Tutorial 3
Online Review
Embedded Files
This is our last tutorial online review before the midterm test!
We're excited that back for another review of the tutorial content before the test. The solutions and discussion are based off of Professor Barber's tutorial solutions.
🖼️Multimedia: Question 1 - updated
🖼️Multimedia: Question 1 - updated
Suppose there are two people who live next door to each other. Dave has loud parties. Eva dislikes the noise from parties. Dave claims that he has the right to have parties on his property. Eva claims that she has the right to live noise free. They ask the court to clarify the allocation of their property rights.
Suppose there are two people who live next door to each other. Dave has loud parties. Eva dislikes the noise from parties. Dave claims that he has the right to have parties on his property. Eva claims that she has the right to live noise free. They ask the court to clarify the allocation of their property rights.
Dave has four options for parties. Below is a table with their relationship with the effects of increasing the number of parties.
Dave has four options for parties. Below is a table with their relationship with the effects of increasing the number of parties.
a) Sketch the marginal benefit and cost curves
When Dave plays music, the external cost is Eva's private cost with no external benefits. With this, we get:
Social Marginal Benefit (SMB) = MB of Dave
Social Marginal Cost (SMC) = MC of Eva
b) How many parties is it efficient for person Dave to have?
At every decision point of 1 -> 2 -> 7 parties, there is higher marginal benefit than marginal cost for each increase...
As such, when maximizing social welfare through optimizing social costs and benefits, it is efficient for Adam to have 7 parties (one per day) as SMB > SMC for each decision.
The social surplus is calculated as the TOTAL amounts, which would be:
Total Social Benefit = 1500 + 700 + 600 = $2800
Total Social Cost = 75 + 125 + 500 = $700
Total Surplus = 2800 - 700 = $2100
c) How should the court rule in terms of granting the right to parties or being noise free? Clearly show the consequences of ruling on Dave and Eva. Assume that any bargaining that takes place is Nash Bargaining. What effects do these rules have for the number of parties and the distribution of income?
CASE 1: Court Rules in Favour of Dave - Right to Party Granted
CASE 2: Court Rules in Favour of Eva - Right to Noise-Free Granted
As shown, the efficient outcome is having daily parties (7 parties) no matter the allocation of rights which follows from Coase Theorem. This is the variant version because the final allocation outcome (distribution of wealth) is variant to the initial assignment of rights from the court ruling of rights.
Clearly, the second case has a final distribution of income that favours Eva. The important distinction is the distributive flow of income.
d) Suppose there are transactions costs associated with bargaining. At what level of transactions cost would you change your answer in the above question (c)?
As we saw, bargaining only occurs when the court rules in favour of Eva with the right to a noise-free space. We saw that the social surplus was $2100 that could be distributed as an added incentive from Dave to Eva for agreeing to the contract.
If transaction costs exceeded $2100, there would be no contract as Dave would not have the $700 to compensate Eva's damages from Daily Parties, or any party for that matter.
e) Suppose now costs are above this level found in (d). How should the court rule?
If transaction costs are above $2100, no bargaining will take place. The results would be:
Court Rules in Favour of Dave = daily parties, $2100 surplus (no change)
Court Rules in Favour of Eva = no parties, $0 surplus (no more bargaining opportunity)
The Normative Hobbes Theorem deals with the issue where transaction costs are too high and bargaining will not take place. The court will choose ruling in favour of Dave because the social surplus is $2100 with daily parties rather than $0 with no parties.
...of course at the expense of Eva - sorry!
🛣️Series: Question 2
🛣️Series: Question 2
Adam plays Nickelback tapes in his backyard that drives his neighbour Blair crazy. The marginal utility to Adam is $500.00. The disutility to Blair is $600.00.
Adam plays Nickelback tapes in his backyard that drives his neighbour Blair crazy. The marginal utility to Adam is $500.00. The disutility to Blair is $600.00.
a) From the point of view of welfare economics, is it efficient for Adam to play Nickelback?
What do you think? We will assume that utility/disutility are comparable with these dollar quantifications.
Answer: No! (highlight)
Answer: No! (highlight)
Using cost-benefit analysis, the binary decision of music or no music leads to the following possibilities:
Play Music: $500 - $600 = -$100
No Music: $0 - $0 = $0
If Adam plays Nickelback music, the net value from the decision is -$100. This is a worse outcome than no music which everyone is neutral at $0.
b) Assuming transaction costs are zero, how might the Theorem of Coase resolve this?
c) A bylaw is passed prohibiting noise that disturbs neighbours. What will Adam and Blair do? Assume Nash Bargaining, if needed.
Further Consideration: What about Adam playing music but paying Blair a certain amount of money as compensation?
Since Adam only gains $500 from playing Nickelback music, he will need to pay Blair at least $600 to off-set Blair's disutility (loss) of $600 when Nickelback music plays.
Clearly, that is not feasible for Adam who would then be at a net value of $500 - $600 = -$100.
d) What is the maximum legal fee that can be charged to still permit the actions Blair or Adam take in (b) and (c)?
Part-b) The scope of bargaining of $0 to $100 exists between the two Adam and Blair.
If Adam bargained hard (and maybe had some sort of power/leverage), we may see the money split 80%-20%. On the other hand, if Blair drove a hard bargain, we may end up with something in the other direction like 32%-78%. In this question, we are asked to assume Nash Bargaining, which means symmetrical power and a 50%-50% outcome.
A 50%-50% outcome means that the $100 "savings" are divided as: $50 to Adam + $50 to Blair. This means that if Blair were to seek legal assistance and pay costs, they would only have up to $50 in surplus to cover legal fees.
Thus the maximum legal fee given Nash Bargaining is $50 for Blair. It is important to note that this answer assumes splitting of the surplus occurs BEFORE legal fees. If assumed as legal fees first, then the scope of bargaining would be the remainder after subtracting legal fees from the $100.
Part-b) The scope of bargaining of $0 to $100 exists between the two Adam and Blair.
Perhaps something to consider instead is what is the maximum transaction cost that Blair is willing to pay for the enforcement of the bylaw. If telephone calls costed money, perhaps Blair would have a maximum willingness to pay of up to $100 for the phone call. This could be relevant if enforcement necessitated a paper-work trip to the court for an injunction.
e) What are the law and economic issues involved if Blair recruits other neighbours who have a disutility to Nickelback to help her?
It would be more difficult for the neighbours organize or agree to pay Adam as a group as a transaction cost.
Some members of the group would free ride on Blair’s payment to Adam for the elimination of Nickelback.
Different group members have varied preferences on the level of Nickelback endurance.
From a simplified level, this makes a bargain less likely, so Adam continues to play Nickelback.
🖐️Interact: Question 3
🖐️Interact: Question 3
Compare the efficiency of the following two methods of amending the just-compensation constraint:
Compare the efficiency of the following two methods of amending the just-compensation constraint:
Just-Compensation Constraint: the amount of money to compensate an owner for expropriating their property/assets (in the context of this question)
Expropriation: when a government forces a private property owner to give up land or assets for public use
Public Use: property, land, or resources dedicated to the benefit, convenience, or enjoyment of the general community (Social Benefit, Public Externality)
The two options for just-compensation constraint:
The two options for just-compensation constraint:
Option 1: Define just compensation to be fair market value (including relocation costs) plus, say, 20 percent.
Option 2: Allow private property owners to make their own assessments of the value of their property. Property owners agree to pay property taxes on that self-assessed value. If the government ever takes the property, it agrees to pay the self-assessed property value as just compensation
💰Why is it important for property owners to pay property taxes on the self-assessed value?
💰Why is it important for property owners to pay property taxes on the self-assessed value?
Property tax constrains the private property owner in making untruthful, extreme assessments as higher property value means higher taxation. The incentive to exaggerate the value is offset by the prospect of paying tax on this higher amount.
Without this requirement, the owner can claim their assessed value for a house is 100x times higher than market value. That is probably unreasonable as compensation for the house.
Ideal valuation of property is the subjective value the owner assigns to his or her property. The key is compensation for individual's disutility from the loss of property...
Option B is better than Option A (highlight)
📑Read: Question 4
📑Read: Question 4
If everyone has free access to a public beach, who, if anyone, has the power to control the use of this resource?
If everyone has free access to a public beach, who, if anyone, has the power to control the use of this resource?
Excludable: something can be prevented from being used or accessed typically by requiring payment or other conditions.
Rival: one person’s consumption prevents or reduces the ability of others to consume it simultaneously.
📺Watch: Question 5
📺Watch: Question 5
Suppose the statute of limitations for adverse possession is 10 years. After 9.9 years of trespass owners retain full rights, but after 10 years of trespass owners lose all of their rights. Instead of owners losing their rights abruptly at the end of 10 years, the statute could be written so that the rights depreciate gradually over time. For example, the trespasser could be granted a 10 percent interest in the property for each year of adverse possession, so that after one year the trespasser would own 10 per cent of it and after 10 years the trespasser would own all of it. Compare the efficiency of the “discontinuous rule” and the “continuous rule.”
Suppose the statute of limitations for adverse possession is 10 years. After 9.9 years of trespass owners retain full rights, but after 10 years of trespass owners lose all of their rights. Instead of owners losing their rights abruptly at the end of 10 years, the statute could be written so that the rights depreciate gradually over time. For example, the trespasser could be granted a 10 percent interest in the property for each year of adverse possession, so that after one year the trespasser would own 10 per cent of it and after 10 years the trespasser would own all of it. Compare the efficiency of the “discontinuous rule” and the “continuous rule.”
The proposed policy can be simplified to:
% of time as a squatter = % of rights gained
at a rate of 10% per year for 10 years → 100%
With this policy, the discussed advantages of adverse possession are minimized because after just one year, the trespasser has 10% interest in the property. In other words, the squatter can block the use or sell portions of the property after just one year.
The result is likely increased costs to the original owners as they now need to actively monitor their land to eject trespassers who might otherwise become part-owners. It also makes it difficult for companies to shutdown in the short-run when not profitable because of the looming risk of losses in land title.
📺Watch: Question 6
📺Watch: Question 6
If the value of a lost object is low enough, the estray statutes do not apply. Consequently, the finder has no legal obligation to advertise. Discuss the costs that need to be balanced to the most efficient lower bound in the value of a lost object for purposes of the estray statutes.
If the value of a lost object is low enough, the estray statutes do not apply. Consequently, the finder has no legal obligation to advertise. Discuss the costs that need to be balanced to the most efficient lower bound in the value of a lost object for purposes of the estray statutes.
If costs of trying to find the original owner are too high, then there may be a disincentivization issue. Of course, if the finder chooses not to abide by estray statutes, they risk being caught and subject to penalties under the law.
On a similar note, if the value of the object is very low, it may not be socially efficient to spend money on advertising or even transportation, when the lost object is not more than a mere rubber band. The transaction costs of search must, therefore, not exceed the subjective value of the object to its original owner.
Benefits of Estray Statutes
Estray statutes tend to clear the clouds from title and transfer property to productive uses
Estray statutes also provide an incentive for owners to monitor their property
Estray statutes induce the dissemination of information by finders and thus reduce the search costs of owners who lose or mislay their property
📑Read: Question 7
📑Read: Question 7
What if the government needs to purchase a single, large piece of property in order to provide a public good, say, a satellite-tracking station? There is only one private owner with whom to deal. And his property is the only one that is suitable for the station. Should the government be allowed to compel this individual, a monopolist for the contemplated public use, to sell at fair market value?
What if the government needs to purchase a single, large piece of property in order to provide a public good, say, a satellite-tracking station? There is only one private owner with whom to deal. And his property is the only one that is suitable for the station. Should the government be allowed to compel this individual, a monopolist for the contemplated public use, to sell at fair market value?
This question extends the topic introduced in Question 3. The government is expropriating property and needs to compensate an individual for their property. BUT how much should they give?
There are a few factors to consider:
Fair Market Value: This amount is typically determined by a neutral appraiser. Factors such as sentimentality, rootedness in the land, etc. are not always captured in fair market value.
A socially efficient/optimal price reflects this subjective value. Fair market value tends to underestimate the subjective value that an owner places on his or her property.
Public Good Value: Land expropriated by the government is put into public use where there is a public goods externality (social benefit to the community). The social benefit could be very large, such as a subway system or a community centre, which extends many times greater than the individual private benefit of the original property owner.
Public Good valuation from its external benefits tends to overestimate the value of the property.
Making a payment decision:
Since there is a social gain from converting a private good to a public good, the government could choose to share the amount with the homeowner, covering the subjective/sentimental aspects of the original property owners' assessment.
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