Handout 2_sol.pdf - September 20th 2019 Email...

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Econ 522: Law and Economics September 20 th , 2019 TA: Meng-Chien Su Email: [email protected] Office Hours: Thursday 10:00-12:00 Social Sciences 6439 Handout 2: The Coase Theorem and Property Right 1 Review 1. The Coase Theorem Theorem. In the absence of transaction costs, if property rights are well-defined and tradable, then voluntary negotiations will lead to efficiency. Remark. The Coase Theorem relies on three crucial assumptions: (i) Property rights are well-defined. (ii) Property rights are tradable. (iii) No transaction costs. If the conditions do not hold, there is no guarantee that an efficient outcome can be reached via negotiation. In particular, transaction cost is quite relevant. If the cost is ignorable, we can still expect efficiency. However, in real world, the cost is substantial in many cases. If the cost is large enough to affect market transactions, the courts directly influence economic activity. 2. Bargaining If property right is negotiable and if there is no cost of bargaining, we would expect the parties involved to bargain and reach an efficient outcome. The following concepts are particularly useful: (i) Threat point : The payoff each player can guarantee for himself if he doesn’t agree to a deal. (ii) Gains from cooperation : Increase in combined payoffs if a deal is reached. If a deal is reached, the parties involved split the gains from cooperation and end up with payoffs equal to their own threat points plus the share of gains from cooperation they get. 3. Transaction Costs (i) Search Costs: Difficulties in finding a trading partner. (ii) Enforcement Costs: Difficulties in enforcing the agreement afterwards. (iii) Bargaining Costs: Difficulties in reaching an agreement. Asymmetric information/adverse selection Private information/not knowing each others’ threat points Uncertainty about property rights/threat points Large numbers of buyers/sellers – holdout, freeriding Hostility 1 Revised from Jonathan Becker’s discussion section handout in Fall 2018. 1
4. Property Law Basics (i) Approaches to Property Law: a) Normative Coase: Structure the law to minimize transaction costs. Optimal when transaction costs can be made low enough to lubricate bargaining, or when the costs to the regulatory body of obtaining information are high. b) Normative Hobbes: Structure the law to allocate property rights to whoever values them the most. Optimal when transaction costs can not be made low enough to lubricate bargaining, or when the costs to the regulatory body of obtaining information are low. (ii) Rules for Protecting an Entitlement: a) Property Rule/Injunctive Relief: Violation of my entitlement is punished as a crime, but entitlement is negotiable. When transaction costs are low, a property rule is more efficient. Injuree (person whose entitlement is violated) always prefers a property rule, because

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