Economics the Law Midterm 2 Study Guide Davis 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 solutions c Encourage efficient disclosure of information within the contractual d Secure the efficient level of breach explained below via expectation relationship damages e Secure optimal reliance 2 Bargain Theory a What promises should be enforced i 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 made 1 Bargains have 3 elements Offer Acceptance Consideration a Offer what one side proposes to give up in a trade b Acceptance other side agreeing to the offer c 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 given b Expectation damages i IF the promisor person entity making promise doesn t fulfill their offer breaches Expectation Damages would be paid to promise ii ONLY in the amount that the promisee would ve received if the promise were fulfilled iii Expectation damages guarantee efficient breach c Drawbacks of bargain theory i It s not that accurate of a description of what modern courts actually do ii It s not always efficient in that it does not enforce certain promises that both sides might have wanted to be enforceable 3 Breach when a promisor fails to keep their promise a Reliance their promise i Reliance is the investments that depend on a promisor keeping ii 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 Default i Default rules are rules made and applied by courts to fill gaps 1 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 breach i Breach is efficient when social benefit of breach is greater than social cost of benefit ii social benefit cost here really just means the benefit or cost to the promisor of keeping the promise iii Promisor will breach exactly when it s efficient when liability from breach promisee s benefit 4 What promises should not be enforced a A contract is not enforceable if it cannot be performed without breaking the law b Also unenforceable are contracts made under i Impossibility ii Fraud iii Failure to disclose iv Frustration of purpose v Mutual mistake vi Overly vague or in favor of one side 5 Expectation damages a A remedy for a promisor breaching a contract b 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 kept c Key point expectation damages are meant for the promisor to internalize the negative externality to promisee of breach a In actual courts include reliance damages in the amount that the promisor could reasonably expect the promisee to rely b 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 amount 6 Reliance damages c When is reliance efficient i When benefit of reliance cost of reliance d Don t include reliance in expectation damages i If included promisee will over rely a Restitution damages giving back the money received for a contract 7 Restitution Damages when it was breached b Like returning a deposit 8 Specific performance a If a contract is breached a court will order the breaching party to perform the act in the contract rather than pay damages b Sometimes used for unique goods i It s really hard to determine the value of something rare ii So rather than try to assign a value court could follow specific performance and order that the action in the contract be done a Damages paid by the breaching party that approximates the damage 9 Liquidated damages done by breaching 10 Unfortunate contingency a Contract is written between A B b But B may need some luck to perform the contract i 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 A 11 Fortunate contingency a 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 Duress a A kind of dire constraint b 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 constraint 13 Necessity a Another kind of dire constraint i Dire constraint is imposed on promisor by someone other than the promisee b You re out of gas and I won t sell you gas unless you pay 500 gallon c Contracts are not enforceable when made under dire constraint 14 Frustration of purpose a A change in circumstances that makes the original promise pointless i 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 unenforceable 15 Mutual unilateral mistakes a Mutual mistake neither party knew something about a contract that i In a mutual mistake a court would invalidate the contract b Unilateral mistake only ONE party has wrong information about the changes its value 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 worth and you agree ii In unilateral mistakes contract is generally enforced 16 Fraud a One party was deliberately tricked by the other party b