2.2 — The Coase Theorem

# 2.2 — The Coase Theorem
## ECON 315 • Economics of the Law • Spring 2021
### Ryan Safner Assistant Professor of Economics <a href="mailto:safner@hood.edu">safner@hood.edu</a> <a href="https://github.com/ryansafner/lawS21">ryansafner/lawS21</a> <a href="https://lawS21.classes.ryansafner.com"> lawS21.classes.ryansafner.com</a>

---

# Outline

### [Property Law](#3)
### [The Coase Theorem](#18)
### [Transaction Costs](#41)

---

# Property Law

---

# Property Rights

.pull-left[
.smaller[
> “.hi[Property] is a bundle of legal rights over resources that the owner is free to exercise and whose exercise is protected from interference by others” (Cooter and Ulen, p.73)

- This bundle contains a lot of rights, to:

> possess, use, develop, improve, transform, consume, deplete, destroy, sell, donate, bequeath, transfer, mortgage, lease, loan, or exclude others

]
]

---

# Property Rights

- Three important legal points:

1. These rights are .hi[impersonal] — they attach to property, not persons

2. Owner is .hi[at liberty] to exercise rights over her property (law neither forbids nor obliges her to)

3. Others are .hi[forbidden to interfere] with owner’s exercise of her rights

]

---

# Property Rights

1. What can be privately owned?

2. What can (and can't) an owner do with her property?

3. How are property rights established?

4. What remedies are available when property rights are violated?
]

---

# It's Not So Simple: A Story

---

# It's Not So Simple: A Story

---

# This Story Has Million Dollar Implications

*Fontainebleau Hotel Corp. v. Forty-Five Twenty-Five, Inc* (1959) 114 So. 2d 357, 1959 Fla. App.
]
]

.source[Source: [Florida Trend (2014)](https://www.floridatrend.com/article/17938/the-spite-wall-between-the-fontainbleau-and-the-eden-roc)]
]

---

# “The Fox Case”

.pull-left[
.smaller[
- In 1802, .hi-turquoise[Lodowick Post] organized a fox hunt in Southampton, NY
  - His dogs caught the scent, and he gave chase to a fox

- .hi-purple[Jesse Pierson] appears “out of nowhere,” kills, and claims the fox for his own
  - Claims not to have seen Post

- .hi-turquoise[Post] sued .hi-purple[Pierson] to get the fox back
  - Lower court sided with .hi-turquoise[Post]; .hi-purple[Pierson] appealed to NY Supreme Court
]
]
.pull-right[
.center[
![](../images/fox-hunting.jpg)
]
]

---

# “The Fox Case”

- Legal question: When do you own an animal?

- NY Supreme Court ruled for .hi-purple[Pierson] (who killed fox)

.quitesmall[
> “If the first seeing, starting, or pursuing such animals...should afford the basis of actions against others for intercepting and killing them, .hi[it would prove a fertile source of quarrels and litigation]”

> “However uncourteous or unkind the conduct of Pierson towards Post, in this instance, may have been, yet his act was productive of no injury or damage for which a legal remedy can be applied. We are of opinion the judgment below was erroneous, and ought to be reversed.”

]
]

---

# “The Fox Case”

- Judge Livingston’s dissent:

.quitesmall[
> “[A] fox is a "wild and noxious beast." Both parties have regarded him, as the law of nations does a pirate, *"hostem humani generis,"*...His depredations on farmers and on barn yards, have not been forgotten; and to put him to death wherever found, is allowed to be meritorious, and of public benefit. Hence it follows, that our decision should have in view the greatest possible encouragement to the destruction of an animal, so cunning and ruthless in his career.”

> “But who would keep a pack of hounds; or what gentleman, at the sound of the horn, and at peep of day, would mount his steed, and for hours together...pursue the windings of this wily quadruped, if, just as night came on, and his stratagems and strength were nearly exhausted, a saucy intruder, who had not shared in the honours or labours of the chase, were permitted to come in at the death, and bear away in triumph the object of pursuit?”

]
]

---

# What Rule?

- If .hi-purple[Pierson] gets the fox
  - simpler rule: “finders keepers”
  - bright-line, easy to implement, discourages disputes

- If .hi-turquoise[Post] gets the fox
  - better incentives for hunting hard-to-catch noxious animals (like foxes)

- Same tradeoff between simplicity and good incentives as the whaling cases!
]

---

# Some More Examples of Disputes

.pull-right[
.quitesmall[
- .hi-green[My neighbor likes tall trees]
  - does she have the right to plant a tree on her property that shades my pool?
  - do I have a right to an unobstructed view? or an unshaded pool?

- .hi-green[You want to have a party]
  - do you have the right to make noise in your house/dorm?
  - does your neighbor have the right to good nights sleep in their house/dorm?

- .hi-green[I own a small plant located on a river]
  - do I have a right to use the river for cooling?
  - do I have a right to pollute as much as I want?

]
]

# How Should Property Rights Be Allocated?

.pull-left[
.smaller[
.bg-washed-green.b--dark-green.ba.bw2.br3.shadow-5.ph4.mt5[
.hi-green[Example]: There is a car which you value at $3,000, and I value at $4,000.
]

- It is .hi-purple[efficient] for me to end up with the car.

]
]

---

# How Should Property Rights Be Allocated?

.pull-left[
.smaller[
.bg-washed-green.b--dark-green.ba.bw2.br3.shadow-5.ph4.mt5[
.hi-green[Example]: There is a car which you value at $3,000, and I value at $4,000.
]

- It is .hi-purple[efficient] for me to end up with the car.

- Suppose I start out with the car

]
]

---
# How Should Property Rights Be Allocated?

.pull-left[
.smaller[
.bg-washed-green.b--dark-green.ba.bw2.br3.shadow-5.ph4.mt5[
.hi-green[Example]: There is a car which you value at $3,000, and I value at $4,000.
]

- It is .hi-purple[efficient] for me to end up with the car.

- Suppose I start out with the car

- Suppose instead, *you* own the car

]
]

---

# How Should Property Rights Be Allocated?

.smaller[
.bg-washed-green.b--dark-green.ba.bw2.br3.shadow-5.ph4.mt5[
.hi-green[Example]: There is a car which you value at $3,000, and I value at $4,000.
]

- It is .hi-purple[efficient] for me to end up with the car.

- Suppose I start out with the car

- Suppose instead, *you* own the car

- .hi-turquoise[It does not matter who is *initially* assigned a property right, our bargaining will reach the efficient result]!
]
]

---

# The Coase Theorem

---

# It (Often) Doesn't Matter How We Start

> If .hi-purple[transaction costs are low], with .hi-purple[well-defined] and .hi-purple[tradeable property rights], parties can bargain voluntarily to reach the efficient outcome.

- Note: the starting point *does* matter for distribution!
]

---

# It (Often) Doesn't Matter How We Start

- Resources tend to flow to those who value them the most

- .hi-green[Example]: I will pay you to acquire the car if you currently own it

]

---

# More Interesting: Incompatible Uses

- We don't need to resort to law for mutually-agreeable transactions (like the car)

- What's more interesting are .hi[incompatible uses] of our own property that give rise to conflict
  - One person's use of their own property imposes an .hi-purple[externality] on another

- Here, we *do* need the law to define the rights...but that's not the end of the story
]

---

# The Pigouvian View

A.C. Pigou

1877-1959
]
]

- Each party only considering own `$MPC$` and `$MPB$`

- Injurer `$\xrightarrow{harms}$` Injured

- .hi-green[Examples]: 
  - polluting factory `$\xrightarrow{harms}$` households living nearby
  - neighbor planting trees `$\xrightarrow{harms}$` my shaded pool
  - partying neighbor `$\xrightarrow{harms}$` quiet neighbor

- Tax/restrain injurer (A) until his MPC = MSC
]

---

# Externalities as a Property Rights Problem

(1910-2013)

Economics Nobel 1991]

]
]

- Harm is actually .hi-turquoise[bilateral], not unilateral
  - Party A `$\underbrace{\iff}_{harms}$` Party B

- Requires *two* associating parties to have a dispute

- Settling the dispute *will* impose a cost on *some* party

- Origin of the problem is unclear property rights!
  - Who has right/duty over activities creating the externality?

]

---

# Externalities as a Property Rights Problem

(1910-2013)

Economics Nobel 1991]

]
]

> “The traditional approach has tended to obscure the nature of the choice that has to be made. The question is commonly thought of as one in which A inflicts harm on B and what has to be decided is: how should we restrain A? But this is wrong. We are dealing with a problem of a reciprocal nature. To avoid the harm to B would inflict harm on A. The real question that has to be decided is: should A be allowed to harm B or should B be allowed to harm A?” (p.2).

]

---