Contracts – General
I. Assumptions of Contract Law
A. People are rational actors. Will only enter contracts that will make them better off than when they started
1. Free Will. Parties act w/o coercion
2. Self-knowledge. Parties have reasonably clear knowledge of what they prefer
a. Present selves can predict what future selves will want
b. Indifferent combinations. Combinations that would make you just as happy as you are now
c. Indifference curve.graph of all combinations of A’s goods given up for B’s goods that would make A indifferent
d. Area of Preference.Combinations above this curve are more likely to make A happier.
3. Parties can distinguish btwn alternative goods & services (basic knowledge of options)
a. Differences induce agreement – trading allows ppl to take advantage of difference
b. …in initial endowments of goods, preferences, comparative skills, info
B. The market works. The two things traded are somehow comparable
1. Objective Valuation. The amts we are willing to pay reflect our relative value of the product & not relative levels of wealth
2. Economic theory.Bc ppl differ, society benefits from the reallocation of rsrcs to those ppl or uses who value them the most.
3. Ppl may value the same item differently, and when both agree to trade the item for a $ amt between their differences, then both are happy with the deal
4. Mkt is accessible by anybody
C. Organizational Theme – Role of law is to:
1. Set stds for detecting whether gains from trade existed @ time of K
2. Restrict enforceability of trades tainted by lack of rationality
3. Regulate transax that adversely affect 3d parties
4. Enhance trades.Facilitate execution, perf & efficiency
5. Regulate terms of trade to seekfairer distrib of gains
6. Goal of K law = compensation for π (not punishment, retrib, or absolute deterrence)
D. Principal Questions in K law
1. Formation. Has a K been formed?
2. Duties & obligations w/in relationship?
3. Consequences/Dmgs when one party doesn’t perform?
II. Theory of Economic Efficiency
A. Pareto Efficiency. Both parties cannot make any more trades that would be more useful/desirable to them
1. Pareto Efficient Allocations. Spectrum of feasible outcomes btwn parties – w/in this spectrum is an area of mutual development
a. Single consideration is how to allocate economic resources in a fashion that maximizes the value that society as a whole derives from them.
(1) P – In order to provide incentive for ppl to enter Ks freely, encouraging trade
(2) Con – does not acct for distributional fairness
2. Efficient Breach (aka Pareto-improving transaction).We want ppl to exit Ks freely if a better deal comes along (break off trades that would be socially wasteful, or some breaches may be better for both parties & for soc’y)
3. Cf. Positive Coase Theorem – if seller knows buyer values prod less than a 3d party, can pay buyer off to release her from the K
a. would give item to the person who most wants it thru negotiations rather than breach & resale
b. nonbreaching pty could get a piece of the gains from the trade & soc’y is still equally better off, but the rsrcs are allocated among the 3 parties differently
c. assumes transax are costless, but transax costs lead to inefficiency
d. Normative Coase Theorem. Best rule will minimize transax costs by lubricating bargaining process or mimicking the mkt (mitigate conseqs of failed trade)
B. Expectation dmgs automatically insure Pareto Efficient Breach resultsA worthwhile breach – even when full expectation damages are paid – is by definition a Pareto improving move.
1. This justifies expectation dmgs only if
a. It’s relatively costly for the original buyer to resell;
b. Seller & buyer face transax costs in renegotiating their K; and
c. Structure of the legal rule cannot do much to affect the magnitude of
a. Cons- does an insurance “product” actually exist? inaccurate comparisons of diff ppl’s utility
E. Vs: Allocate risks of transax onto lowest cost risk avoider
1. Which party has most efficacious/least expensive opportunity to reduce/minimize risk at its disposal?
2. P – deterrence of harmful/risky conduct
3. Con – may deter desirable risky conduct (e.g. certain profitable/socially beneficial business ventures)
III. Criticism of K Theory
A. Ignores:
1. Problem of externalities – if one person uses the good to commit a crime, and the negative cost of that is absorbed by society, then it looks like it is Pareto-improving. also, if one uses the good to give pleasure/benefit to many members of soc’y, this improvement is not reflected in the well-being of the indiv who did so (e.g. the numbers may hide the true soc’l benefit)
2. “Consumer surplus” – when the buyer acquires an item that s/he values highly for a smaller amt of cash
3. Real World Irrationality. Compulsive/addictive behav; cognitive biases/errors (optimism, framing, anchoring, boundedly rational heuristics); promises procured by force/pressure; incapacitating cond
4. Incommensurability/Commodification. Putting price on certain things may be offensive to those who don’t participate (e.g. sale of embryos, organs, family members, wedding rings)
a. Constrain how certain Ks should be enforced
5. Distributional Equity/Fairness. Efficiency not enough, must consider equitable allocation of resources
a. Unregulated K’ing may lead to greater wealth disparities
