Handout for Econ 522, Fall 2009, Disc #5, 10/09
1. Bargaining Theory
--Offer, Acceptance, Consideration
--When Daniel sells a car to Chao, who is the promisor and who is the promisee? (the answer
should be both depend on which part of the promise we look at)
2. Expectation Damages
--To make the promisee as well off as if the contract is performed.
Let’s beat the example in the lecture alive and then beat it to death.
So we have a buyer and a seller of a airplane. The buyer values the airplane at $500,000. The
seller’s cost normally is 250,000. And they reach a deal at $350,000.
(1) If the price was paid in advance，what is buyer’s expected gain/surplus from this deal? What
about seller? What is the expectation damage? What is the amount of money that the seller
need to pay to the buyer if the seller chooses to breach the contract?
(compare promisor’s cost and promisee’s benefit)
(2) Answer the above questions when the price will be paid at delivery.
Now let’s assume the price will be paid at delivery.
(3) If the seller’s cost has risen to $300,000, is it efficient for the seller to breach the contract?
What if cost rises up to $400,000 and 600,000?
(4) Why expection damages set the right incentive for the promisor to choose whether to breach or
not? (think about externatliy)
3. Reliance:
Now suppose the buyer can build a hanger at $75,000 which can increase his valuation of the
plane by $100,000.
(5) If the seller is required to pay expectation damage, how much would he owe the buyer if he
breaches the contract and the buyer invested in the hanger? Will the buyer invest in the hanger?
(6) If the probability of seller’s cost to go up to $1 million is 0.2, is it socially efficient for the
buyer to make this reliance?
(7) Under what liability rule will the promisee make the efficient reliance decision? Will the
promisor generally choose efficient breach under this liability rule? How do we solve the
problems of overreliance and inefficient breach at the same time in practice?
4. Risk Bearing
Without reliance, suppose the probability of seller’s cost to go up to $1 million is still 0.2.
(8) If the seller can purchase the raw material now and avoid this risk. But the cost will go up by
$50,000. Who is the efficient bearer of the risk? And what will happen when the price does go up
and the buyer didn’t cover this risk?