Econ 522
Economics of Law
Dan Quint
Fall 2012
Lecture 9
Reminders
 Second homework due tomorrow night
 First midterm next Wednesday
1
Discussion question
 Should record labels sue illegal music downloaders?
2
More on
Remedies
3
Remedies (review)
 Maximum liberty: owner can do whatever he/she wants,
as long as it doesn’t interfere with another’s property

When it does interfere, externality, or nuisance
 Affects small number: private externality, or private bad

Transaction costs low  injunctions preferable
 Affects large number: public externality, or public bad

Transaction costs high  damages preferable
4
Types of damages
 Compensatory Damages



intended to “make the victim whole”
compensate for actual harm done
make victim as well off as before
 Can be…


Temporary – compensate for harms that have already occurred
Permanent – also cover present value of anticipated future harm
5
Temporary versus permanent damages
 Temporary damages


Require victim to keep returning to court if harm continues
Create an incentive to reduce harm in the future
 Permanent damages


One-time, permanent fix
No incentive to reduce harm as technology makes it easier
6
Efficient nuisance remedies
 If a nuisance affects a small number of people (private
nuisance), an injunction is more efficient
 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/costly to measure and innovation occurs
slowly, permanent damages are more efficient
 What’s done in practice for public nuisances?


temporary damages and injunction against future harm
but…
7
Boomer v Atlantic Cement Co
(NY Ct of Appeals, 1970)
 Atlantic owned large cement plant near Albany




dirt, smoke, vibration
neighbors sued
plant was found to be a nuisance, court awarded damages
neighbors appealed, requesting an injunction
 Court ruled that…




yes, this was a valid nuisance case
and yes, nuisances are generally remedied with injunctions
but harm of closing the plant was so much bigger than level of
damage done that court would not issue an injunction
ordered permanent damages, paid “as servitude to the land”
8
Boomer v Atlantic Cement Co
(NY Ct of Appeals, 1970)
 Atlantic owned large cement plant near Albany




dirt, smoke, vibration
neighbors sued
plant was found to be a nuisance, court awarded damages
neighbors appealed, requesting an injunction
 Court ruled that…




yes, this was a valid nuisance case
and yes, nuisances are generally remedied with injunctions
but harm of closing the plant was so much bigger than level of
damage done that court would not issue an injunction
ordered permanent damages, paid “as servitude to the land”
9
Next: two important limitations on property
rights imposed by government
 Government can limit how you use your property

Regulation
 The government can take your property

“Eminent domain”
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Eminent Domain
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Takings
 One role of government: provide public goods



When public goods are privately provided  undersupply
Defense, roads and infrastructure, public parks, art, science…
To do this, government needs 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
12
Takings
 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
13
Takings
 Why allow takings?
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Takings
 Why allow takings?
 Why these limitations?

why require compensation?
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Takings
 Why allow takings?
 Why these limitations?

why require compensation?
$10 MM
$9 MM
$3 MM
$1 MM
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Takings
 Why allow takings?
 Why these limitations?


why require compensation?
why only for public use?
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Takings
 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
18
Poletown Neighborhood Council v Detroit
 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)
19
More recent case: Kelo v. City of New London
(2005 US Supreme Court)
 Posner (Economic Analysis of Law) describes:

…Pfizer had decided to build a large research facility next to a 90acre stretch of downtown and waterfront property in New London.
The city hoped that Pfizer’s presence would attract other businesses
to the neighborhood.
The plaintiffs owned residential properties located on portions of the
90-acre tract…
It might have been impossible to develop those areas… had the
areas remained spotted with houses.
The city… solved the problem by condemning the houses.
It said, “the area was sufficiently distressed to justify a program of
economic rejuvenation.”
 Attorney arguing case:

“If jobs and taxes can be a justification for taking someone’s
home or business, then no property in America is safe.”
20
Recent example
of eminent domain
 Bruce Ratner owned the Nets from 2004-2011


Bought for $300 MM, sold for less (80% for $200 MM)
This “loss” held up by David Stern as evidence NBA owners were
losing money, players needed to make concessions
 Recent Malcolm Gladwell article on Grantland





Ratner didn’t want the Nets – he wanted
development rights to a 22-acre site in Brooklyn
Buying it all up would be difficult
Seizure a la Kelo would be possible, but
politically unpopular
If plans included a basketball stadium, becomes
clear-cut case for eminent domain
Even if Ratner took a “loss” on the team, he got
what he wanted out of the deal
21
Regulation
22
Multiple forms of public ownership
 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
“Anti-commons” caused by existing intellectual property
 Political Control/Regulation
23
Third form of public ownership: political
control/regulation
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.
24
Third form of public ownership: political
control/regulation
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.
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Similar to how Iceland maintains fishing stock
 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.
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Regulation
27
Regulation: Pennsylvania Coal v. Mahon
 1800s: PA Coal purchased mineral and
support estates, Mahon owned surface
 1921: Kohler Act prohibited “mining of
surface estate
anthracite coal in such a way as to cause
the subsidence of, among other things,
support estate
any structure used as a human
habitation.”
mineral estate
 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.”
28
Regulation: Pennsylvania Coal v. Mahon
 1800s: PA Coal purchased mineral and
support estates, Mahon owned surface
 1921: Kohler Act prohibited “mining of
surface estate
anthracite coal in such a way as to cause
the subsidence of, among other things,
support estate
any structure used as a human
habitation.”
mineral estate
 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.”
29
Regulation: Pennsylvania Coal v. Mahon
 1800s: PA Coal purchased mineral and
support estates, Mahon owned surface
 1921: Kohler Act prohibited “mining of
surface estate
anthracite coal in such a way as to cause
the subsidence of, among other things,
support estate
any structure used as a human
habitation.”
mineral estate
 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.”
30
Regulation: Pennsylvania Coal v. Mahon
 1800s: PA Coal purchased mineral and
support estates, Mahon owned surface
 1921: Kohler Act prohibited “mining of
surface estate
anthracite coal in such a way as to cause
the subsidence of, among other things,
support estate
any structure used as a human
habitation.”
mineral estate
 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.”
31
Blume and Rubinfeld, “Compensation for
Takings: An Economic Analysis”
 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
32
Blume and Rubinfeld, “Compensation for
Takings: An Economic Analysis”
 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
33
“Maximum liberty” vs. government’s right to
regulate
 Ruling a year ago 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”
34
Zoning
 Zoning laws

Distinguish industrial areas from residential areas
35
Zoning
 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
36
Zoning
 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
37
Property law: the big-picture question
 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?
End of material on first midterm
 Up next: contract law
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Why do we need contracts?
 Some transactions don’t occur all at once


I’m flying to Boston for Thanksgiving…
…or I hire someone to paint my house…
39
Why do we need contracts?
 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
40
Example: the agency (trust) game
Player 1 (you)
Don’t
Trust me
Player 2 (me)
(100, 0)
Share profits
(150, 50)
Keep all the money
(0, 200)
 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
41
(One solution: reputation)
42
Another solution: legally binding promises
Player 1 (you)
Don’t
Trust me
Player 2 (me)
(100, 0)
Share profits
(150, 50)
Keep all the money
(125, 25)
 Now we get cooperation (and efficiency)
 Purpose of contract law: to allow trade in situations where
this requires credible promises
43
So… what types of promises should be
enforced by the law?
 “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.”
44
The Bargain Theory
of Contracts
45
The bargain theory of contracts
 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
46
What is consideration?
 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
47
What is consideration?
 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
48
The bargain theory does not distinguish
between fair and unfair bargains
 Hamer v Sidway (NY Appeals Ct, 1891)
 Uncle offered nephew $5,000 to give up drinking and
smoking until his 21st 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.”
49
Under the bargain theory, what is the
remedy?
 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
50
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
51
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
52