Institutional Economics

Demsetz: Toward a theory of

property rights (1967)

Ari Rahmawati
Dimas Abi Aufan
Mayang Wulandari
Theodorus Pandhu Bhaskoro
• I. The Concept and Role of Property Rights
• A primary function of property rights is that of guiding incentives to achieve a greater internalization of externalities.
• All that is needed to internalize externalities is ownership, which includes the right of sale.

• II. The Emergence of Property Rights

• Property rights develop to internalize externalities when the gains of internalization become larger than the cost of internalization.
• New property rights emerge to cope with new externality problems that come with changes in technology, the opening of new markets, changes in
social mores, changes in common law precedents, etc.

• III. The Coalescence and Ownership of Property Rights

• Communal ownership means that the community denies to the state or to individual citizens the right to interfere with any person's exercise of
communally-owned rights.
– Disadvantage:
• Results in great externalities and rules out a "pay-to-use-the-property" system; high negotiation and policing costs make ineffective a "pay-him-not-to-use-the-
property" system.
• Private ownership implies that the community recognizes the right of the owner to exclude others from exercising the owner's private rights.
– Advantages:
• The concentration of benefits and costs on owners creates incentives to utilize resources more efficiently.
• The cost of negotiating over externalities will be greatly reduced because any negotiations take place between two private owners; under communal ownership,
negotiations would have to be between all users of the property.
– Negotiation options in the market to deal with externalities:
• Contractual agreement among owners that directly deals with externalities at hand.
• The buyout of some owners by others. If there are several externalities, so that several contracts will need to be negotiated, or if the contractual agreements should
be difficult to police, then outright purchase will be the preferred course of action.
• State ownership implies that the state may exclude anyone from the use of a right as long as the state follows accepted political procedures for
determining who may not use state-owned property.
• Exception to the assertion that ownership tends to be an individual affair: publicly-held corporatism.
– Advantage:
• There might be significant economies of scale in the operation of large corporation if not all owners need to participate in the decisions the company must make.
– Disadvantage:
• Depending on the structure of ownership, there may be some externality difficulties under the law of partnership; externalities depend on the liability of the owners.
 Lesson Learned
• 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."
• Negotiating to reach mutual agreement is very costly
• 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)
 General Contribution
• Property rights:
– menginternalisasi eksternalitas sehingga owner
lebih aware thd efek dari setiap keputusan
ekonomi yg diambil
– Maksimisasi benefit (sudut pandang owner)
– Mengurangi dampak eksternalitas negatif pada
masyarakat
– Mengurangi negotiation cost
 Possible Concern
• Land ownership problem in Indonesia
(everyone can buy land or island in Indonesia
whatever their nationalities as long as they
have money)
• Individual Property Rights in Indonesia (songs,
musics, books, ideas)