Bounded Rationality and the Theory of Property

Strong, property rule protection—implemented via injunctions, criminal sanctions, and supercompensatory 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