Property rights in a market system | Basic Economic Concepts | AP(R) Microeconomics | Khan Academy

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.

It's just the idea that everyone agrees on who owns what and what they can do with that property. 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. If they were to sell that house, we know 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 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 you then, than the market value, otherwise we're going to hurt you in some way."

So, in some ways, they're infringing on those property rights. Or the government might just come in and say, "We're going to take that property from you because we want it." In those situations, property rights would be weakened.

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. So let's stick with the house analogy.

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 at the top, and let's say it's owned by something like this.

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. So there's a market of potential buyers. Let me draw the buyers right over here. 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.

Whoever is willing to pay the most for that blue house will get it. Let's say that this person is willing to pay—I'll just say—one dollar sign for the house. The ownership of the house will go to that person. Same thing for the pink houses. Maybe this person right over here is the one 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.

Then they will get title to the house. Maybe a ton of people are really interested in these arched houses, and maybe they bid for it. The bidding keeps going higher and higher and higher. This person wins at the end, and they have to pay up a lot for that orange house, and then they get title for it.

Let's just assume that for whatever reason, they're all about the same cost to build. Well, what would happen in this market then? Home builders, or even people who own 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. In fact, they're all price signals, and when you take them together, you're saying, "Hey, I get more for an orange house than a blue house." So maybe if they all cost the same to build, we'll start producing more of these orange houses. The builders will produce more of these orange houses, and maybe some people might remodel their blue houses to have these orange arches on them.

You could imagine that might happen from that 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. 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 they want to sell this house, these people are like, "Is it really your house?" 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." Then this person says, "Um, I have a lot of guns, and I don't care what you 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? 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. So then in this market, people will say, "Oh, maybe we'll build more of the arched orange houses because that's what the market demands." You can quickly see that when property rights break down, the market system breaks down.

The market system is all about people using a 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. This breakdown would often be characterized as a market failure.

Now you could say, "Okay, there are other types of systems that we talked about in other videos. We talk about command economies, and in the extreme, in a command economy, you have no profit, you have no private ownership of things."

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.

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 gets it by the government, there's very little incentive to try to innovate, to try to build more, to invest, or whatever else. We talk about that in other videos, so I will let you go there.

This is just the 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.