen if circumstances change and development becomes more
appealing
Remedies for Violations of Property Rights
(This is largely a review of the Calabresi and Melamed stuff we covered earlier)
The book made the case earlier that the common law roughly approximates a legal
system of “maximum liberty,” under which I can do whatever I want with my property as
long as that doesn’t interfere with anyone else’s property. When the use of my property
does interfere with someone else’s use of theirs, we have an externality. In property law,
harmful externalities are called nuisances.
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When an externality is imposed on a small number of others, we say it’s a private
externality, or in the language of public and private goods, a private bad
In these cases, transaction costs should generally be reasonably low, and the
problem can be solved through negotiation.
o (This might be the case with neighbors fighting over a tree that crosses the
property line.)
In these cases, relief by injunction is generally attractive – the court does not need
to go through the exercise of calculating damages, and the clear enumeration of
property rights will hopefully encourage the neighbors to reach an efficient
outcome by bargaining.
o (We saw this with the example of the brewery whose smoke affected only
one consumer – he and the brewery could agree to a Pareto-improving
transaction to reduce pollution)
On the other hand, when an externality is imposed on a large number of people –
as with a factory polluting air in an area of dense population – the transaction
costs of private negotiation are often prohibitively high
This is a public externality, or public bad
In these cases, from an economic point of view, damages are ideal
Damages cause the factory to internalize the externality – that is, the cost to the
neighbors becomes a private cost to the factory – but the factory can still choose
to accept this cost and continue polluting when this is efficient
o (With high transaction costs, an injunction would likely force the factory
to stop polluting, which may not be efficient.)
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Compensatory damages is the term for damages intended to “make the victim
whole,” that is, to return the victim to being as well off as he or she was before the
harm occurred
(We’ll come back to other types of damages later on, in contract and tort law)
Compensatory damages can be either temporary or permanent
o Temporary damages compensate for harms that have already occurred.
o Permanent damages compensate in addition for the present discounted
value of harm that is expected to be done in the future
o That is, by paying temporary damages, a factory compensates the
neighbors for whatever pollution has already occurred; by paying
permanent damages, the factory is effectively pre-paying the neighbors for
the right to pollute in the future.
There are pros and cons to both types of damages
 Temporary damages require the victim to keep returning to court as the harm
continues, and require the court to keep calculating the amount of damages each
time, so they impose a high transaction cost
 However, under temporary damages, future reductions in the harm itself lead to
reductions in the damages owed, so the factory has an incentive to take steps to
reduce pollution, or to pay the neighbors to take steps that reduce the harm on
their end if this is more efficient.
 On the other hand, permanent damages are a one-time, permanent fix, and
therefore less costly to implement
 But once permanent damages have been paid, the factory is not penalized for any
additional harm they do (they’ve already paid for it); so there is no incentive to
reduce the harm as technology makes this easier
 In addition, since permanent damages are based on the expected discounted value
of future harm, it depends both on future technology and future prices, which
cannot be predicted with accuracy
 So Cooter and Ulen say that permanent damages suffer from high “error costs,”
that is, whatever inefficiency is introduced by the amount of the compensation
being incorrect.
Thus, they offer the following general proscription for appropriate remedies for
nuisances:
 if a nuisance affects a small number of people (private nuisance), award an
injunction, and count on the parties involved to negotiate an efficient solution
 if a nuisance affects a large number of people (public nuisance), damages are
more efficient
 if damages are easy to measure and innovation occurs rapidly, temporary
damages are more efficient
 if damages are difficult (or costly) to measure and innovation occurs slowly,
permanent damages are more efficient
They make the point, however, that this is not what is typically done in practice: that with
public nuisances, the remedy tends to be temporary damages (for harm already incurred)
and an injunction against future harm. However, they discuss one very interesting case
that shows the court becoming more receptive to damage remedies in these situations, in
spite of all the precedent in favor on injunctions.
The case is Boomer v Atlantic Cement Co, decided in 1970 by the NY Court of
Appeals
 Defendant owns a large cement plant near Albany, which, along with cement,
produces dirt, smoke and vibration
 The neighbors sued, the plant was found to be a nuisance, and they were awarded
temporary damages, but denied an injunction against future harms
 Plaintiffs appealed, requesting an injunction.
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The appeals court ruling was very interesting
They agreed that yes, this was a valid nuisance
And yes, nuisances are generally remedied with injunctions
But in this case, the harm of forcing the plant to close so greatly outweighed the
level of the damage being done that they refused to issue an injunction, and
instead ordered permanent damages to be paid
They pointed out that the two sides could settle the issue instead through
voluntary negotiations, but that “the imminent threat of closing the plant would
build up the pressure on defendant…”
They also pointed out that techniques to reduce dirt and vibration from the cement
production process would be developed by the industry as a whole, not just by
this one plant, and that these were therefore outside the defendant’s control and
unlikely to occur within a short time
Pointing out that the court had estimated the total of permanent damages to all
plaintiffs to be $185,000, and that the company had invested $45,000,000 in the
plant and it employed 300 people, they refused to issue the injunction.
(Technically, they issued an injunction that would automatically be vacated once
permanent damages to the plaintiffs were paid.)
They also noted that the damages were paid as “a servitude to the land,” that is,
the fact that damages had been paid attached itself to the land, not the individual
plaintiffs
So if these plaintiffs, having already received permanent damages, sold their
property, the new owners could not sue for damages
Instead, the ongoing nuisance caused by the cement company would simply be a
feature of the land, and would presumably be figured into the price that they could
sell it for.
(This is conceptually similar to an easement…)
Permanent damages typically compensate for “all reasonably anticipated future harms.”
 Presumably, if Atlantic Cement in the future were to expand greatly, or adopt a
much noisier or dustier process of production, these new harms would still be
liable for damages; but the established level of harm had already been
compensated.
That’s it for today. Thursday, we’ll wrap up property law by considering governmental
takings, that is, the seizure of private property under eminent domain laws, including the
Blume and Rubinfeld article.
note to self: this lecture took 45 minutes