EC410 Exam 2 Study Guide -2 University of Alabama EC 410

EC410 Exam 2 Study Guide  Bargain Theory: Hamer v. Sidway  Bargain Theory: Allegheny College v. Chautauqua National Bank  Contract Formation: Lucy v. Zehmer  Optimal Reliance: Hadley v. Baxendale  Optimal Reliance: Allied Canners & Packing v. Victor Packing Co.  Optimal Reliance & Promissory Estoppel: Pertz v. The Edward J. Corporation  Optimal Reliance & Promissory Estoppel : Hoffman v. Red Owl Stores  Gratuitous Promises: Cosgrove v. Bartolotta  Mistakes: ALCOA v. Essex Group Incorporated  Remedies & Performance: Campbell Soup v. Wentz  Remedies, Damages & Performance: Jacob & Young v. Kent  Breach & Remedies: Walgreen Co. v. Sara Creek Property Co.  Remedies, Incentives, & Efficient Breach: Peevyhouse v. Coal & Mining Co.  Remedies & Damages: Autotrol Corp v. Continental Water Systems  Breach and Formation Defenses: Alaska Packers’ Association v. Domenico Contracts:  The result of a bargain  Does a bargain = a transaction?  Is it a promisor? An enforceable promise?  One way to think about it: it binds the parties together What is the purpose of a contract?  Creates incentive to keep promise (negative consequences)  It specifies the details of the transaction The Bargain Theory The fact of a bargain determines enforceability The expected value of a bargain measures damages  The Bargain Principle: A promise is legally enforceable if it is given as part of a bargain; otherwise, a promise is unenforceable. o So, Courts must decide if a bargain occurred.  Bargaining: a dialogue on value to agree on a price.  Dialogue must include: o Offer o Acceptance o Consideration (aka: inducement)  Each bargain involves reciprocal inducement: The promise gives something to induce the promisor to give the promise (for ex: money, goods, service, or another promise)  Consideration makes the promise enforceable  There must be a “meeting of minds” to warrant an offer/ acceptance. So, there must be no confusion.  A contract is fair when the value of the promise is proportional to the value of the consideration. Inequality of consideration may invalidate a contract.  Unconscionability: compare to economic assumption of rationality. Assume both parties are rational & would not agree to something that would make them worse off. However, unconscionable contracts are so one-sided that they are unenforceable under law. o Duress o Unequal Bargaining Power o Unfair Surprise o Limiting Warranty o Undue Influence  According to Bargain Theory, a court should enforce bargains induced by consideration, regardless of whether it was equivalent in value to the promise. Courts should merely determine whether a bargain occurred, not inquire into whether it was fair. This would burden the courts.  Remedy for the breach of enforceable promises are expectation damages o The benefit that the promisee could reasonably expect from performance o Loss of future income o Often speculative  CRITICISM of theory: o Requires all promises to have consideration (think car shopping and “firm offer”) -underinclusive o Requires that all bargains be enforced -overinclusive Economic Theory  Principle: Contracts should be pareto efficient – that is, they should make both parties better off  Economic efficiency requires enforcing a promise that both parties WANT enforced at the time the contract was made (timing) The Purpose of Contract Law: 1. Enable cooperation 2. Provide remedies when promises are not kept 3. Induce optimal reliance 4. Induce optimal information disclosure 5. Minimize contracting transaction costs (default terms) 1) Contracts should enable cooperation  Makes a promise credible (some sort of commitment)  Move from inefficient to efficient setting 2) Provides remedy for breaking enforceable promises- secure optimal commitment to performance  Party-designed remedies o The contract stipulates a remedy in specific terms  Court-imposed damages o Expectation damages: damage based on the value of expected performance. Perfect expectation damages leave the victim indifferent between performance and breach. o Reliance damages: seek to return P to a null financial state, equal to prior to the contract. Perfect reliance damages leave victim indifferent between no contract and breach.  Specific performance o Requires the promisor to do what he or she promised in the contract o Usually used when the case involve goods for which no close substitutes exist. o ***Might be more efficient than damages bc courts avoid the task of determining the promisee’s subjective valuation 3) Reliance is the behavior on the part of the promisee- costly behavior in response to the belief that the promise by the promisor would be kept. -Contracts should lead to:  Optimal Reliance: expected value of increase in value by addition. Reliance EXCEEDS the expected value of increase of cost of breach caused by the additional reliance  Efficient reliance: Expected gain from reliance cost of reliance -Attaining Optimal Reliance  Not too little/ not too much  Overreliance vs. underreliance  Balancing of costs & benefits 4) Minimize transaction costs of contracting by Default Terms  Gaps in contracts happen all the time  Courts impute terms to fill a gap in a contract by default, which means “in the absence of explicit terms to the contrary”  Default terms can be efficient by reducing the cost of negotiating explicit terms. Rule for efficient terms: Impute the terms to the contract that the parties would have agreed to if they had bargained over all the relevant risk.  Default rules can be inefficient when the parties can gain by replacing them with explicit terms, although the must bear the transaction costs of negotiating these explicit terms. Perfect Contracts  All risks are efficiently allocated  All relevant info is communicated  All resources allocated to those who value it the most Exceptions to Perfect Contracts:  Individual Irrationality o Incompetence o Dire constraints (necessity, duress)  Transaction Costs o Spillovers (third parties ca