Econ 522 Economics of Law Dan Quint Spring 2011 Lecture 10 Reminders Second homework due tomorrow 5 p m First midterm next Wednesday March 2 Extra OH next week 2 Applications examples of property law What things can be privately owned Intellectual Property patents copyrights trademarks trade secrets What can can t an owner do with his her property Restraints on alienation unbundling inalienability regulation How are property rights established First Possession versus Tied Ownership How are they lost adverse possession eminent domain What remedies are given Injunctions vs damages temporary vs permanent damages Private necessity emergency as exception to property protection Eminent domain as damages protection regulatory takings 3 Contract Law 4 Why do we need contracts Some transactions don t occur all at once I m flying to Boston for Thanksgiving or I hire someone to paint my house 5 Why do we need contracts Some transactions don t occur all at once I m flying to Boston for Thanksgiving or I hire someone to paint my house or you can get 10 for a purple poker chip but don t have any cash on you right now to buy it from someone with a lower number A contract is a promise which enables trade when transactions aren t concluded immediately 6 Example the agency trust game Player 1 you Trust me Don t Player 2 me 100 0 Share profits 150 50 Keep all the money 0 200 Subgame perfect equilibrium I ll keep all the money so you don t trust me Inefficient outcome 100 200 And we re both worse off 7 One solution reputation 8 Another solution legally binding promises Player 1 you Trust me Don t Player 2 me 100 0 Share profits 150 50 Keep all the money 125 25 Now we get cooperation and efficiency Purpose of contract law to allow trade in situations where this requires credible promises 9 So what types of promises should be enforced by the law The rich uncle of a struggling college student learns at the graduation party that his nephew graduated with honors Swept away by good feeling the uncle promises the nephew a trip around the world Later the uncle reneges on his promise The student sues his uncle asking the court to compel the uncle to pay for a trip around the world One neighbor offers to sell a used car to another for 1000 The buyer gives the money to the seller and the seller gives the car keys to the buyer To her great surprise the buyer discovers that the keys fit the rusting Chevrolet in the back yard not the shiny Cadillac in the driveway The seller is equally surprised to learn that the buyer expected the Cadillac The buyer asks the court to order the seller to turn over the Cadillac A farmer in response to a magazine ad for a sure means to kill grasshoppers mails 25 and receives in the mail two wooden blocks with the instructions Place grasshopper on Block A and smash with Block B The buyer asks the court to require the seller to return the 25 and pay 500 in punitive damages 10 The Bargain Theory of Contracts 11 The bargain theory of contracts Developed in the late 1800s early 1900s A promise should be enforced if it was given as part of a bargain otherwise it should not Bargains were taken to have three elements Offer Acceptance Consideration 12 What is consideration Promisor person who gives a promise Promisee person who receives it In a bargain both sides must give up something reciprocal inducement Consideration is what the promisee gives to the promisor in exchange for the promise Under the bargain theory a contract becomes enforceable once consideration is given 13 What is consideration Promisor person who gives a promise Promisee person who receives it In a bargain both sides must give up something reciprocal inducement Consideration is what the promisee gives to the promisor in exchange for the promise Under the bargain theory a contract becomes enforceable once consideration is given 14 The bargain theory does not distinguish between fair and unfair bargains Hamer v Sidway NY Appeals Ct 1891 Uncle offered nephew 5 000 to give up drinking and smoking until his 21st birthday then refused to pay The promisee previously used tobacco occasionally drank liquor and he had a legal right to do so That right he abandoned for a period of years upon the strength of the promise We need not speculate on the effort which may have been required to give up the use of these stimulants It is sufficient that he restricted his lawful freedom of action within certain prescribed limits upon the faith of his uncle s agreement and now having fully performed the conditions imposed it is of no moment whether such performance actually proved a benefit to the promisor and the court will not inquire into it 15 Under the bargain theory what is the remedy Expectation damages the amount of benefit the promisee could reasonably expect from performance of the promise meant to make the promisee as well of as he would have been had the promise been fulfilled 16 Problems with the bargain theory Not that accurate a description of what modern courts actually do Not always efficient Does not enforce certain promises that both promisor and promisee might have wanted to be enforceable 17 Problems with the bargain theory Not that accurate a description of what modern courts actually do Not always efficient Does not enforce certain promises that both promisor and promisee might have wanted to be enforceable Does enforce certain promises that maybe should not be enforced 18 What does efficiency say about what promises should be enforced 19 What promises should be enforced In general efficiency requires enforcing a promise if both the promisor and the promisee wanted it to be enforceable when it was made different from wanting it to actually be enforced 20 What promises should be enforced In general efficiency requires enforcing a promise if both the promisor and the promisee wanted it to be enforceable when it was made different from wanting it to actually be enforced The first purpose of contract law is to enable people to cooperate by converting games with noncooperative solutions into games with cooperative solutions or enable people to convert games with inefficient equilibria into games with efficient equilibria 21 What promises should be enforced In general efficiency requires enforcing a promise if both the promisor and the promisee wanted it to be enforceable when it was made different from wanting it to actually be enforced The first purpose of contract law is to enable people to cooperate by converting games
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