Unit5 Feb2015 PDF

5
February 2015 beta
PROPERTY, CONTRACT
AND POWER
Mr and Mrs Andrews, Thomas Gainsborough, 1750, National Gallery
HOW INSTITUTIONS INFLUENCE THE BALANCE OF POWER BETWEEN

ECONOMIC ACTORS, AND HOW THIS AFFECTS THE FAIRNESS
AND EFFICIENCY OF THE ALLOCATIONS THAT RESULT FROM
INTERACTIONS AMONG THEM.
You will learn:

How technology and biology limit what is economically feasible.
How interaction between economic actors can result in mutual gains, and also in
conflicts over how the gains are distributed.
How institutions influence the relative power and other bargaining advantages of actors
and can therefore shape the allocations that arise from interaction.
How the concept of Pareto efficiency can be applied to economic interactions
How we can evaluate outcomes using the concepts of fairness and Pareto efficiency.
See www.core-econ.org for the full interactive version of The Economy by The CORE Project.
Guide yourself through key concepts with clickable figures, test your understanding with multiple choice
questions, look up key terms in the glossary, read full mathematical derivations in the Leibniz supplements,
watch economists explain their work in Economists in Action and much more.
Funded by the Institute for New Economic Thinking with additional funding from Azim Premji University and Sciences Po
coreecon | Curriculum Open-access Resources in Economics

perhaps one of your distant ancestors considered shipping out with Blackbeard,
or Captain Kidd, for an opportunity to earn income. If he had settled on Captain
Bartholomew Roberts pirate ship The Rover, he and the other members of the
crew would have been required to consent to the ships written constitution. This
document (called The Rovers Articles) guaranteed, among other things, that:
Source: Leeson, P. 2007. An-Argh-Chy: The Law and Economics of Pirate Organization. Journal of Political
Economy, 115, pp. 1050-94.
The Rover and its Articles were not unusual. During the heyday of European piracy
in the late 17th and early 18th centuries most pirate ships had written constitutions
that guaranteed even more powers to the crew members. Their captains were
democratically elected, the Rank of Captain being obtained by the Suffrage of the
UNIT 5 | PROPERTY, CONTRACT AND POWER

Majority. Many captains were also voted out, at least one for cowardice in battle.
Crews also elected the quartermaster who, when the ship was not in a battle, could
countermand the captains orders.
If your ancestor had served as a lookout and had been the first to spot a ship that
was later taken as a prize, he would have received as a reward the best Pair of Pistols
on board, over and above his Dividend. Were he to have been seriously wounded in
battle, the articles guaranteed him compensation for the injury (more for the loss of
a right arm or leg than for the left). He would have worked as part of a multiracial,
multiethnic crew of which probably about a quarter were of African origin, and the
rest primarily of European descent, including Americans.
The result was that a pirate crew was often a close-knit group. A contemporary
observer lamented that the pirates were wickedly united, and articled
together. Sailors of captured merchant ships often happily joined the roguish
Commonwealth of their pirate captors.
Nowhere else in the world during the late 17th and early 18th century did ordinary
workers have the right to vote, or to compensation for occupational injuries, or to the
protection of the kinds of checks on arbitrary authority that were taken for granted
on The Rover.
Nor could workers in British textile mills and other industrial establishments claim
such a large share of income. The prize-sharing system described in The Rovers
articles, if faithfully implemented, would have resulted in a Gini coefficient (see
Unit 1 to recall how it is calculated) for the Dividend of approximately 0.05. A Gini
coefficient of 0 indicates perfect equality, and that a pie divided among two people
with a Gini coefficient of 0.05 would imply that the smaller piece was 47.5%, and
the larger only 52.5%. In contrast, when the Royal Navys ships Favourite and Active
captured the Spanish treasure ship La Hermione, the division of the spoils among
the captain, officers and crew of the two British men-of-war resulted in a Gini
coefficient of 0.65: about the same as the Gini coefficient for income in some of the
most unequal countries in the world today. By the standards of the day, pirates were
unusually democratic and fair-minded in their dealings with each other.
Another unhappy commentator remarked: These Men whom we term the Scandal
of human Nature, who were abandoned to all Vice were strictly just among
themselves.

5.1 INSTITUTIONS: THE RULES OF THE GAME
the rovers articles were part of the pirate institutions that determined who
did what aboard shipwhether your ancestor would serve as a lookout or as a
helmsman, for exampleand who would get what as a result of what each did, for
example the size of his dividend compared to that of the gunner. Other aspects of
their institutions were the unwritten informal rules of appropriate behaviour that the
pirates followed by custom, or to avoid condemnation by their crewmates.
In economics, institutions are the written and unwritten rules that govern both what
people do when they interact in a joint project, and the distribution of the products
of their joint effort. Using the terminology of game theory introduced in the previous
unit, we could say that The Rovers articles were the rules of the game, much as the
rules of the Ultimatum Game specify who can do what, when they can do it, and how
this determines each players payoff. The institutions provided both the constraints
(no drinking after 8pm unless on deck) and the incentives (the best pair of pistols for
the lookout who spotted a ship that was later taken). In this unit we use the terms
institutions and rules of the game interchangeably.
We have already seen that, in experiments, the rules of the game matter for how
the game is played, for the size of the total available to those participating, and for
how this total is divided. The institutionsthe rules of the Ultimatum Game for
exampledetermine who gets to be the Proposer; how much money the Proposer has
when the game starts; and the fact that the Responder can refuse any offer, resulting
in no payoffs for either player. In the standard Ultimatum Game, with a Proposer and
one Responder, recall that the total to be divided may be zero for both players if the
Responder refuses the Proposers offer. Or, if the Proposers the offer is accepted, the
Responders share is the amount that the Proposer offers to share, while the Proposer
gets what remains.
We also saw that changing the rules changes the outcome: if there are two
Responders in the Ultimatum Game rather than just one, the Proposer knows that
at least one of the Responders is likely to accept a low offer. Each Responder knows
this too. And because they cannot be sure that their rejecting a low offer will result in
the proposer will be punished (the other Responder may accept) Responders tend to
accept low offers they would have rejected as unfair had they been a sole Responder.
This means the Proposer has more bargaining power, and gets a larger payoff as a
result. We discover in Unit 7 that, when people must purchase goods from a single
business organisation, they have less bargaining power than when there are many
sellers.

In the Ultimatum Game (and in the economy) the division of the payoffs depends on
what is called bargaining power. A partys bargaining power is the extent of their
advantage when dividing the pie. The Proposer in the Ultimatum Game has the
fortunate position of making the offer, and so is likely to get at least half of the pie,
while the most the Responder is likely to get is half. Being the Proposer means having
more bargaining power; but the power is limited. The Proposers bargaining power is
limited by the need to get the Responder to accept the offer.
The Proposer could have even more than this take-it-or-leave-it power: the rules
might allow a Proposer simply to divide up the pie in any way, without any role
for the Responder other than to take whatever he gets (if anything). In this case
the Proposer has all of the bargaining power and the Responder none. There is an
experimental game like this, and it is called (you guessed it) the Dictator Game. The
past, and even the present, provide many examples of economic institutions that
are like the Dictator Game, in which there is no option to say no. Examples include
slavery as it existed in the US prior to the end of the American Civil War in 1864, or
todays remaining political dictatorships such as North Korea. Criminal organisations
involved in sex trafficking and drugs would be another modern example.
Units 1 and 2 showed that the pay people receive for their work depends on the rules
of the game as well as technology, and we will explore this further in subsequent
units. Remember from Unit 1 that, even though the amount that people produced
started to increase in Britain around the middle of the 17th century, it was not
until the middle of the 19th century that a combination of labour scarcity and new
institutions, such as trade unions and the extension of the vote to workers, gave wage
earners the bargaining power to raise wages substantially.
Rather than the isolated student or farmer studied in Unit 3, in this unit we continue
the studyintroduced in Unit 4of how people interact. But, instead of experiments
or history, we will explore a model of situations describing who produces what, who
gains from the process, and what they gain. Like the experiments we will see that
both cooperation and conflict occur: cooperation leading to a larger pie, and conflict
over how it is divided. As in the experiments, and in history, we will find that the
rules matter.
To do this we will return to the model in Unit 3 of the farmer who produces a crop.
Here we introduce a second person who would also like some of the harvest: the
owner of the land on which the farmer works.

5.2 MUTUAL GAINS AND CONFLICT: FEASIBLE OUTCOMES
recall that the farmer in Unit 3 cultivated land; and the harvest depended
on the amount of labour devoted to farming according to the production function.
The farmer now has a name: meet Angela. Angela has company. The farmer in Unit
3 had no economic dealings with anyone else; Unit 3s farmer worked the land,
enjoyed the remainder of the day as free time, and consumed the grain that this
activity produced. In the real world few individuals work on their own and can claim
everything they produce, because few people own the tools, land, or other capital
goods that they require in their work.
To study what happens in a more realistic case, meet Bart. Bart, not Angela, owns the
land. Bart has many parcels of land and is not interested in working the land himself.
If Angela works for Bart as an employee for a wage, or by paying a fixed rent, or
giving Bart a share of the crop, they will divide whatever Angela produces.
How many hours Angela works, how much she produces, and how much of this
output that she and Bart each get is (using the terms introduced in Unit 4) an
economic outcome, or an allocation resulting from their interaction. Recall from Unit
4 that there are two aspects to every allocation: the extent to which the possibility
of mutual gains are realised (is the allocation Pareto efficient?) and the distribution
of the gains from exchange (is the allocation fair?). Figure 1 shows Angela and Barts
combined feasible consumption frontier. The frontier indicates how many bushels
of grain Angela can produce given how much free time she takes. If Angela takes 12
hours free time and works for 12 hours then she produces ten bushels of grain. Point
E is a possible outcome of the interaction between Angela and Bart. The distribution
of grain at point E is such that five bushels go to Bart, and Angela retains the other
five for her own consumption.
DISCUSS 1: USING INDIFFERENCE CURVES

In Figure 1, point F shows an allocation in which Angela works more and gets less,
and point G shows the case in which she works more and gets more. Show how you
could use Angelas indifference curves (from Unit 3) to determine which of these
three points she prefers.
12
10
Bushels of grain
Total grain
produced
What
Bart gets
What
Angela gets
Feasible consumption
frontier: Angela and
Bart combined
H
12
0
Angelas free time
24
Angelas work
Angelas hours of free time
Figure 1. Mutual gains and conflicts over distribution.
INTERACT
Follow figures click-by-click in the full interactive version at www.core-econ.org.
To see how every economic interaction, and the distribution of the gains, among
people can be analysed from two standpoints, consider an example. When you sign
on to Amazon Mechanical Turk (LINK), the online marketplace for work, you may
select one of more than 400,000 human intelligence tasks, or HITs. The HITs are
offered by requesters, businesses and individuals looking for individuals to complete
tasks such as listing product preferences, writing product descriptions, choosing
preferred images, or even naming places that they honeymooned. Each HIT is
described, along with the qualifications required and the payment per selected task.
As a Mechanical Turk worker (a turker), you complete the HIT you have selected and
are then paid.
The allocation in this case is the time you spent, your product transferred to the
requester (the completion of the HIT), and your pay. Figure 2 compares the farming
model with Mechanical Turk.
EXTENT OF MUTUAL
GAINS REALISED
DISTRIBUTION OF
MUTUAL GAINS
FARMER
TURKER
Could both Angela and Bart

be better off if she worked
fewer or more hours?
Is there a redesign of the HIT,

the pay and other aspects so
that both the requester and
the turker could be better off?
Given her hours of work

and his ownership rights in
the land is the distribution
of grain and her working
time fair?
Is his ownership of the
land fair?
Is the pay a fair

compensation for the effort
and skills of the turker, given
the benefit to the requester
and their economic situation.
Figure 2. Mutual gains and conflict in farming and turking.
DISCUSS 2: ALLOCATIONS YOU HAVE KNOWN

Consider a job that you, or someone you know has done and identify the allocation
associated with this job and whether it was Pareto efficient and fair.
We study two aspects of the allocation resulting from Angelas interaction with Bart,
in two steps. First, we will determine the set of technically feasible combinations
of Angelas hours of work and the amount of grain she produces, and Angela and
Barts share of grain. By technically feasible we mean outcomes that are possible
if technology (the production function) and biology (Angelas need to get at
least enough nutrition to carry out the work tasks of the allocation and survive)
impose the only limits on what can occur. Then, in the next section, we ask how
the institutions governing their interaction determine which technically feasible
allocations actually occur.
How do we determine what is technically feasible? We know from the feasible
consumption frontier in Unit 3 that the total amount consumed by Bart and Angela
combined cannot exceed the amount produced and, as determined by the production
function, this depends on the hours that Angela works. Figure 1 shows the feasible
consumption frontier from Unit 3.

But, as we have just seen, there is another limit on what can happen. There are
some combinations of consumption of grain and free time that would leave Angela
so undernourished or overworked that she would not survive. So, for example, an
outcome in which Angela works 12 hours, Bart consumes the entire amount produced
and Angela consumes nothing (point H in Figure 1) is biologically infeasible.
Angelas minimum nutrition requirements depend on how much she works. In Figure
3 we show the minimum consumption that would allow Angela to survive for each
amount of work that she does. If she does not work at all, then she needs two bushels
to survive. If she expends energy working she needs more food; thats why the curve
is higher when she has fewer hours of free time. This is the biological feasibility
frontier. Points below it are biologically infeasible, while points above the feasible
consumption frontier are technically infeasible.
Angelas biological feasibility frontier
12
Bushels of grain
Technically
infeasible
Technically
feasible set
Biologically
infeasible
2
0
Bart combined
24
Minimum amount of work

Angela must do to survive
Maximum amount of work

Angela must do to survive
Figure 3. Technically feasible allocations.

Note that in the figure there is a minimum amount of work that Angela must do to
survive even if she can consume the entire crop. And, given the feasible consumption
frontier, there also is a maximum amount of work that would allow her barely to
survive, even if she could consume everything she produced.
As we saw in Unit 2, throughout human history people crossed the survival threshold
when the population outran the food supply. This is the logic of the Malthusian
population trap. The productivity of labour placed a limit on how large the
population could be.
In Angelas case, however, it is not only the limited productivity of her labour
that might jeopardise her survival, but rather how much of what she produces is
successfully claimed by Bart. To see the difference note in Figure 3 that, if Angela
could consume all of what she produced, (the height of the feasible consumption
10

frontier) and if she could choose her hours of work, her survival would not be in
jeopardy. The reason is that the biological feasibility frontier is below the feasible
consumption frontier for a great many hours of work and free time that she might
choose. The question of biological feasibility arises because of Barts claims on her
product.
In Figure 3, the feasible solutions to the allocation problem are bounded by the
feasible consumption frontier and the biological feasibility frontier (including
points on the frontier). This lens-shaped shaded area gives the technically possible
outcomes. We can now ask what actually happenswhich allocation occurs, and how
does this depend on the institutions governing how Bart and Angela interact?
DISCUSS 3: MORE ON THE MALTHUSIAN TRAP

Go back to Unit 2 and use the two frontiers in Figure 3 in this unit to explain how
the Malthusian Trap worked. Why was the feasible consumption frontier different
in Unit 2, compared to Figure 3 in this unit? Hint: youll have to shift the feasible
consumption frontier up and down as the amount of population per unit of land
changes.
5.3 INSTITUTIONS: PROPERTY, CONTRACT AND POWER
the second step in determining the allocation when Bart and Angela interact
depends on institutions. To understand how this works, we need to introduce four
terms: ownership, property, contract, and power.
Ownership means the right to use and exclude others from the use of something,
and the right to sell it (or to transfer these rights to others). A sign that tells you
No trespassing is an expression of ownership; another expression of ownership is a
copyright, which, among other things, excludes a musician from recording a tune for
the purpose of selling it without compensation to the songwriter. Property is what is
owned (the land, or the right to perform the song).
A contract is a legal document or understanding that specifies a set of actions that
the parties to the contract are to undertake. For example, a sale contract for a car
transfers ownership, meaning that the new owner can now use the car and exclude

others (including the former owner) from its use. A rental contract on an apartment
does not transfer ownership (which would include the right to sell the apartment);
instead it allows the tenant to engage in a limited set of uses of it including right to
exclude others (including the landlord) from its use.
Under a wage labour contract, an employee transfers to the employer the right
to direct him to be at work at specific times, and during those times to accept the
authority of the employer over the use of his time. The employer does not own the
employee as a result of this contract, unless the employee is a slave: we can say that
the employer has rented the employee for particular times of the day.
Power is the ability to do and get the things we want in opposition to the intentions
of others. The Proposers bargaining advantage in the Ultimatum Game is a form
of power. The Responder could instead have been the lucky one, having the power
associated with being Proposer, and going home with a half or more of the pie.
In experiments, the assignment of the role of Proposer or Responder, and hence
the distribution of bargaining power, is typically assigned by chance. But in real
economies the assignment of power is definitely not random.
Those who own a factory or other business are the ones proposing the wage and the
hours of work. Those seeking employment are like Responders, but with a difference:
typically more than one person is seeking to land a job, so if one of them rejects the
employers proposal the employer can move to the next potential worker, just as in
the Ultimatum Game when there are two Responders. We will see in the next unit
how the labour market, along with other institutions, gives power to employers. In
Unit 7 we explain how firms selling goods sometimes have the power to propose takeit-or-leave-it offers to consumers, and in Unit 11 how the credit market gives power to
banks and other lenders over people seeking mortgages and loans.
Power can be used in less subtle ways too. Perhaps the reason that Bart owns the land
rather than Angela is that Angelas family was displaced from the land by force. In
this case Bart gained his power to make take-it-or-leave-it offers due to his ownership
of the land, because he exercised a more overt form of power: physical coercion. But,
in a capitalist economy in a democratic society, most economic interactions are not
conducted at the point of a gun. They are usually the result of individuals pursuing
their objectives as best as they can (as in Unit 3) given the property and contracts
available to them, and given the power they exercise under the institutions of that
economy.
11

5.4 WHY PROPERTY, CONTRACT AND POWER MATTER
to see why institutions matter, we consider two extreme cases. In the first, Bart
allows Angela to work the land without payment (or perhaps the land is simply free
for the taking, as it was in many land abundant regions in the past, and Bart has not
yet arrived to claim ownership of it). What is the resulting allocation?
Recalling the analysis from Unit 3, Angela values both the grain produced and her
free time. The value that she places on free time and on grain depend on how much
of each she has, because of diminishing marginal utility. We represent these values,
as we did in Unit 3, as indifference curves, giving all of the combinations of grain and
free time for which she does not prefer one to the other. The feasible consumption
frontier is just the mirror of the production function, showing how much free time
and grain are jointly feasible given the productivity of an hour of her labour.
Angela is free to choose her typical hours of work, and the decision that gives her
the most preferred combination of free time and grain is point C in Figure 4 (which is
similar to Figure 9 in Unit 3). Recall that the slope of the indifference curve is called
the marginal rate of substitution between grain and free time and the slope of the
feasible consumption frontier is the marginal rate of transformation of free time into
grain. Figure 4 shows that the best Angela can do, given the limits set by the feasible
consumption frontier, is to work for six hours, giving her 18 hours of free time and
producing eight bushels of grain. This is the number of hours of work at which the
marginal rate of substitution is equal to the marginal rate of transformation. She
cannot do better than this! (If youre not sure why, go back to Unit 3 and check.)
Slope of feasible
= Marginal rate of
consumption frontier
transformation
Slope of
indifference curve
12
Bushels of grain
12
= Marginal rate of
substitution
At point C, marginal = Marginal rate of

rate of transformation
substitution
Angelas best feasible indifference curve
18
Angelas feasible
24
Figure 4. Farmer-owner Angelas feasible consumption frontier, best feasible indifference

curve and choice of hours of work.

The resulting allocation is:
6 hours of work
18 hours of free time
8 bushels of total output
Angela consumes 8 bushels
Bart consumes 0 bushels
Bart has plenty of other parcels of land, so we dont need to worry about his survival.
Now consider the other extreme. Bart has arrived heavily armed, and there is no one
to protect Angela from his threats of violence. It doesnt matter whether he owns
the land or not; he has the power to implement any allocation that he chooses. He
is the dictator in the Dictator Game. Unlike the experimental subjects in Unit 4 he
is entirely selfish. He wants only to maximise the amount of grain he can get from
Angela.
But because Bart thinks about the future, he will not take so much that Angela will
die. He has to impose some allocation that is biologically feasible. He has to choose
some point in the purple lens-shaped technically feasible set of allocations. But
which one?
Bart reasons like this:
For any number of hours that I order Angela to work, she will produce the amount
determined by the feasible consumption frontier of the production function (Figure
3). But for that amount of work Ill have to give her at least the amount shown by the
biological feasibility frontier. I get to keep the difference between what she produces
and what I need to give her, so that I can continue to exploit her. Therefore I should
find the hours of Angelas work for which the vertical distance between the feasible
consumption frontier and the biological feasibility frontier is the greatest.
The amount that Bart will get if he implements this strategy is called his economic
rent or his surplus, in this case meaning the amount he gets over what he would get if
Angela did no work at all, which in this case is zero. Economic rent here also means
the amount of the harvest that Bart requires Angela to give him, so it corresponds
to the everyday meaning of rent. But remember from Unit 2 that an economic rent is
any payment or other benefit that exceeds the next best option that the individual
has (in this case letting the land go fallow).
13

Bart first considers letting Angela continue working six hours a day, as she did
when she had free access to the land. At that time she produced eight bushels, as
shown by Figure 5. The distance between the feasible consumption frontier and the
biological feasibility frontier indicates that Bart could now take five of them without
jeopardising his future opportunities to benefit from Angelas labour.
Angelas biological
feasibility frontier
Bushels of grain
12
10
Bart combined
13
18
24
13
18
24
12
What Bart gets
14
6
5
Figure 5. Power and plunder. The maximum technically feasible transfer from Angela to
Bart.
Bart is studying Figure 5 and asks your help. You say:
Bart, your plan cannot be right. If you forced her to work a little more, you wouldnt
have to let her have much more grain because the biological feasibility frontier is
relatively flat at six hours of work. But the feasible consumption frontier is steep, so
while youd have to let her have a little more, shed produce a lot more if you imposed
longer hours.
You add:
You have to work out, for any length of working day that you impose, how much
grain you will get while making sure that Angela survives to be exploited next year.

You would present him with an updated version of Figure 5, which indicates that
the vertical distance between the feasible consumption frontier and the biological
feasibility frontier is the greatest when Angela works for 11 hours. If Bart commands
Angela to work for 11 hours then she will produce 10 bushels and Bart will get to keep
six of them for himself. We can use Figure 5 to find out how many bushels of grain
Bart will get for any technically feasible allocation. The grey arrows in the figure
show that the amount Bart gets falls as when Angela works for more or less than 11
hours. If we join up the points then we can see that the amount Bart gets is humpshaped, and peaks at 11 hours of work and 13 hours of free time.
How can you calculate Angelas hours of work to give Bart the greatest amount of
grain, consistent with Angela surviving? Find out how to do this mathematically in
EINSTEIN 1.
EINSTEIN 1
How can you figure out Angelas hours of work that gave Bart the greatest amount
of grain, consistent with Angela surviving? To the right of 13 hours (more free time
for Angela), the biological feasibility frontier is flatter than the feasible consumption
frontier. That means the marginal rate of transformation of hours of labour into
output is greater than the marginal rate of substitution of hours of labour into
subsistence nutrition requirements. So moving to the left (Angela working more)
results in an increase in production (her marginal product) that is greater than the
increase in her subsistence needs. So Angela working more increases Barts surplus,
which you recall is his economic rent. To the left of 13 hours of free time (Angela
working more), the reverse is true. Barts surplus is greatest at the hours of work
where the slopes of the two frontiers are equal. That is:
Marginal rate of
transformation of work hours
into grain output
Marginal rate of substitution

of work hours into subsistence
requirements
15
16

5.5 VOLUNTARY EXCHANGE: HOW THE MUTUAL GAINS ARE DIVIDED
we check back on Angela and Bart much later, and immediately notice that
Bart is no longer armed. He explains that this is no longer needed, as there now is
a government with laws administered by courts, and professional enforcers called
police. Bart now owns the land, and Angela must have permission to use his property.
He can offer a contract in which she can farm the land. In return she gives him part of
the harvest. Alternatively, she can refuse the offer.
It used to be a matter of power, Bart says, but now both Angela and I have property
rights: I own the land, and she owns her labour.
The new rules of the game, he adds, mean that I can no longer force Angela to
work. She has to agree to the allocation that I propose.
And if she doesnt?
There is no deal. She doesnt work on my land, I get nothing, and she gets barely
enough to survive from the government.
Just like the Ultimatum Game, you think.
So you and Angela have the same amount of power? you ask.
Certainly not! Bart replies, surprised, I am the one who gets to make a take-itor-leave-it offer. I am like the Proposer in the Ultimatum Game; except that this
is no game. If she refuses she goes hungry, and I have a plenty of grain from other
farmers.
But you get zero if she refuses?
That never happens, Bart assures you. Bart knows that if he makes an offer that
is just a tiny bit better for Angela than not working at all and getting subsistence
rations from the government, she will accept. So now he asks you a question similar
to the one he had asked earlier, and which you had answered by showing him the
biological feasibility frontier. Now the limitation is not that the offer is such that
Angela survives, but rather that she agrees.
Over years of interacting with Angela and people like her he knows that she values
her free time, so the more hours he offers her to work, the more he is going to have to
pay. Bart turns to you again, and you explain:

Why dont you just look at Angelas indifference curve that passes through the point
where she does not work at all and barely survives? That will tell you how much is the
least you can pay her for each of the hours of free time she would give up to work for
you.
Figure 6 shows this curve. Point O, the allocation in which Angela does no work
and gets only survival rations from the government (or from her family) is called
her reservation option: if she refuses Barts offer she has this option in reserve. The
curve giving all of the allocations that are just as highly valued by Angela as the
reservation option is called her reservation indifference curve: below or to the left of
the reservation indifference curve she is worse off than in her reservation option.
Above and to the right she is better off.
Angelas biological
Angelas reservation
indifference curve
Bushels of grain
12
Economically
feasible set
2
0
Bart combined
O: Angelas reservation option
24
Figure 6. Economically feasible allocations when exchange is voluntary.

The points in the area bounded by the reservation indifference curve and the
feasible consumption frontier (including the points on the frontiers) is the set of all
economically feasible allocations, once the principle has been accepted that in order
for it to be implemented, Angela has to agree to the proposal that Bart makes. Bart
thanks you for this handy new tool for figuring out the most he can get from Angela.
You remind him that what you showed him is exactly the same as the reservation
indifference curve of the farmer in Unit 3.
The biological feasibility frontier and the reservation indifference curve have a
common point (point O): Angela does no work and gets subsistence rations from the
government. Other than that the two curves differ: the reservation indifference curve
is uniformly above the biological feasibility frontier. The reason, you explain to Bart,
is that however hard she works along that frontier, she barely survives; and the more
she works the less free time she has, so the unhappier she is. Along the reservation
17
18

indifference curve, by contrast, she is just as well off as at her reservation option,
meaning that being able to keep more of the grain that she produces compensates
exactly for her lost free time.
DISCUSS 4: BIOLOGICAL FEASIBILITY

Explain why a point on the biological feasibility frontier is higher (more grain is
required) when Angela has fewer hours of free time. Why does it also get steeper as
she works more? Why is the shape of the two frontiers different for all except one
amount of Angelas free time?
We can see that both Angela and Bart may benefit if a deal can be made. The reason
is that their exchangeallowing her to use his land (that is, not using his property
right to exclude her) in return for her sharing some of what she producesmakes it
possible for both to be better off than if no deal had been struck. As long as Bart gets
some of the crop he will do better than if there is no deal. If there is no deal his land
lies fallow and he gets nothing, making his reservation option zero (as we have seen).
As long as Angelas share makes her better off than she would have been if she took
her reservation option, taking account of her work hours, she will be also benefit.
This potential for mutual gain is why their exchange need not take place at the
point of a gun, but can be motivated by the desire of both to be better off. All of the
economically feasible allocations that represent mutual gains are shaded dark purple
in Figure 6.
Of course the fact that mutual gains are possible does not mean that both Angela
and Bart will benefit. It all depends on the institutions in force. If Bart has the power
to make a take-it-or-leave-it offer, subject only to Angelas agreement, then he can
capture the entire surplus, leaving none for Angela. Bart knows this already.
Once you have explained the reservation indifference curve, Bart knows the take-itor-leave-it offer that he should make. For every possible level of work hours he might
require, he looks at the vertical distance between the reservation indifference curve
and the feasible consumption frontier, and finds the hours for which this distance is
the greatest. He uses a modified version of Figure 5, taking into account that Angela
has to agree to any proposal. In the economically feasible case Angela gets just
enough grain to compensate for the value of her foregone free time due to working.
Only Bart benefits from the exchange.
Angelas biological
Angelas reservation
indifference curve
12
Bushels of grain
Bart combined
13 15
24
What Bart gets
12
Technically
feasible
Economically
feasible
0
13 15
24
Figure 7. Barts take-it-or-leave-it proposal when exchange is voluntary.

Figure 7 shows that Bart should make an offer where Angela works for nine hours
and is allowed to keep whatever is left after Bart has taken five-and-a-half bushels
of grain. We can see that the amount of grain Bart gets falls as Angela works more
or less than nine hours. Again, if we join up the points we can see that the amount
Bart gets is hump-shaped. The peak is lower than when Bart has the power to order
Angela to work, because he needs Angela to agree to the proposal.
19
20
DISCUSS 5: TAKE IT OR LEAVE IT

Why is it Bart, and not Angela who is in a position to make a take-it-or-leave-it offer?
Are there conditions under which the farmer, not the landowner, might have this
power?
Suppose that Bart could not force Angela to work a particular number of hours
(because, for example, he lives far away, and cannot observe what she is doing). But
he can charge rent of a number of bushels for her use of the land. What rent will he
charge?
TEST YOUR UNDERSTANDING

Test yourself using multiple choice questions in the full interactive version at
www.core-econ.org.
Bart will choose the rent that maximises the amount of grain he gets, while taking
into account the fact that Angela will not accept any offer below her reservation
indifference curve. The maximum feasible rent is therefore five-and-a-half bushels
of grain, which is equal to the maximum amount of grain Bart can get when
exchange is voluntary (see Figure 7). The imposition of maximum rent by Bart is
shown by the downward shift of the feasible consumption frontier in Figure 8. Point
A, where Angela is working for nine hours, is the best that she can do when Bart is
charging maximum rent. At this point she is on her reservation indifference curve,
so is indifferent between accepting the offer and refusing the offer and living on
government rations.We will suppose that Bart charges a tiny bit less rent than this, so
she accepts.
Angelas reservation
indifference curve
Bushels of grain
12
Bart combined
6.5
A
3.75

0
Barts maximum
economically
feasible rent = 5.5
Point A is the best that

Angela can do when Bart
charges the maximum rent
15
24
Angelas feasible
after paying maximum rent
Figure 8. Barts maximum feasible rent, and the best Angela can do when he charges it.
DISCUSS 6: ANGELAS HOURS OF WORK

In Figure 8, we show that the best Angela can do when Bart imposes maximum rent
is to work for nine hours. Would she be willing to work any other number of hours
when maximum rent is charged?
5.6 SHARING THE MUTUAL GAINS FROM EXCHANGE
bart thinks that the new rules, requiring him to make an offer that Angela will
not refuse, are not so bad after all. Angela too is better off than she had been when
she had barely enough to survive. The reason is that, under the old rules, she had no
choice but to accept whatever allocation proposal Bart imposed, even if he made her
worse off than when she did no work at all.
21

But she is not pleased, because Bart is capturing all of the gains from exchange. She
would like to benefit too. Although it stretches the meaning of mutual in this case, as
a matter of definition we say that there are mutual gains from exchange, because Bart
benefits and Angela is no worse off.
It does not feel very mutual to her. She and her fellow farm workers agitate for a new
law that limits the work time that can be imposed to four hours a day, while requiring
that total pay is at least three bushels. They threaten to not work at all unless the law
is passed.
Bart says that they are bluffing. Angela makes it clear they are not.
Bart, we would be no worse off at our reservation option than under your contract,
working the hours and receiving the small fraction of the harvest that you impose!
They campaign, inspired by the slogan of the early American labour movement: Eight
hours for sleep, eight hours for play, eight hours for work, eight dollars a day! They win,
and the new law imposes even more leisure time, and limits her working day to four
hours.
How did things work out?
Angela was working for nine hours and getting 3.75 bushels of grain before the new
law (when Bart was charging maximum rent); see point A in Figure 9. The new law
implements the allocation at point D: Angela and her friends now work four hours,
getting 20 hours of free time as a result and three bushels. Although they receive less
grain, they have five more hours of free time, which, given their preferences, more
than compensates for the lower amount of grain. You can see that Angela is better off
at D than at A (Angelas indifference curve through point D is above and to the right
of her indifference curve through point A).
Point B is the Pareto efficient

outcome (better than D for
Angela; not worse than D for Bart)
12
Bushels of grain
22
3 = what
Bart gets
3 = what
Angela gets
6
5.25
B
B'
3.75
3
0
Point D is a Pareto inefficient

outcome (resulting from the new
legislation)
15 16
20
IC3
IC2
IC1
24
Figure 9. Angelas revenge. The effect of legislation.
Vertical distance between IC1 and

IC2 is a measure of how much
better off Angela is, measured in
grain, under the new legislation
Barts rent anywhere on the
feasible consumption frontier
passing through point D

What did the law change? Angela and her friends are now benefitting from the
exchange. They are better off under the new rules of the game than they had been
before. More important: they are better off than they would be if they could not work
for Bart. They are better off than they would be with their reservation option , which
means they are now receiving an economic rent. Note that we are using the term
rent in the way we defined it above, and in Unit 2. Unlike when we used the term to
refer to Bart, its use here is quite different from the everyday use of the word. Bart
is not paying Angela a rent in the usual sense of the word (or any other sense).The
size of Angelas rent is how much better off she is at the new situation than at her
reservation option. One measure of how much better off she is, measured in grain, is
the vertical distance between her reservation indifference curve and the indifference
curve she is able to achieve under the new legislation. In Figure 9, this is the vertical
distance between indifference curves IC1 and IC2.
Another way to describe Angelas part of the gains from exchange is that its the
maximum amount of grain per year that Angela would give up to live under the
new law rather than in the situation before the law was passed. Or, because Angela
is obviously political, it is the amount she would be willing to pay (lobbying the
legislature, contributing to election campaigns and the like) so that the law passed.
Bart is not happy. You try to cheer him up:
Next time they threaten to quit working, saying they have nothing to lose, they
really will be bluffing. They have their economic rent to lose. Remember, Bart,
Angelas economic rent is for her the opportunity cost of telling you to get lost: now
she will not be tempted to walk away.
Bart can see that this rent will be useful later. We will return to it in the next unit,
and later in the course.
5.7 EFFICIENT AND FAIR ALLOCATIONS
angela and her friends are pleased with their success. She asks what you think
of the new policy. This time, you say:
Congratulations, but your policy is far from the best you could do.
You lay out Plan B.
Under your new law, Bart is getting three bushels and cannot make you work more
than four hours.
23
24

Why dont you offer to pay him the three bushels that he is now getting, in exchange
for agreeing to let you keep anything you produce above the three bushels you have
given to him? Then you get to choose how many hours you work.
You can now redraw Figure 9, explaining that, after paying Bart three bushels in rent,
Angelas feasible consumption frontier is just like the earlier feasible consumption
frontier for the two togetherexcept that it is shifted down by the amount of the
rent, which in this case is equal to three bushels. Now, because she has already paid
Bart, it refers to her feasible consumption only.
You show her the new figure with the downshifted feasible consumption frontier
passing through point D. Under Plan B, you can have any point on the frontier, you
explain.
Although Angela values having more free time, she can see that, because the feasible
consumption frontier is steeper than her indifference curve at point D, it would
not make sense to work less; the increase in free time would be more than offset by
the reduction in grain she would get. But if she works longer hours she can get to a
higher indifference curve and be better off.
What is the best you can do, given what is now feasible, as indicated by the
feasible consumption frontier after paying rent to Bart? you ask Angela. She now
understands how the figure works and puts her finger on point B in Figure 9.
Seeing that Bart will otherwise have to learn to live with point D, changing to B would
be no worse for Bart, and if she conceded just a little more rent than three bushels,
then it would be better for both of them.
Before the legislation to limit working hours Angela considered the distribution
to be unfair, but this outcome did have a desirable property: there was no feasible
alternative allocation in which both parties would have been better off. Recall from
Unit 4 that an allocation that has this property is termed Pareto efficient. The outcome
was Pareto efficient because Bart alone was benefitting from the exchange and, as a
result, he made sure to benefit as much as he could.
Making Angela better off (if she worked a different number of hours, or Bart allowed
her more of the harvest) would make Bart worse off.
Is the new law Pareto efficient? No, because Angela could be made better off without
making Bart worse off: point D is Pareto inefficient. Point B, on the other hand, like
point A is a Pareto efficient outcome. Any change from point B that makes Bart better
offAngela working the same hours and keeping less of the grain, or keeping the
same amount and working more hours, for examplewould make Angela worse off.
And correspondingly, anything that would make Angela better off would make Bart
worse off.
DISCUSS 7: PARETO EFFICIENCY

Test Pareto efficiency: indicate two points in Figure 9 at which Bart would be better
off than at point B, and using Angelas indifference curves show why Angela would be
worse off as a result. Do the same for two changes that would make Angela better off
and show that they would make Bart worse off.
We have already seen another Pareto efficient outcome. It was the initial allocation
that resulted when Angela had free use of the land. Go back to Figure 4. When
Angela worked six hours, and received the whole harvest of eight bushels she was
doing the best she could under the constraints of the technology available (and the
free use of the land). Bart, however, got nothing. Is there an allocation that could
have made both Bart and Angela better off than under this outcome (or made one of
them better off and the other not less well off)? The answer is no, because Angela had
already chosen the allocation that she preferred, so any change (including giving Bart
some of the harvest) would make her worse off. So the outcome was Pareto efficient.
This is of course just the mirror image of the Pareto efficient outcome that resulted
when Bart had enough bargaining power to choose the allocation, subject only to the
limitation that Angela had to agree to it.
You can see that Pareto efficiency is only distantly related to the usual way that
the term efficiency is used. When we talk of a way of doing something as efficient
it means a reasonable or sensible means to some end. Something can be Pareto
efficient, however, and seem far from reasonable or sensible. If Angela and Bart were
dividing the pie discussed in Unit 1, then any way the pie was divided would be Pareto
efficient, including Angela getting none of it, or all of it. The only thing that Pareto
efficiency requires is that they not simply throw away some of the pie.
Figure 10 shows the three Pareto efficient points that we have discussed so far. What
they have in common is that at each allocation one of Angelas indifference curves
is tangent to her feasible consumption frontier, meaning that her marginal rate of
substitution (the slope of her indifference curve) is equal to her marginal rate of
transformation of free time into grain (the slope of her feasible consumption frontier
after the payment of rent to Bart). They differ, of course, in how well-off each of
them are. At point A, Bart alone experiences gains from exchange (compared to the
reservation option in which Angela does not work his land at all). At point C the
opposite is true and Angela is experiencing all the gains from trade. At point B, both
Angela and Bart experience gains from exchange. LEIBNIZ 7 shows you how to find
Pareto efficient allocations using calculus, when the utility function and the feasible
consumption frontier are expressed algebraically.
25

At point A, Bart experiences all
the gains from trade
Angelas reservation
indifference curve
At point B, Angela and Bart

share the gains from trade
12
Bushels of grain
26
8
B
5.25
3.75
At point C, Angela experiences

all the gains from trade
Angelas best feasible indifference

curve when she pays no rent
A
0
Barts
lesser rent
15 16 18
24
Barts
maximum
rent
Figure 10. Pareto efficient allocations with differing distributions of the gains from
exchange.
LEIBNIZ
For mathematical derivations of key concepts, download the Leibniz boxes from
www.core-econ.org.
Outcomes in which gains from exchange are shared rather than monopolised by
one or the other party seem fairer; and being win-win they are easier to implement,
either by agreements of the kind that Angela has proposed to Bart, or by government
policy. The move from point A (at which Bart had all the bargaining power and alone
experienced gains from exchange) to point B, with shared gains, consists of two
distinct steps. The first is from A to D, the outcome imposed by Angelas legislation.
This was definitely not win-win: Bart lost because his rent at D is less than the
maximum feasible rent that he got at A. Angela benefitted.
Once at the legislated outcome, there were many win-win possibilities open to them.
They are shown in the purple shaded area in Figure 9. Win-win alternatives to the
allocation at D are possible by definition, because D was not Pareto efficient.
Bart is open to a deal, but is not happy with Angelas proposal.

I am no better off under your proposed Plan B than I would be just living under that
legislation that you passed, he says.
You can help if you persuade Bart to accept the fact that, as a result of the legislation,
Angela now has bargaining power, too.
What has happened because of the legislation is that Angelas reservation option
is no longer 24 hours of free time at survival rations. Her reservation option is the
legislated allocation at point D.
Bart already knows he has to learn to live with Angelas new bargaining power. He
makes a counter offer. Ill let you work the land for as many hours as you choose if
you pay me four and a half bushels. They shake hands.
Because Angela is free to choose her work hours, subject only to paying Bart the rent
of four and a half bushels, she will seek to find the highest indifference curve that
she can attain, resulting in an allocation, point B in Figure 9, that is Pareto efficient.
DISCUSS 8: NEGOTIATING A PARETO EFFICIENT ALLOCATION

Explain, using Figure 9, why point B is better for both Bart and Angela than point D.
Explain how you know that B is Pareto efficient.
There are many other such Pareto efficient outcomes with shared gains compared
to the initial reservation options prior to the legislation; some favour Angela, some
favour Bart. In Figure 11 we compare the allocations A, B, C, and D in Figures 9 and
10.
27
28

POINT A
POINT B
POINT C
POINT D
Bart owns the

land and gives
Angela a takeit-or-leave-it
offer
Angela pays a
3-bushel rent to
Bart and chooses
her hours of work
Angela has free

use of the land
Angela passes
a labour law
ANGELAS
HOURS OF WORK
ANGELA'S SHARE
(BUSHELS)
3.75
5.25
BART'S SHARE
(BUSHELS)
5.5
PARETO
EFFICIENT?
Yes
Yes
Yes
No
No (Bart gains,
Angela does
not)
Yes
No (Angela
gains, Bart
does not)
Yes
WHAT
HAPPENS?
GAINS SHARED
(COMPARED
TO POINT O)
Figure 11. Pareto efficiency and shared gains from exchange as aspects of economic
outcomes, and the institutions that support them.
There are three lessons here, to which we will return when we discuss policies to try
to implement Pareto efficient outcomes with distributions that are considered to be
fair by most people. The first is that when one person or group has power to dictate
the allocation, subject only to not making the other party worse off than in their
reservation option, the powerful party will capture all of the gains from exchange.
They will implement an allocation that makes their gains as large as possible, subject
only to the other party not being worse off than with no exchange at all. If they have
done this, then there cannot be any way to make either of them better off without
making the other worse off. So the result must be Pareto efficient.
The second lesson is that those who consider their treatment unfair often have some
power to influence the outcome through legislation and other political means, and
the result may be a more fair distribution, but one that is not necessarily Pareto
efficient. So societies may face trade-offs between Pareto efficient but unfair
outcomes, and fair but Pareto inefficient outcomes.
Finally, if we have institutions under which people can jointly deliberate, agree on,
and enforce alternative allocations then there may be outcomes that make both
parties better off, and that are also more fair than the status quo. Angela and Bart
managed this. Starting from a very uneven distribution of the benefits of exchange
(only Bart benefitted) legislation was passed increasing Angelas bargaining power,
and then the two agreed on a win-win outcome that was Pareto efficient. In this case
a society need not accept the trade-off between Pareto efficiency and fairness.
DISCUSS 9: LOVE CONQUERS ALL

Suppose (improbably) that Angela and Bart fall in love and marry; but as a
thoroughly modern couple they decide to keep their economic matters separate, at
least as far as bookkeeping is concerned. As before, Bart cannot work on the land.
1. Which allocation do you think they would implement?
2. Does evidence from the economic experiments in the previous unit give you any
clues?
5.8 CONCLUSION
when the pirates on Captain Roberts The Rover agreed unanimously to a

constitution, they accepted a set of rules of the gamethat is institutions
that would determine who did what on the ship and how the spoils were to be
divided. The same is true of the terms proposed by requesters, and agreed to by the
turkers, who proofread texts or evaluate the attractiveness of images in the online
marketplace for work.
When two or more people voluntarily come together to undertake a common project,
whether pirates, turkers, or Angela farming Barts land when Barts proposed terms
were at least minimally acceptable to Angela, their cooperation results in the
possibility of mutual gains from exchange. They are potentially both better off having
engaged in a common project than they would have been otherwise, when they gain
only their reservation utility.
The same is true when people directly exchange, or buy and sell, goods for money. If
you have more apples than you can consume, and your neighbour has an abundance
of pears, the same logic applies. The apples are worth less to you than they are to
your neighbour, and the pears are worth more to you. So there must be some rate of
exchange under which you are happy to exchange some apples for some pears.
The same logic applies to apples and pears, land and labour, or the requesters need
for a human intelligence task to be completed by would-be turkers with time on their
hands. When people with differing needs, property and capacities meet, there is an
opportunity to generate mutual gains, so that all parties can potentially benefit. That
29
30

is why people often like to come together in markets, online exchanges and pirate
ships. The mutual gains are the pie. For the most part, however, people engage in
these projects not for the pie, but for their slice.
Whether they are able to mutually benefit depends on technology and biology. If
Barts land had been so unproductive that no amount of labour would have produced
enough to compensate Angela for her time, then there would have been no deal
that they could strike. Mechanical Turk is possible because people around the world
(many of them with abundant free time and little income) can work on the projects of
comparatively rich, but busy, requesters in the US.
Among the set of allocations that are technically feasible, the ones that we observe
through history are largely the result of the institutions, including property rights
and bargaining power, that were (or are) present in the economy. The institutions
answer two questions. The first is: who does what, so that mutual gains are possible?
The second is about distribution: who gets what, or how are the mutual gains
distributed among the parties to the exchange? A summary of these points appears in
Figure 12.
PREFERENCES
Bargaining power
INSTITUTIONS
Reservation options
Economically
feasible allocations
BIOLOGY
Allocation
(outcome): who
does what &
who gets what
Technically feasible
allocations
TECHNOLOGY
Figure 12. Institutions, mutually beneficial interactions and distribution.

Aside from the government and families, the most important institutions of a
modern economy are markets and firms. In the next unit, we study how firms
(business organisations) address questions of allocation. We need to know how they
work, and how well they work.
In the units that follow we study markets. Some have single firms selling to many
buyers, others have large number of buyers and sellers. We investigate how they
may implement allocations that allow mutual gains from exchange, and how they
influence how those gains are distributed among buyers, sellers, and others. We

also study the combination of markets and firms that make up the modern capitalist
economy, and ask how successfully this set of institutions allows for Pareto efficient
allocations and fair distributions. In later chapters we will ask what we can do to
make the results more nearly Pareto efficientand more fair.
UNIT 5 KEY POINTS
1. There are technological and biological limits on the economic outcomes that can
occur.
2. Every economic interaction results in an outcome (allocation) with two aspects: the
extent to which potential mutual gains are full exploited, and the distribution of
these gains compared to a situation in which the interaction had not occurred.
3. Private ownership (property) is the right to use and to exclude others from the use of
something, including the right to sell it.
4. For any particular interaction, a persons reservation option is what that person
would get if the interaction did not take place.
5. Those with better reservation options and those with more power typically get more
in the resulting allocation.
6. Institutions, including the ownership of private property and government, are an
important influence on both the efficiency and the fairness of allocations.
7. When an allocation is not Pareto efficient, it may be possible either for government
policies or private bargaining to introduce win-win policies that improve the
wellbeing of most parties.
31
32
UNIT 5: READ MORE

INTRODUCTION
The law and economics of piracy
Modern-day pirates in the Indian Ocean also use constitutions, though much less
equitable than that of The Rover: LINK.
The Economist. 2013. More sophisticated than you thought, 13 October.
To find out more about 17th and 18th century pirate captains of European descent like
Roberts, read Leesons article (and book): LINK.
Leeson, P. 2007. An-Argh-Chy: The Law and Economics of Pirate Organization. Journal of
Political Economy, 115, pp. 1050-94.
The Invisible Hook: The Hidden Economics of Pirates. Princeton: Princeton University
Press.
At the same time Chinese pirates, including the famous woman pirate commander
Ching Shih, operated on a grand scale, and also used constitutions.
Murray, D. 1987. Pirates of the South China Coast, 1790-1810. Stanford, California: Stanford
University Press.
MORE
Institutions and their long-term effects
Dell, M. 2010. The Persistent Effect of Perus Mining Mita. Econometrica, 78, pp. 1863-903.
Institutions in the New World: LINK
Sokoloff, K. and Engerman, S. 2000. Institutions, Factor Endowments, and Paths of
Development in the New World. Journal of Economic Perspectives, 14(3), pp. 217-32.
Institutions and the path to the modern economy
Greif, A. 2006. Institutions and the Path to the Modern Economy: Lessons from Medieval
Trade. Cambridge: Cambridge University Press.
The birth of impersonal exchange: LINK
Greif, A, 2006. The birth of Impersonal Exchange: the Community Responsibility System
and Impartial Justice, Journal of Economic Perspectives 20(2). pp. 221-236.
Property Rights
Alchian, A. 1987. Property Rights. J. Eatwell, M. Millgate and P. Millgate, The New
Palgrave. London: Macmillan, pp. 1031-34.

Power as an economic concept
Bowles, S and Gintis, H. 2007. Power. S. Durlauf and L. Blume, The New Palgrave
Encyclopedia of Economics. London: McMillan.
Division of the pie: A historical case
Hobsbawm, E. and Rude, G. 1968. Captain Swing. New York: Pantheon.
The effects of labour conf lict in producing defective tyres
Krueger, A. and Mas, A. 2004. Strikes, Scabs, and Tread Separation: Labor Strife and the
Production of Defective Bridgestone/Firestone Tires. Journal of Political Economy, 112(2),
pp. 253-89.
Ravenswood: The steelworkers victory
Juravich, T. and Bronfenbrenner, K. 1999. Ravenswood: The Steelworkers Victory and the
Revival of American Labor. Ithaca: Cornell University Press.
This work is licensed under the Creative Commons Attribution-NonCommercialNoDerivatives 4.0 International License. To view a copy of this license, visit http://
creativecommons.org/licenses/by-nc-nd/4.0/ or send a letter to Creative Commons,
444 Castro Street, Suite 900, Mountain View, California, 94041, USA.
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Mr and Mrs Andrews, Thomas Gainsborough, 1750, National Gallery

HOW INSTITUTIONS INFLUENCE THE BALANCE OF POWER BETWEEN

How technology and biology limit what is economically feasible.

How the concept of Pareto efficiency can be applied to economic interactions

coreecon | Curriculum Open-access Resources in Economics

UNIT 5 | PROPERTY, CONTRACT AND POWER

coreecon | Curriculum Open-access Resources in Economics

UNIT 5 | PROPERTY, CONTRACT AND POWER

coreecon | Curriculum Open-access Resources in Economics

DISCUSS 1: USING INDIFFERENCE CURVES

UNIT 5 | PROPERTY, CONTRACT AND POWER

Angelas hours of free time

Figure 1. Mutual gains and conflicts over distribution.

coreecon | Curriculum Open-access Resources in Economics

Could both Angela and Bart

Is there a redesign of the HIT,

Given her hours of work

Is the pay a fair

Figure 2. Mutual gains and conflict in farming and turking.

DISCUSS 2: ALLOCATIONS YOU HAVE KNOWN

UNIT 5 | PROPERTY, CONTRACT AND POWER

Minimum amount of work

Maximum amount of work

Angelas hours of free time

Figure 3. Technically feasible allocations.

coreecon | Curriculum Open-access Resources in Economics

DISCUSS 3: MORE ON THE MALTHUSIAN TRAP

5.3 INSTITUTIONS: PROPERTY, CONTRACT AND POWER

UNIT 5 | PROPERTY, CONTRACT AND POWER

coreecon | Curriculum Open-access Resources in Economics

At point C, marginal = Marginal rate of

Figure 4. Farmer-owner Angelas feasible consumption frontier, best feasible indifference

UNIT 5 | PROPERTY, CONTRACT AND POWER

18 hours of free time

8 bushels of total output

Angela consumes 8 bushels

Bart consumes 0 bushels

coreecon | Curriculum Open-access Resources in Economics

What Bart gets

Angelas hours of free time

UNIT 5 | PROPERTY, CONTRACT AND POWER

Marginal rate of substitution

coreecon | Curriculum Open-access Resources in Economics

UNIT 5 | PROPERTY, CONTRACT AND POWER

Angelas hours of free time

Figure 6. Economically feasible allocations when exchange is voluntary.

coreecon | Curriculum Open-access Resources in Economics

DISCUSS 4: BIOLOGICAL FEASIBILITY

UNIT 5 | PROPERTY, CONTRACT AND POWER

What Bart gets

Angelas hours of free time

Figure 7. Barts take-it-or-leave-it proposal when exchange is voluntary.

coreecon | Curriculum Open-access Resources in Economics

DISCUSS 5: TAKE IT OR LEAVE IT

TEST YOUR UNDERSTANDING

UNIT 5 | PROPERTY, CONTRACT AND POWER

O: Angelas reservation option

Point A is the best that

Angelas hours of free time

DISCUSS 6: ANGELAS HOURS OF WORK