Handout for Econ 522, Spring 2009, Disc #4, 2/20
Promisor and Promisee
When Daniel sells a car to Chao, who is promisor and who is promisee: what if Chao has already
paid the price, what if Daniel has already given the car to Chao? –we actually need to consider
which step are we looking at.
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 about price rising 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)
Reliance:
Now suppose the buyer can build a hanger at $75,000 which can increase his valuation of the
plane by $100,000.
(5) Under expectation damage rule, is the buyer always going to build the hanger?
(6) What is the trade off with respect to efficiency here? What is the expectation damage now? If
the seller choose to breach the contract, how much does he have to pay to the buyer?
(7) If the probability of seller’s cost to go up to $1 million is 0.2, is it efficient for the buyer to
make this reliance?
Bearing Risk
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 risk realize?
(9) If hedging the risk will cost the seller $200,000, who is the efficient bearer of this risk? And
what will happen when the risk realize?