Here is the story. I have an object X that I wish to assign (gift or give away) to one of three: A, B, or C. How do I determine whom to give it to if I am concerned about allocative efficiency? Assume that A, B, and C have different preferences and abilities to pay.
To put a nice twist to the story, what if I am also concerned about equity? That is, although I have only one object X, I don’t want to be unfair to the other two who will not get the object X. What is the best way—the mechanism—to resolve this issue?
Of course, the answer changes if I don’t wish to give more than just the object X, as opposed to the case where I am willing to give more than X just for the sake of being fair to all three.
Finally, a real world situation. My siblings and I have inherited our parents’ property. The eldest occupies it, but the other three (including me), are waiting for our share. What is the most economically efficient way to distribute the value of the property if the property itself is indivisible?
Your views are solicited. Let’s see if we can find answers to the questions that we find satisfactory. And if we do, perhaps we will understand a little more about the question of how economies work. That is the beauty of economics. From seemingly trivial—though interesting—questions, one can gain insight into larger questions.
POST SCRIPT: I made the mistake of putting two entirely different scenarios on the same post. So there is much confusion. I wish to clarify that the “efficient allocation of an object X” is a seperate matter from the “fair and efficient distribution of an indivisible inherited property.” Conflating the two was not my intention.
Atanu Dey : Life is a Random Draw 
Since the eldest occupies, he/she can continue to occupy it. The rest can sell their share to that person. A fly in the soup is if the eldest took care of your parents in their old age. If they wanted to take care of your parents, fine, but if they sacrificied professional growth, increased income and or time and energy, the right thing would be to sell back your share of the property at a reduced price. But all this needs to be amicable but inheritance matters can get ugly FAST. All inheritance matters are best sorted while parents are in their senses. Another reason to sort it out early is that if you inherit a property, you can take part by part over 8-10 years to reduce your tax burden/estate tax(not sure if this applicable in India but it is so in the US)
If this already a simmering issue among your siblings, best would to sit down and solve it as soon as possible. My father’s siblings have been embroiled in an inheritance dispute for 15 years. Has pretty much ended all civility among them. Sad.
LikeLike
The parents can divide the house ( not literally) into parts and give it to the deserving siblings. The siblings will then figure out what is good for them. They will then decide to trade the parts among themselves or with a third party.
LikeLike
You could demolish the existing house and build 3 identical apartments and take one each. If you decide to sell your share, you can easily dispose it w/o complications
LikeLike
The eldest sibling vacates the house and the house is rented out to an outsider. The rent is then shared equally among the four of you. The house can be sold to an outsider or one of you when all four are in agreement of time and price.
The “sell their share” idea may not be feasible since no one sibling may be able to afford it right now.
The “division of the house” idea may or may not work depending on the way the house is built i.e. there may not be an equal distribution possible.
The “demolish and build apartments” idea means that you lose out on the potential increase in value of the house over time.
LikeLike
A fair solution to the inheritance problem would be to rent out the premises, and share the rent between four siblings. The intial deposit could be shared as well. with the condition of each person chipping an equal amount when the tenant leaves. If the eldest sibling is unwilling to move out, he or she would have to pay rent to the other three based on the valuation of the property.
LikeLike
All five comments so far have been about the division of inherited property. No one has even touched the other problem of how to decide among three who gets X. This is the more interesting question.
The first comment (by M) correctly notes a near universal condition: property disputes do become nasty. At times it gets so nasty that parties acquire weapons of mass destruction to sort out the issue. Fighting is economically wasteful. If the property rights were “well-defined,” and there is a way to enforce those rights, there will be less waste.
Well-defined property rights and enforcement mechanism reduce transaction costs. And at the end of the day, it is transaction costs all the way. People blackmailing others by threatening to starve themselves to death (mahatma mamata) adds sand to the wheels of industry. Industry produce stuff, which means income, which means less poverty.
Capriguy’s solution is elegant. I have seen it done before. Demolishing the old house and building a set of identical apartments has the advantage of upgrading the improvements on the land. If any of the inheritors cannot afford to pay for a new apartment, then the solution is to sell their share to a third party.
I don’t think the renting out the property qualifies as a solution since the problem has been defined such that the property has to be divided. For instance, it could be that if I get my share in cash, I would invest it elsewhere.
I am still waiting for someone to address the more interesting question: how do I decide whom to give X to?
LikeLike
Am assuming X is an inanimate thing of acceptable value in economic terms (if it is a woman, only the lucky bastard in the class gets her, as we all know :(.
There are contradictions when you say you want to be fair.
Say A and B are fairly well-to-do but C is not. What if giving it to C disproportionately increases his wealth and puts him above A and B? More importantly, what if this fact is not apparent at the time of distribution? See, the problem takes on new hues if it is given that the value of X would persist or increase over time (it is something like land/gold).
For the sake of the problem, we will assume that X would be void after sometime (it is a ticket to the superbowl or a concert). In such a case, I would give it to someone whom I think will derive maximum value from it.
LikeLike
I never did well in econ. but this sounds like an interesting problem to solve (econ. or not).
X can either be allocated to 1 or more of the potential inheritors or to none of them. So we have two branches here.
1. None. In this case, X can be sold out and the gains distributed amongst the potential inheritors based on a math that everyone agrees on (if one of the inheritors, say, has invested huge amounts in X or in the parents’ healthcare, then s/he might have a valid argument in demanding more). This also avoids bitter vibes in the property.
2. 1 or more get it. The issue would be to decide who get it. One option is to treat it as an equity asset (not sure whether this is the right term for it) with each person having a share in it. The person who is willing to stay in it, handle maintenance and other details would be a greater shareholder. Transactions on the property would require the ok of all the people on the “board”. If more than one person wishes to occupy it then the house needs to be suitably divided or modified/renovated to accommodate the families.
LikeLike
Launch it on the share market, each sibling gets 1/4th of the shares. Then you can trade and everyone is happy. When disputes arise, you can appoint a board of trustees who (besides drinking endless bottles of Bisleri (to play it safe)) will always be able to decide at the end of each meeting when the next meeting will be. By the time a resolution comes out, I am sure the property would have outlived the contending parties! 🙂
LikeLike
Interesting question. But I think we need to first define what we mean by ‘fair’. In my book, ‘fair apportionment’ need not mean dividing X equally. It may not be possible to do the division properly. Instead, what I would do is to create a situation where there is equal opportunity to A, B and C to compete with each other.And then give X to the best among the three, with a caveat that he/she must help the others come up to speed as well. In case it is not possible to create an ‘equal opportunity’ situation in the short or near term, I would then give X to the one person among the three who I feel has the best ability to increase the value of X. Let us assume this person is A. And I will give it to A under the condition that, in the process of creating more value from X, A will use the services of B and C, or at least help them in some way after the increased value of X benefits A.
Cheers,
Kumar
LikeLike
Why not allocate X to the highest bidder among the three brothers (all the better if outsiders can also be allowed to participate in the bidding) and distribute the proceedings among the three according to their rightful claim?
LikeLike
I made the mistake of putting two entirely different scenarios on the same post. So there is much confusion. I wish to clarify that the “efficient allocation of an object X†is a separate matter from the “fair and efficient distribution of an indivisible inherited property.†Conflating the two was not my intention.
LikeLike
one solution could be to turn over the prize to a third party who can manage the property and maximize future gain out of it.If the prize is indivisible(say-existing house), it could be sold and the proceeds could be entrusted to professional money managers, with the agreement that future gains/losses would be equally shared.
LikeLike
I assume that object X provides a longer term utility (unit of value like money, land, education package, car etc.) while it does not provide instant gratification(a cricket ball, a burger or toothpaste etc.). Something that will be consumed in a very small amount time may have a very small utility too.
Socialist’s Solution: Give X to the poorest(by income) and watch its value being obliterated. The story goes: you feed a fish to a poor man and he will eat for today. But if you teach him to fish he will eat for the rest of his life.
Capitalist’s Solution: Give X to maximize utility, that is maximum returns at a minimum cost (low risk investment). In this case hopefully your utility is the pleasure derived from seeing object X being utilized most efficiently. But again the decision to utilize object X remains in the hands of A, B or C. One could calculate the utility by using indifference curves and income lines and see where would they intersect. Although there is no point in getting into utility functions here as this may be beyond the scope.
My solution: Impose rules of engagement before gifting object X. These rules are derived from the motivation to see best usage of object X. Motivation may include transfer of wealth or knowledge created indirectly as a result of utilizing the object or merely encouragement of responsibility. If objectives are not met in a certain time frame the object is handed to the next best person and so on.
Best case scenario: Object X provides maximum utility to A, B and C.
Worst case scenario: Object X changes hands very frequently and looses its value gradually.
In the end you will be more satisfied to see object X being utilized by all three A, B and C through a “multiplier effect”. Moreover, your satisfaction will also be a function of how committed you remain to this process.
Cheers…
LikeLike
Well it depends what “your parent” or the owner valued?
One could be need and talent?
Say a child who is gifted teacher and chose to pursue that rather than go a lucrative route which leaves teaching a profession for stupid DFs.
or another could be growth?
if he had a progeny who had a better idea about growing the networth.
You see all of them depend on what the other 3 valid choices are
A smart person may consider choices beyond his progeny
As the Americans Gates and Buffet have shown.
LikeLike
Firstly, it all depends on the nature and value of the object. If it is non-perishable and of high value, you could start a TRUST and fund the trust with the object X and make all three beneficiary. This would be a viable solution where you do not have to split the object X and do not have to feel bad of not giving it to the other two. The best part, if you want to give beyond X then you can always fund the trust with whatever you wish to……
Hope it works !!!
LikeLike
Why not form a company go public, and let them bid for shares as per their ability to pay? 🙂 Okay I hope you get the drift!
LikeLike