Jim Whitney Economics 357

Study Questions: Unit IV: Contracts

A. The economics of contracts

1. Briefly describe the general argument for freedom of contract, in which the courts enforce all contracts exactly as written.
a. Under what circumstances does the general argument not apply, justifying restrictions on freedom of contract?
b. If we accept the principle of freedom of contract, what role is left for courts in determining the terms of contracts?
2. Consider the bilateral monopoly problem.
a. Illustrate the potential conflict it creates in a supply and demand diagram.
b. Why is bilateral monopoly typically a problem after a contract is signed but not before?
c. How can contract law serve a "fundamental purpose" in providing a remedy for the bilateral monopoly problem?
3. Suppose a broker promises an investor a return of 10% on invested funds, of which the broker will keep 2% for services rendered. The investor currently earns a return of 4%. Illustrate how it can be in the best interests of both parties to prefer that a contract between them be legally enforceable.
4. Suppose that your prospective employer holds out two envelopes containing salary offers and informs you one offer is twice as high as the other. After you open the first envelope, you can keep it or trade it for the other envelope. You open the first envelope, and the salary offer is $30,000.
a. If you are risk neutral (meaning you have a constant marginal utility of income), should you accept the offer or trade it for the other envelope? Explain, and illustrate your answer in an income-utility diagram.
b. If you are risk averse, how large would your risk premium have to be to make you indifferent between keeping the first envelope and trading it for the other envelope? Explain, and illustrate your answer in an income-utility diagram.

B. Making contracts

1. I offer to pay you $20 to mow my lawn next weekend, and you reply that you'll do it on Saturday morning as long as it doesn't rain. Discuss whether the requirements for a valid contract have or have not been met.
2. Consider the issue of mutual mistake.
a. Describe an example of a potential mutual mistake.
b. Does the difference in the way contract law handles mutual mistake compared to unilateral mistake make economic sense? Why or why not?
3.  Consider the following information from a lawsuit decided in 1898: The plaintiff sued her grandfather's estate for payment of a note which stated in its entirety: "May the first, 1891. I promise to pay to Katie S-- on demand, $ 2,000, to be at 6 per cent per annum." According to a witness for the plaintiff, the grandfather delivered the note to Katie while she was at work one day and "he says to Miss S--, 'I have fixed out something that you have not got to work any more.' He says, 'None of my grandchildren work and you don't have to.'" Katie quit working shortly after receiving the note.
a. If you were the judge in this case, how would you have ruled? Explain your reasoning.
b. What case assigned for class would you have most likely cited in your decision? Why?
4.  Consider unilateral contracts.
a. How do the requirements differ for unilateral contracts compared to bilateral contracts?
b. What economic incentives would result if contract law reversed its position regarding whether or not knowledge of an offer is necessary for a valid unilateral contract?
5.  Consider implicit contracts.
a. How much is the provider of the service entitled to collect?
b. Decide how each of the following would affect a court ruling about the amount that could be collected under an implicit contract in a case of emergency medical sevices, and briefly explain your reasoning in each case.
(1) The beneficiary, unconscious at the time, turns out to be a Christian Scientist who would have refused medical care.
(2) The beneficiary, unconscious at the time, turns out to be unusually wealthy.
(3) The beneficiary, unconscious at the time, died without ever regaining consciousness.
(4) The beneficiary was conscious at the time.

C. Enforcing contracts

1.  Provide an example for each of the following grounds for refusing to legally enforce a contract:
a. Unacceptable party.
b. Unacceptable purpose.
c. Unacceptable condition.
2.  Consider the following information from a lawsuit decided in 1977: R-- fraudulently got Mrs. E--, who was illiterate, to sign by her mark a deed conveying a much larger mineral interest in her property than she had agreed to sell. R-- then recorded his deed and sold his interest. Mrs. E-- sued to recover title.
a. If you were the judge in this case, how would you have ruled? Explain your reasoning.
b. (1) What case assigned for class most closely approximates this case?
(2) In what important respect do the cases differ?
(3) What economic reasoning accounts for why the two cases might conceivably have different outcomes?
3.  Does contract law treat the deliberate withholding of useful information the same as it treats the deliberate disclosure of false information? If so, why? If not, why not, and under what conditions should it do so?
4. A mugger points a gun at you and demands a thousand dollars. When you explain that you don't have that much cash on you, he asks for a check instead. (Assume that if you are killed, your bank account will automatically be frozen).
a. Consider the possibility of your being legally permitted to stop payment on the check.
(1) What economic advantage is there to the legality of that option?
(2) What economic advantage is there to enforcing the mugger's option to cash the check?
b. Does the general argument for freedom of contract apply here? Why or why not?
5. Consider the case of Alaska Packers Assn. v. Domenico, (1902).
a. Could the defense used by Domenico have failed to be successful if the Alaska Packers Association workers had offered to work an extra fifteen minutes a day in exchange for the doubling of their base compensation that they had insisited on? Why or why not?
b. Consider the following discussion of economic duress from the case of Austin Instrument, Inc., v. Loral Corporation (1971):
[A] mere threat by one party to breach the contract by not delivering the required items, though wrongful, does not in itself constitute economic duress. It must also appear that the threatened party could not obtain the goods from another source of supply and that the ordinary remedy of an action for breach of contract would not be adequate.
Do you think that Domenico could have utilized this line of defense? Why or why not?
6. a. Distinguish between each of the following types of contracts: (1) a contract negotiated under duress; (2) a contract of adhesion; and (3) a contract with unconscionable terms.
b. Rank the three types of contracts from most to least problematic in terms of efficiency concerns, and explain your ranking.

D. Interpreting contracts

1. Indicate which of the following typically best promotes the welfare of contracting parties, and explain your decision in each case:
a. Using efficiency versus intent of the parties to govern how the courts interpret contracts.
b. Using objective market values versus estimated subjective values to govern how the courts interprret contracts.
2. Courts often infer an "implicit insurance term" in a building contract, under which the contractor rather than the homeowner is liable if a home under construction burns down. Why might this implicit term be efficient...
a. based on risk pooling considerations?
b. based on moral hazard considerations?
3. Consider the cases of Suydam v. Jackson (1873) and Greenfield v. Kolea (1976).
a. What missing contract term turned out to be important in both cases?
b. Based on the doctrine of stare decisis, what decision would the court have reached in Greenfield v. Kolea?
c. How did the court justify failing to abide by stare decisis?
d. What are the economic advantages and disadvantages of leaving terms out of contracts?
e. What are the economic advantages and disadvantages of the stare decisis doctrine?
4.  Consider the following information from a lawsuit: The plaintiff sues for the balance owed on a home-construction contract. A contract term for plumbing work specified that "all wrought iron pipe must be well galvanized, lap welded pipe of the grade known as 'standard pipe' of Reading manufacture." Several months after moving in, the homeowner learned that some of the pipe, instead of being made in Reading, was the product of other factories. The homeowner refused further payment pending replacement of the pipe. The cost of replacement is substantial. The mistake was unintentional and unnoticed at the time, and the contractor has evidence that the brands installed, though made by other manufacturers, were the same in quality, in appearance, in market value and in cost as the brand stated in the contract -- that they were, indeed, the same thing, though manufactured in another place.
a. If you were the judge in this case, how would you rule? Explain your reasoning.
b. What case assigned for class would you most likely cite in your decision? Why?

E. Breaking contracts

1.  a. Distinguish between each of the following possible remedies for breach of contract:
(1)  reliance damages
(2)  expectation damages
(3)  perfect expectation damages
(4)  liquidated damages
(5)  specific performance
b. Which of the options would most closely approximate the value of the contract to the promisee?
c.  Which of the options would most closely approximate the cost of the contract to the promisor?
d.  Which of the options would best ensure that only efficient breaches of contract occur?
2.  Consider the Hawkins v. McGee (1929) case.
a. Use an indifference curve diagram to illustrate a situation in which George Hawkins consumes personal wealth (W) and quality of his right hand (H). Depict an initial indifference curve in which Hawkins has $100,000 of lifetime wealth and a right hand that is scarred but otherwise serviceable.
b.  Now suppose that his physician, Dr. McGee, offers the following contract: a fully serviceable right hand, without trace of scar, in exchange for a surgeon's fee ($100) plus four days in the hospital ($5 per day, or $20), plus seven or eight days of pain, valued by a sturdy lad at no more than hospital charges: call it $35.
Depict in your diagram the consequences of a perfectly successful surgery.
c.  Now depict instead the consequences of what Hawkins actually ended up with: a crippled, hairy and interminably bleeding paw with a loss in actual wealth due to earning impairment and pain-equivalent wealth that runs to thousands or even tens of thousands of dollars.
d.  Illustrate each of the following in your diagram: (1) reliance damages, and (2) expectation damages.
3.  Decide whether you think the following is true or false, and explain the reason for your answer: Reliance damages rather than expectation damages are the proper measure of damages for breach of contract in cases (for example, mutual mistake) where there was no meeting of the minds.
4.  A landowner signs a contract for a mining company to strip-mine the landowner's property. The mining company agrees to pay $100,000 and to restore the property (at a cost to the company of $60,000). The landowner values the restoration at $90,000. After mining the land, the mining company breaches the contract by not restoring the property. The landowner sues for damages. Evidence presented at trial indicates that restoration would add $30,000 to the market value of the strip-mined property.
a. Indicate how much the landowner would receive in damages under each of the following precedents: (1) Hawkins v. McGee (1929); (2) Groves v. John Wunder (1939); and (3) Peevyhouse v. Garland Coal (1963).
b.  Is it efficient to breach the contract? Explain.
c.  Under the circumstances described here, which precedent best ensures that a breach of contract will occur only if it is efficient? Explain.
d.  Now suppose that the landowner cares only about the market value of the property, but that the restoration would have added $90,000 to its market value at the time the contract was signed but only $30,000 at the time it was breached. If the courts consistently follow the precedent you listed in part c, is it possible for the parties here to achieve an efficient outcome under these circumstances? If not, explain why not. If so, explain how.
5.  A pays $100 for a ticket to the Super Bowl game. Through some mix-up caused by the ticket broker, the ticket is never delivered to A, and he misses the game. Unknown to the broker, A would have paid $10,000 for the ticket.
a. How much should A be able to collect in damages? Explain.
b. Which contract case assigned for class best supports your decision? Explain.

General note: It is reasonable to anticipate better results if you can make use of basic information from the specific cases you've been assigned to read to make your answers more concrete.