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Demsetz: Toward a theory of property rights

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Demsetz. 1967. Toward a theory of property rights. American Economic Review 57 (May): 347-359.

VARIABLES:

Y: emergence of new property rights

X: transactions costs relative to resource value. The gains of internalization become larger than the (transactions) costs of internalization.

  • The long chain of causation: (1) Changes in technology or the opening of new markets create (2) changes in economic values which increase (3) internalization and (3) lead to property rights. Changes may not be conscious but come about through social mores or common law precedents. Property rights: an instrument that helps us form expectations about our dealings with others
  • Property rights are socially constructed--they are expectations of how we can deal with others, expressed as laws, customs, or norms
  • The "main allocative function of property rights is the internalization of beneficial and harmful effects" (externalities)
  • Thus, property rights emerge b/c of the "emergence of new or different beneficial and harmful effects." They emerge to "internalize externalities when the gains of internalization become larger than the cost of internalization."
    • E.g.: Indians in Quebec established property rights after the (beaver) fur trade picked up--thus, they internalized the externality (over hunting), saving the beavers
    • But SW Indians hunted grazing animals with little commercial value (low benefit of internalization) and the animals wandered a lot (high cost of internalization--hard to keep track of which animals are "yours")  no property rights

Three ideal types of ownership:

  • Communal (all members of community can exercise this right; neither citizen nor state can interfere). Must negotiate over costs of externalities--how much each tribe member will hunt beaver, e.g.
  • Private (owner can exclude others)--greatly reduces negotiation costs
  • State (state can exclude anyone from using the property)