1. Econ 522 Economics of Law Dan Quint Fall 2010 Lecture 9

2. 1  Monday – continued applications of property law  Different types of public ownership  Fugitive property – first possession vs. tied ownership  Temporary vs. permanent damages  Limitations/exceptions to property rights:  Adverse possession  Restraints on alienation  Private necessity  Today: finish property law, begin contract law  HW 2 due next Monday (at start of lecture)  Midterm next Wednesday, in Bascom 272 Plan

3. 2  Property: “a bundle of rights”  Can you unbundle them?  Separate them, sell some and keep others  Usually, no  Prohibition on perpetuities  I can’t separate the right to own/live on my land from the right to sell it or turn it into a golf course  But in some instances, yes… Another limitation on property rights: “Unbundling”

4. 3  Land ownership consisted of three separable pieces (“estates”)  Surface estate  Support estate  Mineral estate Pennsylvania and coal

5. 4  Free unbundling of property rights generally not allowed under common or civil law Unbundling

6. 5  Free unbundling of property rights generally not allowed under common or civil law  Efficiency: allow unbundling when it increases the value of the property?  But if re-bundling the rights is costly, maybe not  Unbundling  uncertainty about rights  harder to trade Unbundling

7. 6  The government can take your property  “Eminent domain”  And the government can tell you what you can or can’t do with it  Regulation Two other limitations on property rights

8. 7 Takings

9. 8  One role of government: provide public goods  When public goods are privately provided  undersupply  Defense, roads and infrastructure, public parks, art, science…  To do this, government needs land  (which might already belong to someone else)  In most countries, government has right of eminent domain  Right to seize private property when the owner doesn’t want to sell  This type of seizure also called a taking Takings

10. 9  U.S. Constitution, Fifth Amendment: “…nor shall private property be taken for public use, without just compensation.”  Government can only seize private property for public use  And only with just compensation  Consistently interpreted to mean fair market value – what the owner would likely have been able to sell the property for Takings

11. 10  Why allow takings? Takings

12. 11  Why allow takings?  Why these limitations?  why require compensation? Takings

13. 12  Why allow takings?  Why these limitations?  why require compensation? Takings $3 MM$1 MM $9 MM $10 MM

14. 13  Why allow takings?  Why these limitations?  why require compensation?  why only for public use? Takings

15. 14  Why allow takings?  Why these limitations?  why require compensation?  why only for public use?  The government should only take private property (with compensation) to provide a public good when transaction costs preclude purchasing the necessary property through voluntary negotiations Takings

16. 15  1981: GM was threatening to close Detroit plant  Would cost city 6,000 jobs, millions in tax revenue  City used eminent domain to condemn entire neighborhood  1,000 homeowners and 100 businesses forced to sell  land then used for upgraded plant for GM  city claimed employment and tax revenues were public goods, which justified use of eminent domain  Mich Sup Ct: “Alleviating unemployment and revitalizing the economic base of the community” valid public purposes; “the benefit to a private interest is merely incidental”  Overturned in 2004 ruling (Wayne v Hathcock)  Similar case, Kelo v. City of New London (2005 US Sup Ct) Poletown Neighborhood Council v Detroit

17. 16  1981: GM was threatening to close Detroit plant  Would cost city 6,000 jobs, millions in tax revenue  City used eminent domain to condemn entire neighborhood  1,000 homeowners and 100 businesses forced to sell  land then used for upgraded plant for GM  city claimed employment and tax revenues were public goods, which justified use of eminent domain  Mich Sup Ct: “Alleviating unemployment and revitalizing the economic base of the community” valid public purposes; “the benefit to a private interest is merely incidental”  Overturned in 2004 ruling (Wayne v Hathcock)  Similar case, Kelo v. City of New London (2005 US Sup Ct) Poletown Neighborhood Council v Detroit

18. 17 Regulation

19. 18 Regulation

20. 19  1800s: PA Coal purchased mineral and support estates, Mahon owned surface  1921: Kohler Act prohibited “mining of anthracite coal in such a way as to cause the subsidence of, among other things, any structure used as a human habitation.”  PA Coal sued government, claiming the regulation was same as seizing their land (without compensation)  “…While property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.” Regulation: Pennsylvania Coal v. Mahon surface estate support estate mineral estate

21. 20  1800s: PA Coal purchased mineral and support estates, Mahon owned surface  1921: Kohler Act prohibited “mining of anthracite coal in such a way as to cause the subsidence of, among other things, any structure used as a human habitation.”  PA Coal sued government, claiming the regulation was same as seizing their land (without compensation)  “…While property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.” Regulation: Pennsylvania Coal v. Mahon surface estate support estate mineral estate

22. 21  1800s: PA Coal purchased mineral and support estates, Mahon owned surface  1921: Kohler Act prohibited “mining of anthracite coal in such a way as to cause the subsidence of, among other things, any structure used as a human habitation.”  PA Coal sued government, claiming the regulation was same as seizing their land (without compensation)  “…While property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.” Regulation: Pennsylvania Coal v. Mahon surface estate support estate mineral estate

23. 22  1800s: PA Coal purchased mineral and support estates, Mahon owned surface  1921: Kohler Act prohibited “mining of anthracite coal in such a way as to cause the subsidence of, among other things, any structure used as a human habitation.”  PA Coal sued government, claiming the regulation was same as seizing their land (without compensation)  “…While property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.” Regulation: Pennsylvania Coal v. Mahon surface estate support estate mineral estate

24. 23  Support compensation for regulatory takings  Shifting burden of regulation from owners of affected property to all taxpayers  Equivalent to selling everyone insurance against harmful regulation  If such insurance were available, people would buy it  But it’s not available, so government should provide it Blume and Rubinfeld, “Compensation for Takings: An Economic Analysis”

25. 24  Support compensation for regulatory takings  Shifting burden of regulation from owners of affected property to all taxpayers  Equivalent to selling everyone insurance against harmful regulation  If such insurance were available, people would buy it  But it’s not available, so government should provide it Blume and Rubinfeld, “Compensation for Takings: An Economic Analysis”

26. 25  Support compensation for regulatory takings  Shifting burden of regulation from owners of affected property to all taxpayers  Equivalent to selling everyone insurance against harmful regulation  If such insurance were available, people would buy it  But it’s not available, so government should provide it Blume and Rubinfeld, “Compensation for Takings: An Economic Analysis”

27. 26  Zoning laws  Distinguish industrial areas from residential areas More on regulation

28. 27  Zoning laws  Distinguish industrial areas from residential areas  Nollan v California Coastal Commission (US Sup Ct, 1987)  Nollans owned coastal property  Asked for permit to expand building, which would diminish view  Commission: donate a public walking path, and you get permit  Supreme Court: such a deal only legal if there is clear connection – a nexus – between the harm being done and the remedy More on regulation

29. 28  Zoning laws  Distinguish industrial areas from residential areas  Nollan v California Coastal Commission (US Sup Ct, 1987)  Nollans owned coastal property  Asked for permit to expand building, which would diminish view  Commission: donate a public walking path, and you get permit  Supreme Court: such a deal only legal if there is clear connection – a nexus – between the harm being done and the remedy More on regulation

30. 29  What are benefits and costs of…  having property rights at all?  expanding property rights to cover more things?  introducing an exception/limitation to property rights?  When will benefits outweigh the costs? Property law: the big-picture question End of material on first midterm  Up next: contract law

31. 30  Some transactions don’t occur all at once  I’m flying to Boston for Thanksgiving…  …or I hire someone to paint my house… Why do we need contracts?

32. 31  Some transactions don’t occur all at once  I’m flying to Boston for Thanksgiving…  …or I hire someone to paint my house…  …or you can get $10 for a purple poker chip, but don’t have any cash on you right now to buy it from someone with a lower number  A contract is a promise…  …which enables trade when transactions aren’t concluded immediately Why do we need contracts?

33. 32  Subgame perfect equilibrium: I’ll keep all the money; so you don’t trust me  Inefficient outcome (100 < 200)  And we’re both worse off Example: the agency (trust) game Player 1 (you) Trust meDon’t Player 2 (me) Share profitsKeep all the money (150, 50)(0, 200) (100, 0)

34. 33 (One solution: reputation)

35. 34  Now we get cooperation (and efficiency)  Purpose of contract law: to allow trade in situations where this requires credible promises Another solution: legally binding promises Player 1 (you) Trust meDon’t Player 2 (me) Share profitsKeep all the money (150, 50)(125, 25) (100, 0)

36. 35  “The rich uncle of a struggling college student learns at the graduation party that his nephew graduated with honors. Swept away by good feeling, the uncle promises the nephew a trip around the world. Later the uncle reneges on his promise. The student sues his uncle, asking the court to compel the uncle to pay for a trip around the world.”  “One neighbor offers to sell a used car to another for $1000. The buyer gives the money to the seller, and the seller gives the car keys to the buyer. To her great surprise, the buyer discovers that the keys fit the rusting Chevrolet in the back yard, not the shiny Cadillac in the driveway. The seller is equally surprised to learn that the buyer expected the Cadillac. The buyer asks the court to order the seller to turn over the Cadillac.”  “A farmer, in response to a magazine ad for “a sure means to kill grasshoppers,” mails $25 and receives in the mail two wooden blocks with the instructions, “Place grasshopper on Block A and smash with Block B.” The buyer asks the court to require the seller to return the $25 and pay $500 in punitive damages.” So… what types of promises should be enforced by the law?

37. 36 The Bargain Theory of Contracts

38. 37  Developed in the late 1800s/early 1900s  A promise should be enforced if it was given as part of a bargain, otherwise it should not  Bargains were taken to have three elements  Offer  Acceptance  Consideration The bargain theory of contracts

39. 38  Promisor: person who gives a promise  Promisee: person who receives it  In a bargain, both sides must give up something  reciprocal inducement  Consideration is what the promisee gives to the promisor, in exchange for the promise  Under the bargain theory, a contract becomes enforceable once consideration is given What is consideration?

40. 39  Promisor: person who gives a promise  Promisee: person who receives it  In a bargain, both sides must give up something  reciprocal inducement  Consideration is what the promisee gives to the promisor, in exchange for the promise  Under the bargain theory, a contract becomes enforceable once consideration is given What is consideration?

41. 40  Hamer v Sidway (NY Appeals Ct, 1891)  Uncle offered nephew $5,000 to give up drinking and smoking until his 21 st birthday, then refused to pay “The promisee [previously] used tobacco, occasionally drank liquor, and he had a legal right to do so. That right he abandoned for a period of years upon the strength of the promise… We need not speculate on the effort which may have been required to give up the use of these stimulants. It is sufficient that he restricted his lawful freedom of action within certain prescribed limits upon the faith of his uncle’s agreement, and now, having fully performed the conditions imposed, it is of no moment whether such performance actually proved a benefit to the promisor, and the court will not inquire into it.” The bargain theory does not distinguish between fair and unfair bargains

42. 41  Expectation damages  the amount of benefit the promisee could reasonably expect from performance of the promise  meant to make the promisee as well of as he would have been, had the promise been fulfilled Under the bargain theory, what is the remedy?

43. 42 Problems with the bargain theory  Not that accurate a description of what modern courts actually do  Not always efficient  Does not enforce certain promises that both promisor and promisee might have wanted to be enforceable

44. 43 Problems with the bargain theory  Not that accurate a description of what modern courts actually do  Not always efficient  Does not enforce certain promises that both promisor and promisee might have wanted to be enforceable  Does enforce certain promises that maybe should not be enforced

45. 44 What does efficiency say about what promises should be enforced?

46. 45 What promises should be enforced?  In general, efficiency requires enforcing a promise if both the promisor and the promisee wanted it to be enforceable when it was made  different from wanting it to actually be enforced

47. 46 What promises should be enforced?  In general, efficiency requires enforcing a promise if both the promisor and the promisee wanted it to be enforceable when it was made  different from wanting it to actually be enforced  The first purpose of contract law is to enable people to cooperate by converting games with noncooperative solutions into games with cooperative solutions  or, enable people to convert games with inefficient equilibria into games with efficient equilibria

48. 47 What promises should be enforced?  In general, efficiency requires enforcing a promise if both the promisor and the promisee wanted it to be enforceable when it was made  different from wanting it to actually be enforced  The first purpose of contract law is to enable people to cooperate by converting games with noncooperative solutions into games with cooperative solutions  or, enable people to convert games with inefficient equilibria into games with efficient equilibria

49. 48 So now we know…  What promises should be enforceable?  For efficiency: enforce those which both promisor and promisee wanted to be enforceable when they were made  One purpose of contract law  Enable cooperation by changing a game to have a cooperative solution  Contract law can serve a number of other purposes as well

50. 49 Information  Private/asymmetric information can hinder trade  Car example (George Akerloff, “The Market for Lemons”)

51. 50 Information  Private/asymmetric information can hinder trade  Car example (George Akerloff, “The Market for Lemons”)

52. 51 Information  Private/asymmetric information can hinder trade  Car example (George Akerloff, “The Market for Lemons”)  Contract law could help  You could offer me a legally binding warranty  Or, contract law could impose on you an obligation to tell me what you know about the condition of the car  Forcing you to share information is efficient, since it makes us more likely to trade  The second purpose of contract law is to encourage the efficient disclosure of information within the contractual relationship.