Endowment Effects February 2017 Professor Levmore

Imagine that Guy and Amy live next door to one another and that Amy sues because Guy begins to erect a
mini-mansion that Amy regards as unsightly. She offers Guy $50,000 to cease construction and to preserve the old,
nice view of the hills that his new house will block. Amy would actually pay up to $80,000 but she has read the best-
seller, Bargaining for Advantage, and so she starts with a low offer. Guy goes ahead with construction, because he
has always wanted a big house. He confides to friends that he would accommodate Amy and build elsewhere if offered
more than $100,000 to do so. Alternatively, Amy might have run to the zoning authority or to court, hoping to block
Guy's looming "nuisance."
1. A court might well decide against Amy, and if so we might say that the judge:
A. has learned from the Coase Theorem, reaching a result the parties might have reached by bargain
B. thinks that nuisance should be limited to noise or physical pollutants
C. followed the negligence principle (what if Guy and Amy were one unit, with a single owner)
D. all of the above
E. two of the above

2. But what if Amy won the case in court? We might predict that Guy would then initiate a bargain and pay up
to $100,000 for the right to build. But it's not obvious that Guy would be able to strike this bargain because:
A. He asks >100 but he now needs to pay Amy, and he might not want to offer anything close to that, because he
must dip into his other wealth to come up with the money
B. Amy might now be expected to ask, or require, more than 100
C. Once a court decides the case, it will be contempt of court to bargain around the judges decision after it is
handed down.
D. A and B

3. Winning a case, and having a legal rule on your side, is itself a valuable:
A. liability B. asset C. c.v.- enhancing item D. dividend E. a commodity that can always be traded

In short, given Guy's taste for other things in life, his willingness to devote wealth to his new house is likely to be a
function of the degree to which he must then cut back on some other things. Similarly, Amy can better afford views
when she is wealthier; when she wins in court she can afford to value the pleasurable view at an amount greater than
when she is less wealthy. It is thus plausible that Guy would ask or require 100,000 to give up the planned
construction, while he may offer only 40,000, say, for the house and legal rights he does not have. This offer-asking
differential is also called a wealth effect, or endowment effect. The idea is that wealth, or the initial endowments one
possesses, affects _____________.
So despite the usual formulation of the Coase Theorem, that a legal rule does not matter because
______________________________, sometimes the rule may actually matter, not because of transaction costs,
culture, stubbornness, or the fear of giving away ones ___________ (as in our fee-shifting handout), but because rules
themselves affect wealth and, therefore, the amount that will be paid for a "right." Indeed, every Hand-formula
calculation is now a bit suspect because _____________________________________________.
The problem may be less serious than it first appears. In the first place, the parties' differentials determine
whether the rule matters. If Guy would sell his right at 100,000 but buy the right he does not have for 80,000, while
Amy would buy at 50,000 and sell at 60,000, the rule will not matter because ______________________________.
Second, if Guy wanted to build not a home but a fast-food franchise, then the spread between his offer and asking price
is likely to be small because _________________________________, and then his offer-asking spread will be less
likely to intersect with Amys.
Another reaction to the offer-asking problem is to think about the long term. If you buy a house that is next
door to a noisy fast-food franchise, you will probably pay ______________. In Guy and Amys case, their property
values probably reflect the legal rules and property rights that were in effect when _________________________.
This hints at the idea that we might generally be unsympathetic to one who ___________ to a nuisance, although you
might do well to wonder about, or expect to see in your Property course, cases where we actually favor one who
comes late.