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Property rights in a market system

Market systems only function well when property rights are well defined. Take a deeper dive into the role of property rights in a market system in this video.

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Video transcript

- [Instructor] In this video we're going to talk about an idea that's crucial to the proper functioning of an economy under a market-based system. And that's the idea of property rights, and it's just the idea that everyone agrees on who owns what and what can they do with that property? And for many of us who live in a part of the world with strong property rights, we take all of that for granted. We know who owns that house and what they have the right to do with that house and if they were to sell that house, how that would occur, but in some parts of the world or in some parts of history, that wasn't so clear. Someone might say they own the house, but then another person might live in that house and they say well I've been living here for 10 years, it's my house now, deal with it. Or they might go hire some thugs to say hey owner sell me the house for less than the market value otherwise we're going to hurt you in some way and so in some ways they're infringing on those property rights or the government might just come in and say we're gonna take that property from you because we want it and in those situations property rights would be weakened, and what we're going to do is a little bit of a thought experiment to see why it's so crucial for the proper functioning of a market economy. And so let's stick with the house analogy. So let's say that we have some blue houses in our economy that look like that. Let's say it's owned by this person right over here. Let's say we have some pink houses that look like that. Let's say it's owned by that person right over there and let's say that we have some orange houses that look something like that. They have some kind of arch on the top and let's say it's owned by something like this, and let's say these people are all interested in selling their house. Maybe they're downsizing or they're retiring or they're moving someplace else. And so there's a market of potential buyers. So let me draw the buyers right over here and so there might be some people and if we have properly functioning property rights, there might be some people who are really interested in the blue house and so whoever is willing to pay the most for that blue house will get it and so let's say that this person is willing to pay I would say one dollar sign for the house and so the ownership of the house will go to that person. Same thing for the pink houses. Maybe this person right over here is the person who really likes the pink houses. They pay a different price, maybe a little bit more. I'll do two dollar signs to represent that, and then they will get title to the house and maybe a ton of people are really interested in these arched houses and maybe they bid for it and the bidding keeps going higher and higher and higher and this person wins at the end and they have to pay up a lot for that orange house that they get title for, and let's just assume that for whatever reason, that they're all about the same cost to build. Well what would happen in this market then? Well home builders or even people in other types of houses will say wow, I can get a lot more for the orange house. The market is giving us a price signal. So this right over here, this is a price signal. In fact, they're all price signals, and when you take 'em together, you're saying, hey, I get more for an orange house than a blue house and so maybe if they all cost the same to build we'll start producing more of these orange houses. So builders will produce more of these orange houses and maybe some people might remodel their blue houses to have these orange arches on 'em, and so you could imagine that might happen from the price signal because it's clear that that's where users preferences are. That's where the demand is, but now let's imagine a slightly more dystopian world and this actually is what much of human history was and even some significant parts of the world today where there aren't clear property rights. When this person says that they have this house for sale, these people are like is it really your house? And then this person comes along and says no it's my house and I have this proof that my grandfather owned it and he never sold it to your grandfather and then this person says I have a lot of guns and I don't care what y'all say and what paperwork you have, but I'm taking the house. Well how much would this person be willing to pay this person right over here in that circumstance? And so this person is much less likely to get these three dollar signs This person said hey, this is kind of a risky investment. I don't really know if I take title from this person whether it's still my house. So they're not willing to give three dollar signs, they're only willing to give one dollar sign or maybe no dollar signs. Maybe this house doesn't even sell. Well then the price signals have broken down, and so then in this market people will tell me maybe we'll build more of the arched orange houses because that's what the market demands and so you can quickly see that when property rights break down, the market system breaks down 'cause the market system is all about people using price to figure out how much they're willing to pay for things but that assumes that when you get something that it's really yours, that it's not going to be disputed and the person you're buying from really has ownership and this break down would often be characterized as a market failure. Now you could say okay there's other types of systems that we've talked about in other videos. We talk about command economies and in the extreme in a command economy, you have no private ownership of things and so you might say maybe that is a solution to this property rights problem, but command economies have significant problems of their own. In fact, very few of them or really none of them in history have proven to really work because they have a major incentive problem because if you're just being told what to build by the government, you're told how to build it by the government, you're told who that gets it by the government. There's very little incentive to try to innovate, to try to build more, to invest, or whatever else, and we talk about that in other videos. So I will let you go there. This is just an introduction to think about this idea of property rights and ask your parents or talk around or if you are a parent, look at the world of how much infrastructure we have in a society like the United States or in much of the world today to enforce property rights.