(2/2)Brilliant economist Harold Demsetz & the common pool exhaustion problem.—@RichardAEpstein

Jan 18, 06:55 AM

Photo: Canadian Beaver (Castor canadensis), Gatineau Park, Quebec, Canada.

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Richard A. Epstein, Defining Ideas/Hoover, in re: Harold Demsetz, economist of the Chicago School. Why do we need firms instead of spot contracts? Because it’s often costly to set a market. . . . Pick the mode of organization the minimizes the costs of the transactions. How to put institutions together in a friction-filled world. For many outputs you need multiple inputs; need the equivalent of an orchestra conductor. That person is the owner; he gets what's left over when everything else is paid for. . . . Previous economists had treated the firm as a black box. Demsetz opened it up and looked at it. Theory of Property Rights, 1967: “One implicit assumption behind this conclusion is that the first possession rule will not exhaust the stock from which resources were made. Demsetz illustrated this weak underside of the first possession rule by referring to the anthropologist Eleanor Leacock's memoir, “The Montagnais ‘Hunting Territory’ and the Fur Trade,” which observed the formation of hunting territories for furs that the Montagnais, a Native American tribe, instituted when the arrival of the French traders dramatically increased their value. In essence, the traditional system, which allowed each hunter to catch animals at will for private consumption, only worked because aggregate consumption did not exhaust the stock. But the arrival of the French created an external market for furs. To stop overhunting, the tribe instituted a system of territories, each assigned to a given hunting group. Creating territories stopped, for example, the overhunting of beavers who themselves were territorial and thus allowed for an increase in overall yield. In Demsetz’s famous phrase, the institution of territories ‘internalized the externality’ of excessive hunting.” Common pool exhaustion problem. Residual claimant gets what's left over.