Handout for Econ 522, Spring 2009, Disc #6, 3/6
Question 1, Parodox of compensation
Efficient Reliance: let’s continue the example of the airplane. The buyer values the airplane at $500,000, the
seller’s cost normally is $250,000 and may go up to $1,000,000 with probability p. The price is set to $350,000. In
addition, whenever the buyer invest $x in building the hanger, his benefit from it will go to 600 x . And the
investment will be wasted if the airplane is not delivered.
a. use words to explain why expectation damages not covering reliance give the correct incentive for efficient
reliance by the buyer, while expectation damages covering reliance does not.
b. show mathematically the above result without solving for x.
c. explain the parodox of compensation
Question 2 (page 255)
Buyer B pays $10,000 to New Orleans grain dealer D in exchange for D’s promise to deliver grain to buyer B’s
London office on October 1. As a result of signing this contract, B decides not to sign a similar contract with
another dealer for $10,500. D contracts with shipping company S to transport the grain. Buyer B agrees to resell
the grain on arrival in London for $11,000 to another party. B pays $100 in advance (nonrefundable) as docking
and unloading fees for the ship’s projected arrival in London.
The ship begins taking water serveral days out of New Orleans and returns to port. Inspection reveals that the
grain is badly damaged by salt water, and D sells it as cattle fodder for $500. D conveys the news to B in London,
who then purchases the same quantity of grain for delivery on October 1 at a price of $12,000.
Question: How would you measure expectation damages, reliance demages and opportunity-cost damages
for D’s breach of contract with B?
Question 3 (page 298)
Professor Schmidt, a geologist, has agreed to purchase McDonald’s farm for a price of $2000 per acre, which
corresponds to the price of good quality farmland in the vicinity. However, Schmidt, on the basis of his own
geological studies, is convinced that McDonalds’s farm contains valuable mineral deposits, which make the
property worth $25,000 per acre. Schmidt’s true motive is discovered by McDonald before Schmidt takes
possession, and McDonald refuses to hand over the property. Schmidt sues for breach of contract. McDonald
defends on the ground that Schmidt had a duty to disclose the results of his studies. According to our economic
principles, who should win?
Question 4
Chao has a friend in China who has a set of old furniture. The set is not protected well, for example, Chao’s
friend let his dog to pee on it. Chao spent some time on the old furniture and realized that this is set was used by a
famous general 200 years ago and thus very valuable. So Chao offers $500 for the set, which is the fair price of
similar furniture out in the market. They agreed on the contract. But in a party one day before Chao’s friend hand
the furniture to Chao, Chao was drunk and told his friend about this information. So Chao’s friend refuse to
perform the contract. Chao sued his friend. His friend defended on the ground that Chao should disclose this
information to him. Who should win? What is an example of “redistributive information”?
Question 5 (little diversion from the course)
Marriage can be thought of a special contract. Lawmakers are considering ways to eliminate the "marriage
penalty" in federal and state tax laws. Many couples, especially when both spouses work and earn roughly similar
amounts, have to pay a lot more in income taxes than they would if they had not married. If we have “marriage
bonus” instead of “marriage penalty”, what will happen to divorce and gay marriage (if law permits)?