# LAW AND ECONOMICS

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```					ECONOMIC ANALYSIS OF PROPERTY LAW
September 26, 2006
ECONOMIC ANALYSIS OF PROPERTY LAW
September 26, 2006

ANNOUNCEMENTS
ECONOMIC ANALYSIS OF PROPERTY LAW
September 26, 2006

• TUTOR FOR ECO320
• Kui (Calvin) Hu
• hukuiwlu@gmail.com
• Every second Friday(10:30 AM to 12:30PM)
»   October 6, 2006
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ECONOMIC ANALYSIS OF PROPERTY LAW
September 26, 2006

• http://www.cooter-ulen.com
• Answers to End of Chapter - Problems
ECONOMIC ANALYSIS OF PROPERTY LAW
September 26, 2006

Recall the “legal” solution to the
“two” agent problem was obtained by
solving:
dL/da1 = F1 - 1 + 1F11 + 2(1-)F12 = 0
dL/da2 = F2 - 1 + 1F12 + 2(1-)F22 = 0
dL/d = 1F1 - 2F2 = 0

/(1- ) = (F22/F11)^1/4
ECONOMIC ANALYSIS OF PROPERTY LAW
September 26, 2006

Is there a solution to this?:
dL/da1 = F1 - 1 + 11F11 + 22F12 + 3(1- 1- 2)F13 = 0
dL/da2 = F2 - 1+ 1 1F12 + 2 2F22 + 3(1- 1 - 2)F23 = 0
dL/da3 = F3 – 1 + 11F13 + 22F23 + 3(1- 1-2)F33 = 0
dL/d1 = 1F1 - 3F3 = 0
dL/d2 = 2F2 - 3F3 = 0
ECONOMIC ANALYSIS OF PROPERTY LAW

PROPERTY RIGHTS
(EXPLICIT AGENCIES)
ECONOMIC ANALYSIS OF PROPERTY LAW

• Types of Property

• Real Property – land, buildings
• Personal Property - cars, clothes,
securities
• Intellectual Property – patents,
ECONOMIC ANALYSIS OF PROPERTY LAW

• At common law
• The source of all property rights was the
sovereign
• What rights one had were determined by
who one was and in which social class
one belonged
ECONOMIC ANALYSIS OF PROPERTY LAW

•   King (Queen)       Absolute title
•   Dukes
•   Counts
•   Earls
•   Barons
•   Freemen            Freehold title
•   Peasants
•   Serfs
•   Slaves
ECONOMIC ANALYSIS OF PROPERTY
LAW
• The sovereign or
“Crown” is the
absolute owner of

• This is “symbolic”, not
personal
ECONOMIC ANALYSIS OF PROPERTY
LAW
• Who or what takes
the place of the
“Crown” in the
United States?

• A concept known as
“eminent domain”
ECONOMIC ANALYSIS OF PROPERTY
LAW
• In both Canada and the United
States, freehold interests (land) and
personal property have two major
components
»Title
»Possession
ECONOMIC ANALYSIS OF PROPERTY LAW

• Title (Owner)
• Legally significant
• Includes possession
• May transfer possession to a third
party
• May transfer or sell title
• May bequeath title to an heir
ECONOMIC ANALYSIS OF PROPERTY LAW

• Possession
• Economically significant
• Exclusivity
• Enjoyment of the property (especially
the economic benefits)
• Cannot transfer or share possession
without the owner’s consent
• Cannot bequeath possession – after
death usually reverts back to the owner
or joint holder of possession
ECONOMIC ANALYSIS OF PROPERTY
LAW
• Posner explains that the creation of
individual property rights is a
necessary rather than a sufficient
precondition for the efficient use of
resources (Ch. 3, 3.1)
ECONOMIC ANALYSIS OF PROPERTY LAW

.

Exclusive Agent
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

• The costs of enforcing property rights
cannot exceed the benefits to social
surplus of having those rights? Why or
why not? (Posner - Ch. 3, 3.2)
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

• Starting with Demsetz, there has to be
“value in use” before a group will incur
the costs of property enforcement or
property recognition
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

• How is “property ” established?
• First, by a “rule of capture” – most
common one?
• Right of First Possession – Cooter, c. 4:I, c.
5:IA
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

• First possession under “the rule of capture”
can vary.
• In the famous case of Pierson v. Post the
New York Supreme Court was divided over
whether possession of a wild fox was
determined by “hot pursuit” or physical
capture.
• Pierson v. Post, 1805, 3 Cal. R. 175, 2 Am. Dec. 264 (Sup. Ct. of
N.Y. 1805), Cooter, c. 5:IA
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

• What is wrong with a “rule of capture”?
• Encourages squatters – This may not be
bad if the possessors enhance the
economic use of the property
• Statutes in most jurisdictions allow for
the eventual transfer of title if the
possession remains unchallenged for a
set period of time
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

• How is “property ”
established?
• Second, by “root of
title”
• Cooter, c. 5:II

• Domesday Book
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

• Enforcing property rights
•   Domesday Book
•   Collection of Deeds To Show Root of Title
•   Registry
•   Land Titles
•   Polaris
•   (Cooter - Ch. 5-II)
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

• Enforcing property
rights
• Domesday Book
• Collection of Deeds
To Show Root of Title
• Registry
• Land Titles
• Polaris
• (Cooter - Ch. 5-II)

• 1638 – Deed
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

• Can title fraud be avoided? - Two situations
• Prior Title (Cooter, c. 5-II)
» Lawyers search title
» Malpractice actions can be costly
• Current Title
» Identity thieves can “pretend” they are the
owners, sell and mortgage the property right
from under the owners
» Malpractice actions and “title” insurance usually
does not apply
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

• Let “a” be the effort or investment a
puts into his or her property

• U(a) = a          UTILITY
• c(a) = a          COST OF EFFORT

• The first order condition or A’s
incentive compatibility constraint is:
• dU/da = 1
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

• Exclusivity Of Property (Taking vs.
sharing)

Surplus at Zero Cost = Value of
Property
Exclusive Possession

U(a) = Social
Surplus

a
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

.
Trespasser

Exclusive Agent
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

• Supposing A loses  of his or her
surplus to the trespasser
• So A keeps (1- ) of his or her surplus

• U((1- )a) - a         UTILITY

• Now the first order condition or A’s
incentive compatibility constraint is:
• dU/da = 1/(1- )
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

• Exclusivity Of Property

(1- a)U(a) = SS

a
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

.
Trespasser

Trespassing
Agent

Agent 2
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

• So A loses  of his or her surplus
• One way to recoup this loss?
• Steal it from another A2?
• U(a2 + (1- )a) - a              UTILITY
• Now the first order condition or A’s
incentive compatibility constraint is:
• dU(a2 + (1- )a)/da = 1/(1- )
ECONOMIC ANALYSIS OF PROPERTY LAW
Exclusive Ownership

• Is there any point to A “bargaining”
with the trespasser?
• Yes. If transaction costs are low as will
be demonstrated with Coase
• Cooter – c. 4-III
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

CONCURRENT
OWNERSHIP
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

.                           Explicit Bilateral Agency
Property

Horizontal Explicit Agency                   Vertical Explicit Agency

Example – Joint Asset                        Example – Landlord and
Tenant
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• Both title and possession can be held
concurrently – by more than one owner
• Joint
» Owners share an undivided interest in the
property
» In the case of title, the interest falls to the
survivor(s) when one dies
• Tenants in common
» Owners share a divided interest in the property
» In the case of title, the divided interest falls to the
estate of the deceased when the deceased dies
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• Horizontal Concurrent Interests (Cournot-like)

AGENT 2
AGENT 1
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• Can Joint Ownership be optimal?:
• Recall Professor Cooter defined Nash
equilibrium and distinguished it from
Pareto efficiency – (4th ed., 2004, c. 2.,
VII, p. 41)
• Equilibrium occurs where these “self-
interested” actions intersect – Nash
Equilibrium – Pareto inferior to the
“exclusivity” optimum
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• Joint Ownership:

• SS(a ,a )=F(a ,a )+(1-)F (a , a )– a –a
1   2        1   2           2       1   2   1   2

• Assume constant returns to scale

• SS(a ,a )= F(a + a ) – a – a
1   2    1           2   1       2
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• Optimal Joint Ownership:
• SS(a ,a )=F(a + a )+(1-)F (a + a )– a –a
1   2     1   2           2   1   2   1   2

• The “best use” or “most valuable use”
satisfies:         F1(a1)– 1 = 0
(1-)F (a )– 1 = 0
2   2
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• Optimal Joint Ownership:
• Contracting to form joint property
effectively creates
• a group that has exclusive rights to the resource
• pertains only to the group's size and
• the joint effort to exclude outsiders.
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• Optimal Joint Ownership:
• If there are two or more concurrent or joint
owners of the same property, will the joint
surplus be as optimal as exclusive
ownership?
• Winter and Neary model – suggests “yes”
• Lueck - “No” – Why?
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• Optimal Joint
Ownership:
• Implicit in the Winter-
Neary model is the
implicit assumption of
homogeneity –
everybody is the
same.
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• Optimal Joint Ownership:
• If people are not the same a form of the
some will apply more effort than others
resulting in what Lueck calls an “internal
rule of capture” (p. 406)
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• Optimal Joint Ownership:
• Dissipation from internal capture can be
limited by maintaining a homogeneous
membership.
• With equal sharing rules, a homogeneous
membership maximizes the present value
of a common property resource (Lueck, p.
399)
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• Optimal Joint Ownership:
• Once a group chooses an equal sharing
rule there is an incentive to maintain
homogeneity. Why?
• With heterogeneous members and equal
shares, highly productive individuals will
supply too little effort and the less
productive will supply too much.
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• Optimal Joint Ownership:
• Dissipation of surplus will occur.
• In effect, equal-sharing rules increase
group wealth with homogeneity among
group members.
• What Luecks is referring to is the “tragedy
of the commons (Luecks, p. 404)
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• This provides an
economic rationale for
preserving
homogeneity.
• Screen potential
members, by
indoctrination, or by
restricting the transfer
of memberships.
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• Optimal Joint Ownership:
• In one important respect these
problems are different:
• There is a “solution” to the “joint
property” problem – discrimination
»   Condominiums
»   Co-ops
»   Gated Communities
»   Mandatory Activity Clubs
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership
• Optimal Joint Ownership:
So the solution to the first order
conditions that generated the optimal
“sharing rule”

/(1- ) = (F22/F11)^1/4

is no longer sufficient unless a further
“rule” that “homogenizes” the owners is
“imposed”
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• Optimal Joint Ownership: So notice
how the “joint property” problem is
analogous to the “collusive contract”
problem because of the following
issues:
• Overcoming the Prisoners dilemna
• Overcoming the inability to observe each
others effort
ECONOMIC ANALYSIS OF PROPERTY LAW
Joint Ownership

• Can Joint Ownership be optimal?:
• The preceding have explored ways that
“avoid” the tragedy of the commons?
ECONOMIC ANALYSIS OF PROPERTY LAW
Commons

COMMON
PROPERTY
ECONOMIC ANALYSIS OF PROPERTY LAW
Commons

• Open Access:
• The absence of property rights leads to overuse
of the asset and complete dissipation of surplus.
• If users are heterogeneous, low cost) users will
earn rents.
• Rent under open access may be an important
factor in preventing the establishment of private
property rights.
ECONOMIC ANALYSIS OF PROPERTY LAW
Commons

• Open Access – Demsetz Thesis:
• Demsetz argues that property rights
emerge to internalize the externalities
present in open access.
• Caution: Demsetz uses the term „common
property‟ to describe what is now called
“open access”.
ECONOMIC ANALYSIS OF PROPERTY LAW
Commons

• Open Access:
• The “actual use” or “overuse” satisfies:
F(a )– 1 = 0
1

 (1-)F(a )– 1 = 0
2

• The “rule” here is not the optimal “sharing”
rule – but what Lueck called an “external rule
of capture”
ECONOMIC ANALYSIS OF PROPERTY LAW
Commons

• This leads to the Tragedy of the
Commons:
• What is the “tragedy of the commons”?
• Mathematically, it is the Prisoners dilemna
game played by a large number of agents
• What happens?
• The Nash equilibrium is the extinction of the
resource do to over-use or exploitation by the
agents
ECONOMIC ANALYSIS OF PROPERTY LAW

HIERARCHIAL
OWNERSHIP
ECONOMIC ANALYSIS OF PROPERTY LAW

• Horizontal Interests   • Vertical Interests
(Cournot-like)           (Stackelberg-like)

AGENT 2              PRINCIPAL
AGENT 1

AGENT
ECONOMIC ANALYSIS OF PROPERTY LAW

• Vertical Interests (Stackelberg-like)
» Two parties agree on a ranking and
order of conduct
Principal – first mover
Agent – second mover
» Example: Landlord and tenant
ECONOMIC ANALYSIS OF PROPERTY LAW

• Exclusivity
• Sole recipient of the profit or surplus
generated by the property
• In this capacity, tenant acts as a
“principal” of the property with the
owner acting as “agent”
• Owner as “agent” receives a fixed rent,
with the tenant as “principal” receiving
the residual or profit remaining
ECONOMIC ANALYSIS OF PROPERTY LAW

• Enjoyment of the property (especially the
economic benefits)
• Tenant acts as a “principal” of the property with the
owner acting as “agent”
• In the case of “tenant” farmers, a huge motivator in
agricultural innovation and productivity
• Thought by Adam Smith and others why England
surpassed other countries in agrarian output in
spite of climactic and other geographical
ECONOMIC ANALYSIS OF PROPERTY LAW

• A principal agency relationship may exist
between the owner (agent) and tenant
(principal) even in the absence of an
express or explicit contract
• It would not be difficult to imagine landlord
and tenant arrangements following either a
vertical or horizontal pattern
ECONOMIC ANALYSIS OF PROPERTY LAW

• Horizontal Concurrent     • Vertical Concurrent
Interest (Cournot-like)     Interest (Stackelberg-like)
ECONOMIC ANALYSIS OF PROPERTY LAW

• (Cournot-like)      • (Stackelberg-like)
• Both Landlord and   • Landlord is risk
Tenant are risk       averse
neutral             • Tenant is risk neutral
• Both share in the         • Franchises
profits             • Landlord is risk
• Cropsharing      neutral
• Tenant is risk averse
• Shopping centres
ECONOMIC ANALYSIS OF PROPERTY LAW

PROPERTY RIGHTS
(IMPLICIT AGENCIES)
ECONOMIC ANALYSIS OF PROPERTY
LAW
• .

McKie v. KVP
Background
PROPERTY RIGHTS
McKie v. KVP

technology,
manufacturing kraft
paper by the sulphate
process. This process
began to take its toll on
the river. Pollution was
discharged into the
river by KVP from its
mill.
PROPERTY RIGHTS
McKie v. KVP

•   In 1946, six downstream landowners
sued. The court granted them damages
and an injunction, rejecting the
defendant's argument that the social
benefits created by the paper industry
outweighed the plaintiffs' riparian rights.

•         Sellick, Karen,
http://oldfraser.lexi.net/publications/forum/1997/april/FF-04-97.html
PROPERTY RIGHTS
McKie v. KVP

•     The Plaintiffs claimed damages and asked
for an injunction on the grounds that:
•     (1) Their comfort and the enjoyment of
their land was interfered with by reason of foul
odours given off from the water.
•     (2) The water had been rendered unfit for
human consumption either in its raw state or
after it has been boiled.
•     (3) The ice taken from the river for
domestic use was unfit for the purposes for
which it is used.
PROPERTY RIGHTS
McKie v. KVP

•     (4) The water was repulsive to farm
animals and milking cows would not drink it in
sufficient quantities to maintain normal milk
supply.
•     (5) The water was unfit to bathe in.
•     (6) The fish in the river were being either
killed or driven therefrom.
•     (7) Wild rice, which was formerly grown in
abundance in the waters of the river, forming a
feeding ground for wild ducks, was destroyed.
PROPERTY RIGHTS
McKie v. KVP

Alfred Huerter, an engineering expert
called by KVP testified at trial that it was
not economically efficient for KVP to
recover the estimated 2% to 2.65% of pulp
loss that got discharged into the river.
PROPERTY RIGHTS
McKie vs. KVP

Note as well the testimony of one of the
plaintiffs who had raised with KVP the
possibility of applying technology to
reduce if not eliminate the water pollution.
PROPERTY RIGHTS
McKie v. KVP

• Chief Justice
McRuer, the trial
finding of fact that
the KVP pollution
did kill the river fish.
PROPERTY RIGHTS
McKie vs. KVP

Note the comment by McRuer that the
pollution was endemic to kraft pulp
producers. This suggests he knew that in
a competitive economy, directing that it
change its technology under threat of an
injunction might put K.V.P. out of
PROPERTY RIGHTS
McKie vs. KVP

McRuer granted relief to the plaintiff,
James B. Vance in the action of trespass,
which carried with it both damages and an
independent right to an injunction against
KVP.
PROPERTY RIGHTS
McKie vs. KVP

•The other plaintiffs were granted both
damages and injunctive relief on the
grounds that their riparian rights had been
breached and that nuisance had been
proved.
PROPERTY RIGHTS
McKie vs. KVP

•This judgment begs some important
questions.

Was KVP found liable because it operated
at a socially optimal level or because it
chose to “ignore” the law and operate at a
private level of efficiency?
PROPERTY RIGHTS
McKie vs. KVP

Was it because KVP
thought it was
“protected by its
Crown lease” or
because it thought
the technology was
neither socially
optimal nor privately
optimal that inspired
the manager to
dismiss the
PROPERTY RIGHTS
McKie vs. KVP

However, McRuer J. dismisses the “Crown
lease” argument on the grounds that any
contract permitting harm to the Plaintiffs'
property must be done by way of an
express contract among all the parties.
PROPERTY RIGHTS
No Liability Rule – McKie v. K.V.P.

• While KVP appealed
McRuer's decision, the
Ontario government
passed a law, named
The Lakes and Rivers
Improvement Act. This
permitted courts to
deny an injunction
against polluters if such
economic results to the
community.
PROPERTY RIGHTS
No Liability Rule – McKie v. K.V.P.

• The case of Boomer v. Atlantic Cement
Co., 122 26 N.Y.2d 219, 309 N.Y.S.2d
312, 257 N.E.2d 870 (Court of Appeals
of New York, 1970) involved a group of
landowners who sought an injunction
against a large cement factory because
of the dirt, smoke, and noise that it
produced.
PROPERTY RIGHTS
No Liability Rule – McKie v. K.V.P.

• That court denied the injunction and
the grounds that the injunction would
have forced the factory to shut down,
causing a loss of jobs and the
company’s substantial capital
investment.
PROPERTY RIGHTS
No Liability Rule – McKie v. K.V.P.

Some sections of the Public Health were
also repealed. The Ontario Water
Resources Commission was given
authority over such matters as herbicides,
water quantity and quality with the power
to issue orders to municipalities and
industries with respect to the
establishment of sewage, water works and
other types of water pollution.
PROPERTY RIGHTS
No Liability Rule – McKie v. K.V.P.

•The Supreme Court of Canada upheld the
trial judge, reasoning that he had decided
correctly considering the state of the law
at the time of his judgment.
PROPERTY RIGHTS
No Liability Rule – McKie v. K.V.P.

•    The Ontario Progressive
Conservative government next passed the
K.V.P. Company Limited Act in 1950 after
KVP lost its appeals to the Court of Appeal
and the Supreme Court of Canada.
Ont. Stat. 1950 c. 33.
PROPERTY RIGHTS
No Liability Rule – McKie v. K.V.P.

•    This law specifically dissolved the
injunction against KVP. Now the company
and its successors were free to pollute.
•
Sellick, Karen,
http://oldfraser.lexi.net/publications/forum/1997/april/FF-04-97.html
PROPERTY RIGHTS
No Liability Rule – McKie v. K.V.P.

• The Boomer v. Atlantic Cement Co
decision seems correct in view of the
high costs of contracting among the
large number of effected homeowners
that would have been necessary to
keep the plant operating under an
injunction.
ECONOMIC ANALYSIS OF PROPERTY
LAW
• .

TRESPASS
ECONOMIC ANALYSIS OF PROPERTY LAW
TRESPASS

.
Trespasser

Exclusive Agent
ECONOMIC ANALYSIS OF PROPERTY LAW
TRESPASS

• In the case of land, externalities arise
because of conflicting uses of adjacent
properties.
• The primary common law actions
(lawsuits) applicable to unwanted
invasions are trespass and nuisance.
ECONOMIC ANALYSIS OF PROPERTY LAW
TRESPASS

• The primary remedy under trespass is an
injunction against the unwanted intrusion.
The landowner‟s right to exclude is
protected by a property rule.

• Examples of trespass are squatters and
boundary encroachment
ECONOMIC ANALYSIS OF PROPERTY LAW
TRESPASS

• Protection of Exclusivity of Possession
• Common law – through the remedy of the action
for trespass
• Historically, had to be launched by the owner (title
holder) on behalf of the tenant
• Now the tenant can sue directly
• Who is it aimed at
» Squatters
» Encroaching neighbours
ECONOMIC ANALYSIS OF PROPERTY LAW
TRESPASS

• Cases of trespass ordinarily involve a
small number of parties where the intruder
is easily identifiable.
• Contracting costs among the parties tend
to be low, and property rules are the
preferred remedy.
ECONOMIC ANALYSIS OF PROPERTY LAW
TRESPASS

• Lueck argues that the "rule of first
possession" emerged as an efficient rule
to clarify ownership. (Lueck, p. 412)

• Squatter's rights were determined in
accordance with the rules of first
possession bring abandoned or unused
assets back into production. (Lueck, p.
416)
ECONOMIC ANALYSIS OF PROPERTY LAW

NUISANCE
ECONOMIC ANALYSIS OF PROPERTY LAW
NUISANCE

.
Nuisance

Exclusive Agent
ECONOMIC ANALYSIS OF PROPERTY LAW
NUISANCE

• Protection of the enjoyment of property
• Common law – through the remedy of the action
for nuisance
• Had to be a “private” harm
• Bamford v. Turnley (1860) 3 B. & S. 62 at 63 (Ex.
Ct.)
• “Public harms” effecting private property had to be
prosecuted through the Crown attorney or criminal
courts
• Who is it aimed at
» Polluting neighbours
ECONOMIC ANALYSIS OF PROPERTY LAW
NUISANCE

• The remedy under nuisance more complicated.
First, the landowner can only obtain relief if the
invasion is substantial, even then, he may have
to be satisfied with money damages (a liability
rule).
• Examples of nuisance are air, water, and noise
pollution.
ECONOMIC ANALYSIS OF PROPERTY LAW
NUISANCE

• Cases of nuisance often involve large
numbers or sources of harm that are
difficult to identify.
• Transaction costs are high and contracting
is unlikely to lead to the efficient outcome.
In cases like this liability rules are
preferred.
ECONOMIC ANALYSIS OF PROPERTY LAW
NUISANCE

• If the landowner wishes the harm to be enjoined,
he must meet the further legal standard of
showing that outweighs the benefit of the
nuisance-creating activity
• Posner argues that the damages and injunction
remedies applied in cases like KVP follow an
economic pattern?
• Damages – High Transaction Costs
• Injunctions – Low Transaction Costs (Ch 3 – X)
ECONOMIC ANALYSIS OF PROPERTY LAW
NUISANCE

• The common law nuisance action
carried with it the right of the person to
“shut-down” a defendant as of right –
so a “defendant” is not compensated
for its loss making this remedy optimal
for plaintiffs but not necessarily anyone
else.
• (Posner, 6th ed., c. 1, p. 16)
PROPERTY RIGHTS
NUISANCE

•    Aldred's Case (1610), 9 Co. Rep. 57b,
59a, 77 E.R. 816 is the earliest case
establishing the “strict liability rule” for
property damages for nuisance law
PROPERTY RIGHTS
NUISANCE

• Protection of Possession
• Common law actions for trespass and nuisance
were governed by the “strict liability” property rule
for damages until the industrial revolution
encouraged its replacement by a different rule in
pollution cases (Horwitz Thesis)

•   [18] Horwitz, Morton, "The Transformation in the Conception of Property in American Law 1780 -
1860', (1980) 40 U. of Chi. L. Rev. 248-290
•   [19] Schwartz, Gary, "Tort Law and the Economy in Ninteenth-Century America: A Reinterpretation',
(1981) 90 Yale L. J. 1717 - 1775
PROPERTY RIGHTS
Socially Optimal Strict Liability Rule

• Agents operate two firms:

a = output of Agent 1
1

a = output of Agent 2
2
PROPERTY RIGHTS
Socially Optimal Strict Liability Rule

• These agents have the following profit
functions

p (a ,a ) = 5a – 3(a )^2
1   1   2    1        1

p (a ,a ) = 5a - (a )^2
2   1   2    2    1
PROPERTY RIGHTS
Socially Optimal Strict Liability Rule

The output of Agent 1 is jointly produced
with pollution which imposes damages on
on Agent 2 according to the damage
function D(a ) = (a )^2
1     1

Suppose that a rule of law makes Agent 1
liable for all pollution damages to Agent 2.
PROPERTY RIGHTS
Socially Optimal Strict Liability Rule

If Agent 1
(i)       knows it is strictly liable for
damages
(ii)      knows the rule can be costlessly
enforced against it
(iii)     acts rationally (is a cost
minimizer or a profit maximizer)
PROPERTY RIGHTS
Socially Optimal Strict Liability Rule

Finding the socially optimal level of Agent
1’s production in the local economy
involves the Agent assuming it will be
sued:
MAX [pa1 – C(a1) – D(a1)]
d[5a1 – 4(a1)^ ]/da1 = 0
2

(a1)* = 5/8
PROPERTY RIGHTS
Socially Optimal Strict Liability Rule

• Competitive Firm – Perfect Information

Strict Liabilty Rule
PROPERTY RIGHTS
Socially Optimal Strict Liability Rule

Profit for Agent 1:
p = p(5/8) – C(5/8) – D(5/8) = 25/16
PROPERTY RIGHTS
Socially Optimal Strict Liability Rule

• AGENT 1 - Competitive Firm - SR
SMC = 8a1
SATC = 4(a1)^2
p= 5

PROFIT

a1
PROPERTY RIGHTS
Socially Optimal Strict Liability Rule

• AGENT 1 - Competitive Firm - LR
LATC

P = MR = LSMC = 5
PROFIT = 0
PROPERTY RIGHTS
Socially Optimal Strict Liability Rule

The strict liability damages rule is socially
optimal provided AGENT 1:

(i)         knows the rule
(ii)        knows the rule can be costlessly
enforced against it
PROPERTY RIGHTS
Socially Optimal Strict Liability Rule

Property damages Agent 1 still imposes
on Agent 2:

D = (5/8)(5/8) = 25/64

How can this happen under a strict
liability rule?
PROPERTY RIGHTS
Socially Optimal Strict Liability Rule

• Reaction Curves
a = a,
1       a =a
1       2   2

• Agent 2 cannot strategically interact
with Agent 1’s “imposed” externality

p* = G (a1, a2)
1       1

p* = G (a1, a2)
2       2
PROPERTY RIGHTS
Socially Optimal Strict Liability Rule

•a Externality – Nash
2                                     Externality – Pareto
Equilibrium                          a Equilibrium – Agent 2
2

profits

Iso-Profit Curve For Agent 2
Iso-Profit Curve For Agent 1

Iso-Profit Curve For Agent 2

a1
a1
PROPERTY RIGHTS
Socially Optimal Strict Liability Rule

• Although Agent 2 can produce more
and Agent 1 will produce less under the
strict liability law, Agent 2 might be
persuaded to also produce less in
exchange for a transfer payment that
might allow Agent 1 to produce more –
in this sense the externality creates
strategic substitutes
PROPERTY RIGHTS
Socially Optimal Strict Liability Rule
• Externality – Nash                  Externality –
Equilibrium                         Pareto
Equilibrium

Agents’ Joint
Surplus
Agents’ Joint                                        [1,0]
Surplus
PROPERTY RIGHTS

Model
No Liability Rule
PROPERTY RIGHTS
No Liability Rule

What happens if AGENT 1
(i) is NOT liable for pollution
damages or
(ii) thinks it is not liable for pollution
damages
PROPERTY RIGHTS
No Liability Rule

AGENT 1 sets its production at a privately
optimal level, which is socially sub-optimal:

MAX [5a1 – 3(a1)^ ] 2

d[5a1 – 3(a1)^ ]/da1 = 0
2

(a1)P = 5/6 > 5/8
PROPERTY RIGHTS
No Liability Rule
Constant Cost – Constant Returns To Scale

• AGENT 1 - Competitive Firm - SR
SMC = 8a1 SMC = 6a1
SATC = 4(a1)^2
p= 5

SATC = 3(a1)^2

y
PROPERTY RIGHTS
No Liability Rule
Constant Cost – Constant Returns To Scale

• Competitive Firm - LR                LATC

PROFIT > 0                     P = MR = LSMC = 5
PROPERTY RIGHTS
No Liability Rule

Profit for Agent 1:

p = p(5/6) – C(5/6) = 25/12 > 25/16
PROPERTY RIGHTS
No Liability Rule

Property damages Agent 1 still imposes on
Agent 2:

D = (5/6)(5/6) = 25/36 > 25/64

What will Agent 2 do if it cannot sue?
PROPERTY RIGHTS
No Liability Rule

•a Externality – Nash
2                                     Externality – Pareto
Equilibrium                          a Equilibrium – Agent 1
2

profits

Iso-Profit Curve For Agent 2
Iso-Profit Curve For Agent 1

Iso-Profit Curve For Agent 2

a1
a1
PROPERTY RIGHTS
No Liability Rule

• Although Agent 1 can produce more
and Agent 2 will produce less under the
no liability law, Agent 1 might be
persuaded to also produce less in
exchange for a transfer payment that
might allow Agent 2 to produce more –
in this sense the externality still creates
strategic substitutes
PROPERTY RIGHTS
No Liability Rule

• Externality – Nash                        Externality –
Equilibrium                               Pareto
Equilibrium

Agents’ Surplus

Agents’                                                [1,0]
Surplus
PROPERTY RIGHTS

• Does one see an analogy to the duopoly
problem?
• Could the polluter and victim collude to
maximize social surplus?
• If there were a Pareto superior position,
would it be stable?
• If not, what would the pattern of defection
be?
PROPERTY RIGHTS

• Under either the strict liability rule or no
liability rule, at least one of the parties is
favoured (unlike the duopoly situation,
where the rule favoured consumers)
• How do these two (2) alternative regimes
differ from the “strategic complementarity”
of antitrust regulation of duopolies?
PROPERTY RIGHTS

• If the parties were to collude would either
the “no liability rule”(which favours Agent
1) or the “strict liability rule” (which favours
Agent 2) “stabilize” any collusive
agreement that arose? Why or why not?
PROPERTY RIGHTS

• Prisoners dilemna   • Prisoners dilemna
works against a       could be “solved” in a
collusive duopoly     collusive externality
agency?
P.O.E

P.O.E
N.E           and   N. E
ECONOMIC ANALYSIS OF PROPERTY LAW

SOURCES
ECONOMIC ANALYSIS OF PROPERTY LAW

• Boyer, Patrick, A Passion For Justice:
the legacy of James Chalmers McRuer
(Toronto: University of Toronto for the
History, 1994)

• http://www.osgoodesociety.ca/books/book-
19941.html
ECONOMIC ANALYSIS OF PROPERTY LAW

• McKie v. K.V.P. Co.. [19481 Ont. W.N.
386. 119481 3 D.L.R. 201 (High Ct.)
• http://www.archives.gov.on.ca/ENGLIS
H/exhibits/paper/profiles.htm
• Right Wing Perspective
• http://www.karenselick.com/CL9611.ht
ml
ECONOMIC ANALYSIS OF PROPERTY LAW

• Left Wing Perspective
• http://www.utpjournals.com/product/ctr/99/
99_Beveridge.html
ECONOMIC ANALYSIS OF PROPERTY LAW

• Demsetz, Harold, "Towards a Theory of Property Rights",
(1967) Am. Econ. Rev. Papers & Proceedings 347

• Ellickson, R., "Alternatives To Zoning", (1973) 40 U. Chi. L. Rev. 681

• Brenner, Joel, "Nuisance Law and the Industrial Revolution",
(1974) 3 J. of Leg. Stud. 403

• Campbell, David, "Of Coase and Corn: A Defence of Private
Nuisance", (2000) 63 Mod. L. Rev 197

• Epstein, Richard A., "Holdouts, Externalities, and the Single
Owner", (1993) 36 Journal of Law & Econ. 553

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