Economics & the Law Midterm 2 Study GuideDavis posted 19 topics that we should be familiar with.These topics are explained/defined below using class, the lecture notes, and handouts.1. Why do we need contracts?a. TO enable trade when transactions aren’t concluded immediately b. Enable people to cooperate by converting games with noncooperative solutions into games with cooperative solutionsc. Encourage efficient disclosure of information within the contractual relationshipd. Secure the efficient level of breach (explained below) via expectation damagese. Secure optimal reliance2. Bargain Theory?a. What promises should be enforcedi. Promise should be enforced if it was given as part of a bargain, otherwise it should not ii. In other words: Efficiency requires enforcement of a promise if both parties wanted it to be enforceable when the contract was made1. Bargains have 3 elements: Offer, Acceptance, Considerationa. Offer: what one side proposes to give up in a tradeb. Acceptance: other side agreeing to the offerc. Consideration: what the accepting side gives up in the trade (equivalent to this side’s offer)i. Under bargain theory, contract is enforceable when consideration is givenb. Expectation damagesi. IF the promisor (person/entity making promise) doesn’t fulfill their offer (breaches), Expectation Damages would be paid to promiseii. ONLY in the amount that the promisee would’ve received if the promise were fulfillediii. Expectation damages guarantee efficient breach c. Drawbacks of bargain theoryi. It’s not that accurate of a description of what modern courts actually doii. It’s not always efficient in that it does not enforce certain promises that both sides might have wanted to be enforceable3. Breach (when a promisor fails to keep their promise)a. Reliancei. Reliance is the investments that depend on a promisor keeping their promiseii. Example: I agree to buy a boat from another person. If I built a boathouse ahead of actually receiving the boat, the boathouse would be considered reliance b. Defaulti. Default rules are rules made and applied by courts to fill gaps1. Gaps are risks or circumstances not specifically addressed in a contract (impossible to cover every scenario in a contract)ii. Efficient default rule: a rule that both parties would have wanted in the contract if they had specified that rule in the contract. (work well when there would have been a high transaction cost of filling the gap in the contract)iii. Penalty default rule: attempt to fill a gap with a rule that the parties would NOT have wanted in the contract. Encourages parties to be thorough and disclose info. (works well when gaps are intentional and strategic)c. Efficient breachi. Breach is efficient when social benefit of breach is greater than social cost of benefitii. “social benefit/cost” here really just means the benefit or cost to the promisor of keeping the promiseiii. Promisor will breach exactly when it’s efficient: when liability from breach = promisee’s benefit4. What promises should not be enforceda. A contract is not enforceable if it cannot be performed without breaking the lawb. Also, unenforceable are contracts made under: i. Impossibility ii. Fraudiii. Failure to discloseiv. Frustration of purposev. Mutual mistakevi. Overly vague or in favor of one side 5. Expectation damagesa. A remedy for a promisor breaching a contractb. When a promisor breaches a contract, they should owe promisee a penalty exactly equal to the benefit that the promise would’ve gotten if the promise were keptc. Key point: expectation damages are meant for the promisor to internalize the negative externality to promisee of breach 6. Reliance damagesa. In actual courts: include reliance damages in the amount that the promisor could reasonably expect the promisee to relyb. Perfect expectation damages: restore promisee to level of well-being he would’ve gotten if the promise was kept and if the promisee would’ve relied the efficient amountc. When is reliance efficient?i. When benefit of reliance > cost of relianced. Don’t include reliance in expectation damagesi. If included, promisee will over-rely7. Restitution Damagesa. Restitution damages: giving back the money received for a contract when it was breached.b. Like returning a deposit8. Specific performancea. If a contract is breached, a court will order the breaching party to perform the act in the contract rather than pay damagesb. Sometimes used for unique goodsi. It’s really hard to determine the value of something rareii. So rather than try to assign a value, court could follow specific performance and order that the action in the contract be done9. Liquidated damagesa. Damages paid by the breaching party that approximates the damage done by breaching10. Unfortunate contingencya. Contract is written between A & Bb. But B may need some luck to perform the contracti. EX: A agrees to buy 20 cars from B, but B is counting on Vin Diesel & Paul Walker to steal those cars for him.1. So, the unfortunate contingency is Vin & Paul not stealing the cars, so B can’t sell them to A11. Fortunate contingencya. If an alternative contract arises that is more favorable/profitable than the original contract, the promisor would want to avoid performance of the original contract.12. Duressa. A kind of dire constraintb. Other party is responsible for situation I’m in.c. A contract signed at gunpoint (not enforceable)d. Contracts are not enforceable when made under dire constraint13. Necessitya. Another kind of dire constrainti. Dire constraint is imposed on promisor by someone other than the promiseeb. You’re out of gas and I won’t sell you gas unless you pay $500/gallonc. Contracts are not enforceable when made under dire constraint14. Frustration of purposea. A change in circumstances that makes the original promise pointlessi. EX: I buy super bowl tickets, and prepay a hotel to stay there that night. If the super bowl is put off to a later date, the hotel wants to keep my money.b. Contracts that concern a frustration of purpose are unenforceable15. Mutual/unilateral mistakesa. Mutual mistake: neither party knew something about a contract that changes its value i. In a mutual mistake, a court would invalidate the contractb. Unilateral mistake: only ONE party has wrong information about the contract.i. EX: I find something that you own, I know it is of great value, you think it’s worthless, I offer to buy it for what you think it’s