A Theory of Contract Choice and the California Gold Rush

Abstract

EVERY time an exchange takes place between two or more people there is a contract, either explicit or implicit. These contracts can take a variety of forms which are subject to the discretion of the contracting parties. The purpose of this paper is to examine the nature of contract choice by employing the tools of price theory. In particular (using a model developed by Cheung1), I will try to explain the choice of contracts observed among gold miners during the California gold rush of 1848-1850. In his 1969 article, Cheung developed one of the first theories of contract choice. The basic proposition set forth in his paper is that individuals, in choosing between a fixed rent or a sharing contract, will select the one which minimizes risk (defined here as the variance in income), but their choice is subject to the constraint of positive transaction costs. While I will use the same methodology as Cheung and, indeed, the same theoretical proposition, there are at least three significant differences which will require modifications of the analysis. First, Cheung's model explicitly assumes that property rights to all the factors of production are clearly delineated. However, as I will show later, this assumption cannot be used when examining contract choice in the California gold fields. Because the mineral lands were a nonexclusive resource, the theory must take into account the additional costs of privately maintaining exclusive rights. Second, Cheung's model was constructed to explain contract choice in agriculture, and so his discussion emphasized the problems in contracting in this particular industry. Yet, his theory suggests that the costs of contracting will be a function of both the production technology and the nature of the product itself. Therefore, a careful examination of the characteristics of gold and the