Property Rights

Question 1

Coase’s Theorem

Answer 1

Coase argued that from an economic perspective, the goal of the legal system should be to establish a pattern of rights such that economic efficiency is attained. The legal system affects transactions costs and the goal of such a system is to minimise harm or costs, broadly conceived. He noted that the negotiations among affected parties would result in an efficient and invariant outcome under the standard assumption of competitive markets (especially, that the costs of transacting are zero), as long as rights are well-defined.

It is necessary to know whether the damaging business is liable or not for damage caused since without the establishment of this initial delimitation of rights there can be no market transactions to transfer and recombine them. But the ultimate result (which maximises the value of production) is independent of the legal position if the pricing system is assumed to work without cost.

Question 2

Coase’s Theorem simplified

Answer 2

The Coase Theorem argues that under the right conditions parties to a dispute over property rights will be able to negotiate an economically optimal solution, regardless of the initial distribution of the property rights. It offers a potentially useful way to best resolve conflicts between competing businesses or other economic uses of limited resources. In order for the Coase Theorem to apply fully, the conditions of efficient, competitive markets (most importantly zero transaction costs) must occur.

Question 3

Hypothesis

Answer 3

Efficiency Hypothesis: regardless of how rights are initially assigned, the resulting allocation of resources will be efficient.
Invariance Hypothesis: the final allocation of resources will be invariant under alternative assignments of rights.

Question 4

Coase Theorem (Part I and II)

Answer 4

Coase Theorem (Part 1): When there are well-defined property rights and costless bargaining, then negotiations between the party creating the externality and the party affected by the externality can bring about the socially optimal market quantity.

Coase Theorem (Part 2): The efficient solution to an externality does not depend on which party is assigned the property rights, as long as someone is assigned those rights.

Question 5

Assumptions of Coase’s Theorem/Property Rights

Answer 5

1. Property rights must be clearly defined.
2. There must be little to no transaction costs
3. There must be few affected parties (or else the transactions cost of organising them gets to be too great)
4. There must be no wealth effects. The efficient solution, regardless of who gets the initial property rights.

Question 6

According to Coase’s Theorem, how should property rights be allocated?

Answer 6

Coase’s theorem says that it does not matter how property rights are assigned. More specifically, under certain conditions, it doesn’t matter for efficiency. In the absence of transaction costs, if property rights are well-defined and tradable, then voluntary negotiations will lead to efficiency.

Question 7

Example of Coase’s Theorem: You have a car worth 3K to you, 4K to me

Answer 7

It is obviously efficient for me to own it … but we don’t need the law to give me the car.

• if I start owning the car: no reason for you to buy it, I end up with it - efficient
• if you start out owning the car: clear incentive for me to buy it, I end up with it - efficient

Regardless of who owns the car at first, we get to the efficient outcome. I’d rather start out with the car - so I don’t have to pay for it. You’d rather start out with it - so you end up with more money. Efficiency does not care about distribution, only who ends up with the car at the end and it does not depend on who started with it.

Question 8

REVISION: Conditions for Coase’s Theorem to be true

Answer 8

1. Property rights have to be well-defined: need to be clear on who has what rights, so we know the starting point for negotiations
2. Tradable: need to be allowed to sell/transfer/reallocate rights if we want
3. No transaction costs: it can’t be difficult or costly for us to buy/sell the right

Question 9

Many externalities can be thought of as missing property rights: examples

Answer 9

Overfishing in a communal lake? It’s because property rights over those fish aren’t well-defined.
Firm polluting too much? It’s because property rights over clean air aren’t well-defined

So one solution: Make property rights complete enough to cover ‘everything’, and tradable, and use the law to minimise transaction cost then Coase kicks in and we get efficiency. But we can’t do this, because of COSTS.

Question 10

The problem with Coasian Solutions

Answer 10

The Assignment Problem: In cases where externalities may affect many agents (eg. global warming), assigning property rights is difficult -> coasian solutions are likely to be more effective for small, localised externalities than for larger, more global externalities involving many people.

The Holdout Problems: shared ownership of property rights gives each owner power over all the others (because joint owners have to ALL agree to the Coasian solution.

Question 11

The Problem with Coasian Solutions

Answer 11

The Free Rider Problem: when an investment has a personal cost but a common benefit, individuals will underinvest.

Transaction Costs and Negotiating Problems: the Coasian approach ignores the fundamental problem that it is hard to negotiate when there are large numbers of individuals on one or both sides of the negotiation.