Bounded Rationality and the Theory of Property

Strong, property rule protection – implemented via injunctions, criminal sanctions and supercomepnsatory damages – is a defining aspect of property. What is the theoretical justification for property rule protection? The conventional answer has to do with the alleged shortcomings of the weaker, liability rule alternative: It is widely held that liability rule protection – implemented via compensatory damages – would interfere with efficient exchange and jeopardize the market system. We show that these concerns are overstated and that exchange efficiency generally obtains in a liability rule regime. But only when the parties are perfectly rational. When the standard rationality assumption is replaced with a more realistic, bounded rationality assumption, liability rules no longer support exchange efficiency. Bounded rationality thus emerges as a foundational element in the theory of property.