Econ 522
Economics of Law
Dan Quint
Fall 2009
Lecture 5
Logistics
 HW1 online – due Tues October 6
 First midterm – Tues October 13 (in class)


covers all material through end of Property Law
sample questions online
 No lecture Thurs October 1
 If you didn’t get my email on Tuesday…
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Last lecture…
 Coase: in the absence of transaction costs, if property
rights are well-defined and tradeable, voluntary
negotiations will lead to efficiency

or, if property rights are comprehensive enough, we can overcome
externalities
 Demsetz: yes, but more comprehensive property rights are
more costly to administer

will only develop when benefits outweigh costs
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Last lecture…
Sources of Transaction Costs:
 Search costs
 Bargaining costs



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Asymmetric information
Threat points being private information or uncertain
Large number of buyers or sellers
Hostility
 Enforcement costs
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Last lecture…
 Coase Theorem: transaction costs  efficiency


Normative Coase: design the law to minimize transaction costs
Normative Hobbes: design the law to minimize losses from
breakdown in bargaining
(or, roughly, allocate rights efficiently)
 Transaction costs vs. information costs


trans costs low, info costs high  minimize transaction costs
(“lubricate private bargaining”)
trans costs high, info costs low  allocate rights efficiently
(make private bargaining unnecessary)
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Today:
what can be privately owned?
what can an owner do?
how are property rights established?
what remedies are given?
5
Calabresi and Melamed treat property and
liability under a common framework
 Calabresi and Melamed (1972), Property Rules, Liability
Rules, and Inalienability: One View of the Cathedral
 Liability

Is the rancher liable for the damage done by his herd?
 Property

Does the farmer’s right to his property include the right to be free
from trespassing cows?
 Entitlements


Is the farmer entitled to land free from trespassing animals?
Or is the rancher entitled to the natural actions of his cattle?
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Three possible ways to protect an
entitlement
 Property rule / injunctive relief


Violation of my entitlement is punished as a crime
Injunction: court order clarifying a right and specifically barring any
future violation
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Three possible ways to protect an
entitlement
 Property rule / injunctive relief


Violation of my entitlement is punished as a crime
Injunction: court order clarifying a right and specifically barring any
future violation
 Liability rule / damages


Damages are a payment to a victim to compensate for actual
damage done
Better when prior negotiation is impossible
 Inalienability
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Comparing property/injunctive relief to
liability/damages rule
 Injuree (person whose entitlement is violated) always
prefers a property rule
 Injurer always prefers a damages rule
 Why?



Punishment for violating a property rule is severe
If the two sides need to negotiate to trade the right, injurer’s threat
point is lower
Even if both rules eventually lead to the same outcome, injurer may
have to pay more
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Comparing injunctive relief to
damages – example
E profits = 1,000
L profits = 300  100
E prevention = 500
L prevention = 100
 Electric company E emits smoke, dirties the laundry at a
laundromat L next door
 E earns profits of 1,000
 Without smoke, L earns profits of 300
 Smoke reduces L’s profits from 300 to 100
 E could stop polluting at cost 500
 L could prevent the damage at cost 100
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First, we consider the
non-cooperative outcomes
E profits = 1,000
L profits = 300  100
E prevention = 500
L prevention = 100
 Polluter’s Rights (no remedy)


E earns 1,000
L installs filters, earns 300 – 100 = 200
 Laundromat has right to damages


E earns 1,000, pays damages of 200  800
L earns 100, gets damages of 200  300
 Laundromat gets injunction


E installs scrubbers, earns 1,000 – 500 = 500
L earns 300
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E profits = 1,000
L profits = 300  100
E prevention = 500
L prevention = 100
Noncooperative payoffs
Polluter’s Rights
Damages
Injunction
E payoff
(non-coop)
1,000
800
500
L payoff
(non-coop)
200
300
300
1,200
1,100
800
Combined payoff
(non-coop)
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What about with bargaining?
Polluter’s Rights
Damages
E profits = 1,000
L profits = 300  100
E prevention = 500
L prevention = 100
Injunction
E payoff
(non-coop)
1,000
800
500
L payoff
(non-coop)
200
300
300
Combined payoff
(non-coop)
1,200
1,100
800
Gains from Trade
0
100
400
E payoff (coop)
1,000
800 + ½850
(100)
500 + ½
(400)
700
L payoff (coop)
200
300 + ½350
(100)
300 + ½
(400)
500
Combined
1,200
1,200
1,200
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How do we choose between the rules?
 In this case…


Polluter’s rights > damages > injunction when there is no
bargaining
All three equally efficient when there is bargaining
 Normative Hobbes: allocate rights efficiently to begin with

Polluter’s rights in this case, no reason to believe this more
generally
 Normative Coase: just work to lower transaction costs, let
people negotiate when they need to
 So what do we do?
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How do we choose between the rules?
 Injunctions are cheaper for court to implement

No need to calculate exact amount of damage done
 Damages are more efficient when private bargaining fails
 Leads Calabresi and Melamed to the following conclusion:
When transaction costs are high,
a liability rule (damages) is more efficient
When transaction costs are low,
a property rule (injunctive relief) is more efficient
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So that’s our answer:
 Calabresi and Melamed
When transaction costs are high,
a liability rule (damages) is more efficient
When transaction costs are low,
a property rule (injunctive relief) is more efficient
 But why are damages more efficient when bargaining fails?




Under damages rule, injurer has two choices: prevent the damage,
or pay cost afterwards
Under injunction, injurer has only one choice: prevent the damage
Injuree is compensated, so doesn’t matter to him
So whichever is cheaper for injurer, is more efficient
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High transaction costs  damages
Low transaction costs  injunctive relief
“Private bargaining is unlikely to succeed in disputes
involving a large number of geographically dispersed
strangers because communication costs are high,
monitoring is costly, and strategic behavior is likely to
occur. Large numbers of land owners are typically affected
by nuisances, such as air pollution or the stench from a
feedlot. In these cases, damages are the preferred
remedy.
On the other hand, property disputes generally involve a
small number of parties who live near each other and
can monitor each others’ behavior easily after reaching a
deal; so injunctive relief is usually used in these cases.”
(Cooter and Ulen) 17
A different view of the high-transaction-costs
case…
“When transaction costs preclude bargaining, the court
should protect a right by an injunctive remedy if it knows
which party values the right relatively more and it does not
know how much either party values it absolutely.
Conversely, the court should protect a right by a damages
remedy if it knows how much one of the parties values the
right absolutely and it does not know which party values it
relatively more.”
(Cooter and Ulen)
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Low transaction costs  injunctive relief
 Cheaper for the court to administer
 With low transaction costs, we expect parties to negotiate
privately if the right is not assigned efficiently
 But… do they really?


Ward Farnsworth (1999), Do Parties to Nuisance Cases Bargain
After Judgment? A Glimpse Inside The Cathedral
20 nuisance cases: no bargaining after judgment
“In almost every case the lawyers said that acrimony between
the parties was an important obstacle to bargaining…
Frequently the parties were not on speaking terms...
…The second recurring obstacle involves the parties’
disinclination to think of the rights at stake… as readily
commensurable with cash.”
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Finally, inalienability
 Inalienability: when an entitlement is not transferable or
saleable
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what can be privately owned?
what can an owner do?
how are property rights established?
what remedies are given?
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Public versus Private Goods
Private Goods



rivalrous – one’s consumption
precludes another
Public Goods

non-rivalrous

non-excludable
excludable – technologically
possible to prevent
consumption

examples: defense against
nuclear attack
example: apple

infrastructure (roads, bridges)

parks, clean air, large
fireworks displays
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Public versus Private Goods
 When private goods are owned publicly, they tend to be
overutilized/overexploited
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Public versus Private Goods
 When private goods are owned publicly, they tend to be
overutilized/overexploited
 When public goods are privately owned, they tend to be
underprovided/undersupplied
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Public versus Private Goods
 When private goods are owned publicly, they tend to be
overutilized/overexploited
 When public goods are privately owned, they tend to be
underprovided/undersupplied
 Efficiency suggests private goods should be privately
owned, and public goods should be publicly
provided/regulated
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Public versus Private Goods
 When private goods are owned publicly, they tend to be
overutilized/overexploited
 When public goods are privately owned, they tend to be
underprovided/undersupplied
 Efficiency suggests private goods should be privately
owned, and public goods should be publicly
provided/regulated
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A different view: transaction costs
 Clean air




Large number of people affected  transaction costs high
 injunctive relief unlikely to work well
Still two options
One: give property owners right to clean air, protected by damages
Two: public regulation
 Argue for one or the other by comparing costs of each


Damages: costs are legal cost of lawsuits or pretrial negotiations
Regulation: administrative costs, error costs if level is not chosen
correctly
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what can be privately owned?
what can an owner do?
how are property rights established?
what remedies are given?
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What can an owner do with his property?
 Priniciple of maximum liberty
 Owners can do whatever they like with their property,
provided it does not interfere with other’ property or rights
 That is, you can do anything you like so long as it doesn’t
impose an externality (nuisance) on anyone else
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That’s it for today
 Up next: applications
 (Textbook ch. 5)
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