Property Law – Professor Joseph Liu
Law and Economics Handout
Law and Economics Primer
.Basic claim: legal rules should be set so as to maximize social wealth; if so, then efficient
a.“Wealth” defined as aggregate market value, measured by willingness to pay
b.“Maximization” defined as:
i.Pareto superiority: one person better off and no one worse off
ii.Kaldor-Hicks: gains to those better off greater than losses to those worse off
..Usually use Kaldor-Hicks criterion, since Pareto criterion is stricter
.Coase Theorem: where transactions costs are zero, awarding entitlement to either party will be equally efficient
-If entitlement given to party who values it more, then efficient result
-If entitlement given to party who values it less, then parties will bargain to efficient result
-Implications for law: legal rules do not matter for efficiency where transactions costs are zero
-Corollary: where transactions costs are not zero, legal rule may have impact on efficiency
.Types of transactions costs that might hinder bargaining
a.Bargaining, negotiation, contracting costs
b.Strategic behavior
c.Imperfect information
d.Inability to agree on splitting the surplus
.Implications for the law
a.Courts should try to lower transactions costs to facilitate bargaining (e.g. clear rules)
b.Where transactions costs are too high, courts should award to party who values more highly
.Broader critiques of this approach
a.Focus on efficiency ignores distributional implications of different legal rules
b.Focus on efficiency ignores other important values, such as fairness, justice, etc.
c.Willingness to pay is not a good measure of social utility
d.Offer price and asking price may differ due to:
i.Wealth effects
ii.Endowment effects
Coase Theorem Example: Fontainebleau v. Eden Rock
.Situation #1: benefit outweighs harm
-Basic facts/numbers
..Fontainebleau considering construction of 14-story addition, blocking light
..Addition is worth $10MM to Fontainebleau
..Eden Roc suffers $6MM in damage
..Efficient for Fontainebleau to build
-If entitlement given to Eden Rock:Fontainebleau enjoined from building
..Fontainebleau willing to pay Eden Roc up to $10MM to suffer damage
..Eden Roc willing to receive more than $6MM to suffer blockage
..Contract: Fontainebleau will pay between $6MM and $10MM to build
-If entitlement given to Fontainebleau:Fontainebleau can build
..Eden Roc willing to pay up to $6MM to get Fontainebleau to stop
..But Fontainebleau won’t stop for less than $10MM
..No contract: Fontainebleau will build the addition
.Situation #2: harm outweighs benefit
-Basic facts/numbers
..Fontainebleau considering construction of 14-story addition, blocking light
..Addition is worth $6MM to Fontainebleau
..Eden Roc suffers $10MM in damage
..Efficient for Fontainebleau not to build
-If entitlement given to Eden Rock:Fontainebleau enjoined from building
..Fontainebleau willing to pay Eden Roc up to $6MM to build
..Eden Roc would not be willing to accept less than $10MM
..No contract: Fontainebleau will not build addition
-If entitlement given to Fontainebleau:Fontainebleau can build
..Eden Roc willing to pay up to $10MM to get Fontainebleau to stop
..Fontainebleau would be willing to accept more than $6MM
..Contract: Eden Roc will pay Fontainebleau $6MM to $10MM not to build
.Situation #3: benefit outweighs harm, but with transactions costs
-Basic facts/numbers
..Fontainebleau considering construction of 14-story addition, blocking light
..Addition is worth $10MM to Fontainebleau
..Eden Roc suffers $6MM in damage
..Efficient for Fontainebleau to build
..Cost of negotiating a contract is $5MM
-If entitlement given to Fontainebleau:Fontainebleau can build
..Eden Roc willing to pay up to $6MM to get Fontainebleau to stop
..But Fontainebleau won’t stop for less than $10MM
..No contract: Fontainebleau will build the addition: efficient result
-If entitlement given to Eden Rock:Fontainebleau enjoined from building
..Fontainebleau willing to pay Eden Roc up to $10MM to suffer damage
..Eden Roc willing to receive more than $6MM to suffer blockage
..Cost of negotiating contract is $5MM: greater than social surplus
..No contract: Fontainebleau will not build the addition: inefficient result