George Mason School of Law
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George Mason School of Law. Contracts I Bargaining Gains F.H. Buckley [email protected]. Next Day. Montesquieu John Stuart Mill, On Liberty Scott 480-501. Up to now. Let’s assume that societal wealth has something to do with national happiness. Up to now. - PowerPoint PPT Presentation
Transcript of George Mason School of Law
Next Day Montesquieu
John Stuart Mill, On Liberty
Scott 480-501
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Up to now
Let’s assume that societal wealth has something to do with national happiness
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Up to now
And does contract enforceability have something to do with societal wealth?
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Where does contract law come in?
What is the relationship between enforceable promises and wealth?
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Cooperate Defect
Cooperate Jointcooperation
Player 1: sucker’s payoff
DefectPlayer 2: Sucker’s payoff
Jointdefection
Player 2
Player 1
Bargains as a Prisoner Dilemma game
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Cooperate Defect
Cooperate
Defect 0
Player 2
Defection dominates for both Players
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Contract Law as a solution
Suppose that the defector is penalized through legal sanctions so that the incentive to defect disappears.
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Why Enforce Contracts:An Economic Analysis of Bargaining Gains
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Modeling Bargaining Gains Indifference Curves The Budget Line Consumer Choice Beneficial Reliance The Edgeworth Box Function Pareto-Superiority and Pareto-
Optimality
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Two dimensional Commodity Space:Every point represents a combination of the two commodities
X axis
Y axis
Commodity x
Commodity y
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Two dimensional Commodity Space:Every point represents a combination of the two commodities
X axis
Y axis
•A
X*
Y*
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The Commodities: Dollars in Two Time Periods
Dollars in Time 2
Dollars in Time 1
•A
X*
Y*
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Two different time preferences(Which is right?)
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Dollars in Time 1
0
Dollars in Time 2
Commodity space: Dollars consumed in two time periods
More of both
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The Budget Line: Allocating $100 between two periods
Dollars in Time 1
100
0
100
Dollars in Time 2
The budget line in red represents every trade-off of $100 in two periods
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Indifference Curves: Preferences about Consumption
Dollars in Time 1
0
Dollars in Time 2
An indifference curve represents a set of trade-offs to which the subject is indifferent
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Indifference Curves: Preferences about Consumption
Dollars in Time 1
0
Dollars in Time 2
Convexity (curve bends inward) assumes decreasing marginal
utility
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Decreasing marginal utility: We’ll always want more, but will enjoy each new scoop less and less
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A C: Subject is willing to give up $BC in Time 2 for $AB in
Time 1 Dollars in Time 1
0
Dollars in Time 2
BC
A
= “is indifferent to”
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A C: Subject is willing to give up $BC in Time 2 for $AB in
Time 1 Dollars in Time 1
0
Dollars in Time 2
BC
A
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Indifference Curves: Preferences about Consumption
Dollars in Time 1
0
Dollars in Time 2
One is better off the further one gets from the origin
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Dollars in Time 1
0 Dollars in Time 2
More is better:I2 > I1
I1
I2
More is better
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Dollars in Time 1
0 Dollars in Time 2
Ordinal Utility: We can’t say how much better I2 is than I1
I1
I2
I3
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Ordinal Utility: We can’t say how much better I2 is than I1
Ordinal numbers: First, second, third
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Ordinal Utility: We can’t say how much better I2 is than I1
Ordinal numbers: First, second, third
Cardinal numbers: 1,2, 3
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Consumption Decision:Uncle Ebenezer gives David $100
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Time 1 I2
I1 100
I2 I1
0
100 Time 2
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Consumption Decision:David has $100 and is best off at A
Maximization subject to the constraint of the Budget Line
I3
Time 1 I2
I1 100
50 A I2 I1
0
50
100 Time 2
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Consumption Decision:David has $100 and is best off at A
Maximization subject to the constraint of the Budget Line
I3
Time 1 I2
I1 100
50 A I2 I1
0
50
100 Time 2
B
B is not optimal
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Consumption Decision:David has $100 and is best off at A
Maximization subject to the constraint of the Budget Line
I3
Time 1 I2
I1 100
50 A I2 I1
0
50
100 Time 2
C
B
C is not feasible
B is not optimal
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Ebenezer gives David another $100: The Shift to a New Budget Line
200 I200
100 A50, 50
50
I100
0 100 32
A new Consumption Decision
B 100, 100
100 I200 A50, 50
50
I100
IDR
0 50 100
Time 1
Time 2
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What happens when the donor promises to give in the future?
Uncle Ebenezer doesn’t have the $100 to give today but promises to give it to David in the next period
What Should David Do?
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What happens when the donor promises to give in the future?
Uncle Ebenezer doesn’t have the $100 to give today but promises to give it to David in the next period
David’s election: to rely or not to rely on the promise in the first period
The good scenario: David relies and Ebenezer performs
B 100, 100
100 I200 A50, 50
50
I100
0 50 100 200
200
Reliance by David means spending $100 in period 1
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B100, 100
I100 I DR
0 50 100
A bad scenario: Detrimental Reliance: David relies and Ebenezer breaches
C 100,0 D
A50, 50 50
Time 1 David spends 100 in period 1 and now has nothing left to spend in period 2
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B100, 100
I100 I DR
0 50 100
A bad scenario: Detrimental Reliance: David relies and Ebenezer breaches
C 100,0 D
A50, 50 50
Time 1 What do we need to give David to make him as well off as he would be had the promise been performed?
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B100, 100
I100 I DR
0 50 100
A bad scenario: Detrimental Reliance: David relies and Ebenezer breaches
C 100,0 D
A50, 50 50
Time 1
The Expectation Interest is CB, or $100
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B100, 100
I100 I DR
0 50 100
A bad scenario: Detrimental Reliance: David relies and Ebenezer breaches
C 100,0 D
A50, 50 50
Time 1 What do we need to give David to make him as well off as he would have been had the promise not been made, or had he not relied?
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B100, 100
I100 I DR
0 50 100
A bad scenario: Detrimental Reliance: David relies and Ebenezer breaches
C 100,0 D
A50, 50 50
Time 1
The Reliance Interest is CD, or about $25
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Fool me once…: Non-reliance: David assumes Ebenezer will breach
Time 1 I1
100 50 B I1
0 50
100 Time 2
Now David spends only 50 in period 1
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Fool me once…: Non-reliance: Ebenezer breaches: No harm, no foul
Time 1 I1
100 50 B I1
0 50
100 Time 2
Now David spends only 50 in period 1
100
I200
50
E150, 50
0 100 150
Loss of Beneficial Reliance: David doesn’t rely and Ebenezer performs
Ino-reliance
Goetz and Scott, 89 Yale L.J. 1261 (1980)
David spends only 50 in period 1
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Where David is on performance
B100, 100 100
I200
50
E150, 50
0 100 150
Loss of Beneficial Reliance: David doesn’t rely and Ebenezer performs
Ino-reliance
Goetz and Scott, 89 Yale L.J. 1261 (1980)
David spends only 50 in period 1
Where David would have been had he relied
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B100, 100 100
I200
50
E150, 50
0 100 150
Loss of Beneficial Reliance: David doesn’t rely and Ebenezer performs
Ino-reliance
Goetz and Scott, 89 Yale L.J. 1261 (1980)46
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Enforceable Contracts provide the gains
associated with beneficial reliance
Now: How parties gain from contracting
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“If one person does not lose, the other does not gain.”
St. Augustine
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Modeling a Bargain: Mums and Roses
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Mum
s
Roses
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Mums
Mary Roses
Two bargainers
Mums
Bess Roses
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Mums
Mary Roses
Rotating Bess’s diagram I
Roses
Mums
Bess
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Mums
Mary Roses
Rotating Bess’s diagram II
RosesMums
Bess
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Rotating Bess’s diagram III
Mums
Mary Roses
Mums
Bess
Roses
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Rotating Bess’s diagram IV
Mums
Mary Roses
Mums
Bess
Roses
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Rotating Bess’s diagram V
0
0
Mums Roses Bess
Mums Mary
Roses
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Mary
Edgeworth Box Function: Bargaining from endowment point A
0
Bess
A
0
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Edgeworth Box Function: Bargaining from endowment point A
Mary
Bess
A
0
0
Rosesbess
Mumsmary Mumsbess
Rosesmary
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Edgeworth Box Function: Bargaining from endowment point A
Mary
Bess
A
0
0
The Edgeworth Box Function permits us to define Efficiency Standards
Pareto-superiority
Pareto-optimality
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Efficiency (Paretian) standardsVilfredo Pareto (1848-1923)
Pareto-superiority: A transformation from A to B is Pareto-superior if at least one person is better off and no one is worse off
Pareto-optimality: No further Pareto-superior transformations are possible
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Pareto-SuperiorityB and C as Pareto-superior to A
D and E as Pareto-inferior
Mary
Bess
A
B
C
D
E
Coleman, 8 Hofstra L.Rev. 905 (1980)
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Are all bargaining gains exploited at F?The bargaining “lens” shrinks through bargaining
Mary
Bess
A
B
C
D
E
F
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The bargaining “lens” shrinks through bargaining
Mary
Bess
A
B
C
D
E
F
G
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Pareto OptimalityAt G no further Pareto-superior transformations are possible
Mary
Bess
A
B
C
D
E
F
G
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The Contract CurveG is a point of tangency of the two sets of indifference curves
Mary
Bess
A
B
C
D
E
F
G
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Mary
The Contract Curve All possible Pareto-optimal contracts at the points of tangency
Bess
A
B
C
D
E
FG
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Efficiency (Paretian) standardsVilfredo Pareto (1848-1923)
• Pareto-superiority: A transformation from A to B is Pareto-superior if at least one person is better off and no one is worse off
• Pareto-optimality: No further Pareto-superior transformations are possible
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Are these attractive moral standards?
Paretian man is not an altruist He takes no interest in the other person
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Are these attractive moral standards?
What’s so good about altruism?
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Are these attractive moral standards?Here’s an altruist…
Gericault, Portrait(Envy)
Is a complete lack of empathy an attractive quality for bargainers?
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Are these attractive moral standards?The bourgeoisie … has pitilessly torn asunder the motley feudal ties … and has left remaining no other nexus between man and man than naked self-interest, than callous “cash payment.” It has drowned the most heavenly ecstasies of religious fervour, of chivalrous enthusiasm, of philistine sentimentalism, in the icy water of egotistical calculation.
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Further Readings
Goetz and Scott, Enforcing Promises: An Examination of the Basis of Contract, 89 Yale LJ 1261 (1980)
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Contract Law in the State of NatureIII.State of Nature.ppt
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