The Department of Economics Theory, History and Development Seminar Series presents

"Efficiency and Property Rights in Land Assembly: Mechanism Design and Experiments"
Zachary Grossman, Assistant Professor of Economics, UC Santa Barbara

Monday, October 22, 2012
3:30-5:00 p.m.
Social Science Plaza B, Room 3266 (Econ Library)

Land can be inefficiently allocated when attempts to assemble separately-owned pieces of land into large parcels are frustrated by holdout landowners. The existing land-assembly institution of eminent domain can be used neither to gauge efficiency nor to determine how to compensate displaced owners adequately. In this talk, Grossman takes a mechanism-design approach to the assembly problem, formalizing it as a multilateral trade environment with perfectly complementary goods. He characterizes the least-inefficient direct mechanism that is incentive compatible, self-financing, protects the property-rights of participants, and does not assume that participants have useful information about the subjective valuations of others. The second-best mechanism, which he calls the Strong Pareto (SP) mechanism, utilizes a second-price auction among interested buyers, with a reserve sufficient to compensate fully all potential sellers, who are paid according to fixed and exhaustive shares of the winning buyer's offer. It may also internalize local externalities. While the SP mechanism only approves efficient sales, efficiency is not sufficient for sale---even with competitive bidding---because the auction reserve may exceed the aggregate seller valuation. The inefficiency of the second-best mechanism implies a Myserson-Satterthwaite (1981)-style impossibility theorem. He proposes a criterion that encompasses concern for both efficiency and the rights of property owners to evaluate the relative performance of assembly mechanisms and the efficiency cost of strict adherence to individual rationality. In a simple example, he compares the expected outcome of the SP mechanism with two alternatives: a plurality mechanism based on SP, but with a lower reserve that is only high enough to fully compensate a plurality of owners and a stylized model of eminent domain.

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