Eminent Domain
Why do we have it and how has it changed over the years?
What is Eminent Domain?
Eminent Domain is when the government takes ownership (condemns) private property for public use.
Are there any restrictions on the government from using eminent domain?
Yes . . .
According to Article I section 8, #18 of the Constitution
The Government must prove that the condemnation is consistent with the necessary and proper clause.
According to the Takings Clause of the 5th Amendment
The Government must provide just compensation for the property.
Note: Courts usually recognized just compensation as meaning fair market price. The courts will not factor in emotional
or sentimental value as part of compensation.
The condemned property must be used for “public use”
Note: In the past, courts have interpreted “public use” as meaning public goods, recently the courts now understand,
“public use” as meaning public purpose, thus broader the definition.
Public use interpreted as public goods= Private property to public property
Public use interpreted as public purpose= Private property to public or private property (if serving a public purpose)
Eminent Domain is intended to
eliminate the threat of the
hold-out problem.
Pareto ImprovementChange in the allocation of resources that makes at least one person better off without making
anybody worse off.
Pareto Efficient (optimal)-
No more improvements can be made without hurting somebody.
Hold Out Problem
Without Eminent Domain (Round 1)
Developer (Government)
Offers Price 1
Owner
Accepts Price 1
Value of Land > Price 1
Price 1 > Value of land
Does not accept Price 1 (Hold out)
Must accept cost
and wasted time
No change and no cost
Hold Out Problem
Without Eminent Domain (Round 2)
Developer (Government)
Offers Price 2
Owner
Accepts Price 2
Value of Land - Price 2- additional cost
(could end up paying more than
market price
Price 2 > Value of land
Does not accept Price 2 (hold out)
Must accept cost
and wasted time +
additional cost
No change and no cost
The owner is assuming a monopoly over the limited resource of land
If the owner continues to “Hold Out” the developer has 2 options:
Option 1:
Offer a price that far exceeds market price.
This is Pareto inefficient because the owner is better off but the developer is worse off.
Or
Option 2:
Give up on plan the was necessary and proper resulting in the public being. worse off
This is Pareto inefficient because the owner is no worse off but the community is worse off.
Hold Out Problem with multiple Owners (very common and much worse.)
Without Eminent Domain
Developer (Government)
Offers Price 1 to each owner
Owner 1
Owner 2
Owner 3
Owner 4
Owner 5
Each time an individual owner accepts the developer’s offer the developer becomes more entrenched in the
project and therefore becomes increasingly vulnerable to hold outs in future negotiations.
The final owner can hold out and name his price. This Pareto inefficient situation harms the owners, the
developer, and the public.
Additionally, if each owner looks forward and reasons backwards the deal will never be complete because
every owner will want to be the last owner offered and thus automatically hold out for a better deal.
Now each owner is assuming a monopoly over the limited resource of land
If each owner continues to “Hold Out” the developer has 2 options:
Option 1:
Offer a price that far exceeds market price.
This is Pareto inefficient because the owner is better off but the developer is worse off.
Or
Option 2:
Give up on plan the was necessary and proper resulting in the public being. worse off
This is Pareto inefficient because the owner is no worse off but the community is worse off.
Eminent Domain is intended to serve as a balance between Equity (value) and Efficiency.
Eminent Domain is Pareto Efficient because economically speaking, someone (community) is
improving but nobody is worse off.
Negotiations With Eminent Domain
VD- Value of land to developer (more than $300,000)
V0- Value of land to owner
Fair market price- $300,000
Court Cost - $10,000
Owner accepts
Developer
Owner
VD – P1= +
P1- VO= +
Both have maximized their Utility given the
circumstances
Developer (Government)
Offers Price 1 ($300,000)
Negotiations With Eminent Domain
VD- Value of land to developer (more than $300,000)
V0- Value of land to owner
Fair market price- $300,000
Court Cost - $10,000
Developer (Government)
Offers Price 1 ($300,000)
Owner rejects
Developer
Files Eminent
Domain and the
case goes court
Developer
Owner
VD – P- court cost
P1- VO- court cost= +
Developer counter
offers
This will continue
until both parties feel
that they have the
best deal.
Eminent Domain puts both the developer and the owner in a Nash Equilibrium where it is in the interest of both parties
to settle out of court.
The Developer should look forward and reason backwards,
“If I don’t offer a fair market price and the owner rejects, I will have to go to court, end up paying fair market price and
pay additional court cost.”
If the developer has offered fair market price then the Owner should look forward and reason backwards,
“If I reject this offer, I will go to court, only to receive just compensation and still have to court cost.”
Knowing how the other will react it is best for the parties to make and accept fair offers in order to avoid court cost.
The Slippery Slope and Eminent Domain