Arnold Kling  

The Coase Theorem and Endowment Effects

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There is a problem with the assignment of property rights on Karl Marx Street.

The street is in Griebnetzsee, a suburb of Berlin, and it sits on a hill overlooking a beautiful lake. It is very chic, with fancy villas. Truman, Churchill, and Stalin all were lodged in various houses along this street during the conference held in nearby Potsdam.

Down near the bottom of the hill, where part of the Berlin Wall used to stand, there is a path that would be very nice for pedestrians and bicyclists. If they could use it, bikers could ride all the way to Potsdam. However, some of the residents claim that the path is on their property, and they have set up bushes or other strong barriers. This forces walkers and bikers to instead ride down Karl Marx Street about one mile, until it ends, before they can join the path with no further obstructions.

The efficient solution is for bikers to be able to use the path. The Coase theorem says that we could arrive at the efficient solution with a clear assignment of property rights, and that it does not matter to whom those rights are given.

Suppose that every bicyclist carried a transponder that could be used for toll collection. If the rich residents have the property rights, then they can collect tolls from every biker who uses the path. Conversely, if the bikers have the property rights, then they would receive a "negative toll" every time they ride down Karl Marx Street because the bike path is blocked. The residents who set up the barriers on the path would be charged for these tolls. With the threat of these "negative tolls," the residents probably would give in and unblock the paths.

My point about endowment effects is this. If you give the property rights to the rich residents, some of them might say, "I don't care about collecting tolls. I have enough money. I don't want bikers going through my property." We might not see the efficient solution. On the other hand, if the bikers have the property rights, then my guess is that the threat of negative tolls would produce the efficient solution.

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CATEGORIES: Property Rights

COMMENTS (21 to date)
Arthur_500 writes:

This problem is currently going on near my neighborhood and we come to the crux of the problem - stay off my property. But what does this do to those who wish to travel that route?

We can't always get what we want.

There needs to be compelling reasons to take away property rights. If public transportation of bicycles is the compelling reason then the only issue is how to arrive at the desired result.

Toll roads are wonderful as it reduces unnecessary use and increases maintenance. However, as you rightly point out, it is often best to determine how best to get the public to acquiesce voluntarily. Economics will produce better answers than legal confiscation every time.

Radford Neal writes:

If you give the property rights to the rich residents, some of them might say, "I don't care about collecting tolls. I have enough money. I don't want bikers going through my property." We might not see the efficient solution.

How is this inefficient? If the property owners value an absence of bikers more than any toll that the bikers would be willing to pay, then no bikers is an efficient solution. And in this situation, why would negative tolls work? This might be the case if the size of the tolls was so large that it significantly affected the property owners overall wealth (eg, if they pay these tolls, they won't have enough money to buy food), but if so, that just shows that both situations - bikers using the path or no bikers using the path - are efficient.

William writes:

Agree with Radford. Why are you assuming that the efficient solution is for it to be open to the public as a bike path?

Also, it's "Griebnitzsee"

Link (in German)

Michael writes:

I think the assumption is that externalities are present when pedestrians and cyclists take to the roads (think accidents and the reduced flow of traffic). These externalties are not present when the bikers are on the bike path as 100% of the parties that are negatively affected are compensated.

Robert Johnson writes:

You highlight a major problem that sits inside of a lot of economic theory: Dollars (or other units of currency) are NOT the same to all people. I've frequently heard economists talk about willingness to pay (in dollars) for a good/service as being equal to the utility a person gains from acquiring the good/service. To quote Samuelson:

"Utility is taken to be correlative to Desire or Want. It has been already argued that desires cannot be measured directly, but only indirectly, by the outward phenomena to which they give rise: and that in those cases with which economics is chiefly concerned the measure is found in the price which a person is willing to pay for the fulfilment or satisfaction of his desire."

Well, if that's how you define utility (in dollars) then you can't compare MY utility against anyone else's utility, because we won't value DOLLARS the same way. You'll effectively be comparing apples to oranges.

If you want to maximize the well-being of the entire society, you can't rely on prices to get you there, because different people value Dollars differently. I think this is the problem you're finding with Coase in the bike path example. My utility in using the bike path could be greater than your utility in preventing me from using the bike path, but we still can't agree on a price because you value Dollars less than I do.

Phil writes:

Is it endowment effects, or a desire for fairness?

If you make the homeowners pay to keep the path, they might feel that the path actually belongs to the cyclists, and want to open it up to relieve their guilt, even if the money doesn't mean much to them. If you make the cyclists pay, the homeowners believe that the path is theirs, and choose not to rent it out for any reasonable price the cyclists may offer.

mick writes:

Name those utility values and where you got them.

I could just as well say the property owners values are multiplied by 1000X for social justice.

Andy Hallman writes:
Name those utility values and where you got them.

This is what Robert Johnson is referring to when he says "utility."

I could just as well say the property owners values are multiplied by 1000X for social justice.

If social justice makes you happy, it is already counted as utility.

ed writes:

When you say "efficient," I would assume you mean "Pareto efficient," since you're an economist. If the outcome is inefficient, you should be able to point to a possible Pareto improvement, which you haven't done. (Or if you are using some other definition of efficiency you should say so.)

So I also agree with Radford Neal.

Mike writes:

This seems like an elementary mistake. Could you explain if you just goofed or perhaps there is something more subtle going on.

Henry writes:

"Negative tolls"? Wouldn't such a system be open to abuse?

Redbud writes:

GIVE -- GIVE? -- property rights?

Who owned the property before the competing interests arose? Surely that can be determined.

If the residents' claim to ownership is valid, it's their property, their decision as to use.

Though it was efficient for the British to house their soldiers in American homes, it caused some trouble.

Weren't and aren't wars fought over property rights?

William writes:


Who owned the property before the competing interests arose? Surely that can be determined.

The East German government. And before that, Jews who were forced to sell by the Nazis.

What now?

redbud writes:

No argument about force associated with property rights.

So whom did the East German government deed the property to? The residents? Or a public easement?

Ownership determines use.

Failure to accommodate a non-owner's claims can prompt the use of force, physical or economic.

David C writes:

Who owned the property before the competing interests arose?

Attila the Hun.

rapscallion writes:

I think you make an important point, but you should recognize that efficiency doesn't have a stable meaning in this scenario. Efficiency in the Paretian sense is always achieved as long as agents are rational. That preferences are dependent on the initial property rights assignments doesn't matter--The Pareto optimum is achieved in either case, it's just not the same optimum. You would need some other non-Paretian criterion to argue for favoring one state over the other.

If you mean efficiency in the wealth-maximizing sense, then it's impossible to say because you have not specified transaction costs.

Mike Sproul writes:


Here's a somewhat embellished version of what Harold Demsetz taught us about that problem 30 years ago at UCLA:

If the walkers value the land at $300, while the homeowners value it at $200, there's $100 to be gained by giving it to the walkers. But if negotiations would more than burn up that $100, while a judge can assign rights cheaply, then a good judge will give the rights to the walkers, leaving society $100 richer. Demsetz call it the "least-cost avoidance" principle.

Ummm....Why can't there be more than one point on the Pareto frontier?

RobbL writes:

Of course the real problem is that if you start with being against coercive state action, then who enforces all these rules? Well of course the nanny-libertarian coercive corporation.

redbud writes:

I believe the state is charged with protecting and enforcing rights of citizens.

liberty writes:

The first two paragraphs are my favorite.

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