1
Beyond Markets: Property
and Contracts
Chapter 9
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2
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3
Surf City’s Lost Oil
In the 1920s Huntington Beach was called “Oil City.” As production began, oil
workers rushed to buy beachfront cottages on 25-foot lots. A few years later they
obtained permission to drill wells in their backyards. By the mid-1930s, the boom
was over. Extracting so much oil so quickly had reduced underground pressure to
the point that it could no longer drive oil to the surface.
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posted to a publicly accessible website, in whole or in part.
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What’s Next
By coordinating their drilling and production the well
owners and consumers would have seen more oil brought to
the surface. Coordination, however, would have required
hundreds of property owners to reach agreement on where
and when to drill and how to share costs and revenues.
Coordination such as this can be facilitated by developing
enforcable agreements. Our purpose here is to understand
how such agreements come about and how disagreements
might be avoided.
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posted to a publicly accessible website, in whole or in part.
5
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or posted to a publicly accessible website, in whole or in part.
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Interchangeability - Perfect
Competition
A seller in a perfectly competitive market makes no special
arrangements to deal with any particular customer. No
investments are dedicated to that relationship that will
lose value if it ends.
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posted to a publicly accessible website, in whole or in part.
7
Interchangeability - Contracts as
Promises and a Market for Contracts
A contract is an enforceable set of promises to take
certain actions over the future. The movement from
markets to contracts is an important one. Contracts will
be more costly to arrange and enforce than spot market
transactions, but they can also bring benefits that are
unobtainable in spot markets.
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posted to a publicly accessible website, in whole or in part.
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Specificity and Property
The parties to a contract transact something quite unlike the
interchangeable units of a spot market commodity. We often
say that a contract specifies a set of property rights connected
with the exchange of some good or service. These are rights to
use something in a defined manner, and they often include
the right to sell or otherwise transfer it.
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posted to a publicly accessible website, in whole or in part.
9
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10
Bees and LoJacks - Bees: Low-Cost
Contracting
The United States has about 200,000 beekeepers, many
part-time. Some travel with their beehives and arrange with
farmers to park in their vicinity for several days. The bees
gather nectar from flowers and turn it into honey, in the
process transferring pollen between flowers. Pollination of
fruit trees and crops like alfalfa increases their yields. The
longer the bees stay, the fewer the flowers still unvisited
and the smaller the daily yields of honey. A contract
between the farmer and beekeeper can create value from
this relationship.
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posted to a publicly accessible website, in whole or in part.
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Bees and LoJacks - LoJack: Some
Agreements Are Too Costly
LoJack Corporation has developed a highly effective system for retrieving
stolen vehicles. Police recover about 95 percent of LoJack-equipped cars intact
but only 60 percent of unequipped cars. Although only a small percentage of
cars actually have LoJack, one installation confers a benefit on other owners.
Police who spot a Lo- Jack-equipped car can follow it to a shop where
criminals tear down stolen cars for their parts. A single LoJack can recover
more than one car and put a dismantling operation out of business.
Ian Ayres of Yale Law School and economist Steven Levitt of the University of
Chicago ran the numbers and concluded that equipping three additional cars with
LoJacks (which last for the life of a car) will deter one auto theft a year in a city,
most likely of an unequipped car. From the community’s standpoint the net
benefits are positive. In deciding to install a LoJack, an individual only considers
the private value proposition, not the community benefit.
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posted to a publicly accessible website, in whole or in part.
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Bees and LoJacks – Introducing
Government
Suppose the government recognizes the community benefit
that comes from the installation of LoJacks on cars. To
achieve this benefit the government could pass a law
requiring the installation of LoJacks on all new cars.
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posted to a publicly accessible website, in whole or in part.
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Efficient Allocations and Coasian
Reasoning - External Costs and
Benefits
Every voluntary transaction creates economic value for
the buyer and seller. A self-interested beekeeper trying to
maximize his wealth would want to reach agreement with the
farmer, who has a similar interest in her own wealth. The
bees produce an external benefit or beneficial externality in
the form of a more valuable apple crop. An externality occurs
when one person’s action affects another’s wealth, whether
positively or negatively.
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posted to a publicly accessible website, in whole or in part.
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Efficient Allocations and Coasian
Reasoning
We can get a fuller understanding of externalities and
transaction costs by bringing another person into the model.
He is a writer who suffers from an allergy that the presence of
bees makes worse. The allergy cuts his daily writing output
and income, which reflects the value readers place on his
work. The activities of the beekeeper and the farmer impose
an external cost on the writer. Should the beekeeper stay?
It turns out that no matter who has the initial property rights,
if negotiation is costless the three will arrive at the same
efficient outcome that maximizes their net benefits as a
group.
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posted to a publicly accessible website, in whole or in part.
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Efficient Allocations and Coasian
Reasoning - High Transaction Costs
When negotiation has costs the law can affect outcomes.
Assume that three-person situations like this one occur
frequently and that usually (unlike the previous example) the
efficient solution gives the writer a totally bee-free world;
that is, consumers value written material very highly relative
to crops and honey. If negotiation is very costly, and the law
gives the beekeeper and farmer the right to use bees, valuable
written works will go unproduced while less valuable apples
and honey are produced.
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posted to a publicly accessible website, in whole or in part.
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Property: A Sequence of Cases - The
Meteor Shower
To make agreements that create value, the parties’
underlying rights must be clearly defined in the law. If
they are undefined or unclear, the promises they make to
each other in a contract may be impossible to carry out
or enforce.
Assume that a meteor shower has left your land (and no one
else’s) covered with diamond-hard stones that you think
would make superior industrial abrasives. If the rights to
the stones are clear and enforcable, you are more likely to be
willing to do whatever is necessary to make the stones
marketable.
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posted to a publicly accessible website, in whole or in part.
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Property: A Sequence of Cases - The
Chickens
Imagine a farmer who raises chickens for market in
facilities that she owns. The law gives her what are
known as possessory property rights in both the
chickens and the facilities. She may do what she wants
with them, subject to not interfering with the same
rights of others.
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posted to a publicly accessible website, in whole or in part.
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Property: A Sequence of Cases - The
Wild Bird
Suppose you and I are neighboring landowners. A wild
pheasant has chosen to nest in one of your trees. The
bird flies over my property while I am hunting,
and I succeed in downing it. The legal rule of “first
possession” makes me its owner, which makes sense
from the standpoint of economic efficiency.
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posted to a publicly accessible website, in whole or in part.
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Property: A Sequence of Cases - The
Cave
On your property you discover the mouth of a previously
unknown cave that extends under land owned by others. To
keep the story simple assume that somehow you know in
advance that it contains a single large diamond that anyone
who explores for a few hours will surely find. The law might
award the diamond to the owner of the land above it, to the
person who owns the opening of the cave, or to whomever is the
first to find it. In practice, the law awards both the diamond
and the cave to the person whose land it opens onto. Economic
efficiency requires that someone find the diamond, which is far
more valuable above ground than below it.
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posted to a publicly accessible website, in whole or in part.
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Contracts and Government – The Oil
Pool
Oil is in various ways similar to chickens, wild birds, and the
diamond in the cave. Oil at the surface can be traded like a
chicken or other commodity. Originally, courts put
underground oil under a right of first possession like the wild
bird, which led to races among landowners to extract it before
their neighbors. Like the diamond the oil is hidden and
must be found, but an underground pool has no opening like a
cave or similar characteristic that might serve to identify an
owner. In addition, the boundaries of an underground pool
may remain unknown well after its discovery.
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posted to a publicly accessible website, in whole or in part.
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Contracts and Government – The Oil
Pool
The governments of oil-producing states have
interests (tax revenue, for one) in maximizing
the total output from an underground pool. Some of
them have laws which specify that if the landowners
cannot agree on unitization the state government
will step in and require them to sign a contract it has
designed.
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posted to a publicly accessible website, in whole or in part.
23
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The Origination and Adaptation of
Property Rights - Fish
The ability to construct value-increasing contracts depends on the definition and
enforceability of property rights. Peoples’ abilities to make mutually beneficial
transactions depend on their legal and technological environments.
Today, law and technology are defining new property rights in fish:
•New laws: Governments around the world have expanded their offshore
jurisdictions to as far as 200 miles from land.
•Farming develops: Some fish and shellfish that need not migrate or do not
move at all are now “farmed” in the ocean and inland.
•Regulatory changes: Governments also set detailed rules that increase the
likelihood of reaching sustainable fish populations.
•Oceangoing cages: Giant cages that can contain and protect large numbers of
fish are on the horizon.
•Identifiable ownership: New breeds of fish are under development that can be
tagged to prevent and detect thefts.
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posted to a publicly accessible website, in whole or in part.
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The Origination and Adaptation of
Property Rights - Scarce Property in
Outer Space
Today there are several hundred
geostationary satellites, and radio
interference is a common problem. To cope
with that problem a market in extraterrestrial
rights is emerging. Nations and businesses
are trading frequency assignments and rights
to use each others’ satellites to minimize
interference and put existing equipment to
more valuable uses.
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posted to a publicly accessible website, in whole or in part.
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The Effects of Property Rights Changes
on Markets - A New Type of Ownership
Between jet owners and airline users lies a growing pool of
businesses and individuals whose travel requirements are
not served well by either. They value setting their own
itineraries and schedules but do not find these benefits
worth the cost of ownership.
Co-ownership was possible but often led to scheduling
conflicts. It also left the owners responsible for hiring a crew
and servicing the plane. Santulli proposed NetJets, the first
time-share program for aircraft. It was the same sort of logic
that had earlier produced time-sharing for condominiums in
vacation areas.
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posted to a publicly accessible website, in whole or in part.
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The Effects of Property Rights Changes
on Markets - Analyzing the Creation of
Value
The NetJets case study summarizes some of this chapter’s
lessons. It shows how a market’s ability to create value will
depend on the types of contracts allowed in it. Of course, we
could instead have assumed, contrary to fact, that a contract
like that of Net-Jets had always been possible but no one had
yet gotten the idea for it. Whether or not NetJets required the
government’s permission, its contract is an innovation quite
like a technology breakthrough.
(c) 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole or in part.