Econ 522 Economics of LawLogisticsPlanSo last Thursday, I’m flying from Boston to Montreal…Slide 4Example: the agency (trust) game(One solution: reputation)Another solution: legally binding promisesSo… what types of promises should be enforced by the law?Slide 9The bargain theory of contractsWhat is consideration?Slide 13The bargain theory does not distinguish between fair and unfair bargainsUnder the bargain theory, what is the remedy?Problems with the bargain theorySlide 17Slide 17What promises should be enforced?Slide 20Slide 21So now we know…InformationSlide 24Slide 25Efficient breachSlide 27Slide 28Remedies and efficient breachThis brings us to…RelianceEfficient relianceEcon 522Economics of LawDan QuintFall 2009Lecture 92Office hours between now and midterm:Me: Tomorrow 1:30-3:30, Monday 1:30-3:30Chao: Thursday 1:00-3:00, Monday 10:00-1:30Midterm #1 next Tuesday, in classNo contract lawLogistics3Last week – finished property lawHandout – two cool examplesThis week – we start contract lawBut first – a digression (true story) that illustrates some of the principles from bothPlan4Uncertainty about rights makes bargaining hardNegotiating with lots of parties is hardWhen transaction costs are high, “damages” are better than “injunctions”But also… what is a ticket?So last Thursday, I’m flying from Boston to Montreal…5Contract Law6Subgame perfect equilibrium: I’ll keep all the money; so you don’t trust meInefficient outcome (100 < 200)And we’re both worse offExample: the agency (trust) gamePlayer 1 (you)Trust me Don’tPlayer 2 (me)Share profits Keep all the money(150, 50) (0, 200)(100, 0)7(One solution: reputation)8Now we get cooperation (and efficiency)Purpose of contract law: to allow trade in situations where this requires credible promisesAnother solution: legally binding promisesPlayer 1 (you)Trust me Don’tPlayer 2 (me)Share profits Keep all the money(150, 50) (125, 25)(100, 0)9“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.”So… what types of promises should be enforced by the law?10The Bargain Theoryof Contracts11Developed in the late 1800s/early 1900sA promise should be enforced if it was given as part of a bargain, otherwise it should notBargains were taken to have three elementsOfferAcceptanceConsiderationThe bargain theory of contracts12Promisor: person who gives a promisePromisee: person who receives itIn a bargain, both sides must give up somethingreciprocal inducementConsideration is what the promisee gives to the promisor, in exchange for the promiseUnder the bargain theory, a contract becomes enforceable once consideration is givenWhat is consideration?13Promisor: person who gives a promisePromisee: person who receives itIn a bargain, both sides must give up somethingreciprocal inducementConsideration is what the promisee gives to the promisor, in exchange for the promiseUnder the bargain theory, a contract becomes enforceable once consideration is givenWhat is consideration?14Hamer 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.”The bargain theory does not distinguish between fair and unfair bargains15Expectation damagesthe amount of benefit the promisee could reasonably expect from performance of the promisemeant to make the promisee as well of as he would have been, had the promise been fulfilledUnder the bargain theory, what is the remedy?16Not that accurate a description of what modern courts actually doNot always efficientDoes not enforce certain promises that both promisor and promisee might have wanted to be enforceableProblems with the bargain theory17Problems with the bargain theoryNot that accurate a description of what modern courts actually doNot always efficientDoes not enforce certain promises that both promisor and promisee might have wanted to be enforceableDoes enforce certain promises that maybe should not be enforced18What does efficiency say about what promises should be enforced?19What 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 madedifferent from wanting it to actually be enforced20What 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 madedifferent from wanting it to actually be enforcedThe first purpose of contract law is to enable people to cooperate by converting games with noncooperative solutions into games with cooperative solutionsor, enable people to convert
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