George Mason School of Law
Contracts I
MW 600 – 740
Hazel 120
F.H. Buckley
[email protected]
1
Contracts I
1. Why Enforce Contracts
2
Contracts I
1. Why Enforce Contracts
2. Where Contracts Should Not Be
Enforced
3
Contracts I
1. Why Enforce Contracts
2. Where Contracts Should Not Be
Enforced
3. Formation of Contracts
4
Contracts I
1. Why Enforce Contracts
2. Where Contracts Should Not Be
Enforced
3. Formation of Contracts
4. Consideration
5
Contracts I
1. Why Enforce Contracts
2. Where Contracts Should Not Be
Enforced
3. Formation of Contracts
4. Consideration
5. Relational Contracts
6
A Law and Econ Perspective
Tony Kronman’s Comment
Dean Henry Manne,
George Mason
Insider Trading and the
Stock Market 1965
7
A Law and Econ Perspective
Le mot de Tony Kronman
Dean Henry Manne,
George Mason
Insider Trading and the
Stock Market 1965
8
Ronald Coase,
U. of Chicago
The Problem of Social Cost
1960
A Law and Econ Perspective
Le mot de Tony Kronman
Dean Henry Manne,
George Mason
Insider Trading and the
Stock Market 1965
9
Ronald Coase,
U. of Chicago
The Problem of Social Cost
1960
Hon. Richard Posner
University of Chicago
Economic Analysis of Law 1973
A Preliminary Question
 Who cares if we enforce contracts?
 The nihilism of the 1970s: What’s
wrong with this contract?
 “If one person does not lose, the other
does not gain.” Augustine
 Consumerism and corporations
10
So why enforce contracts?
 Casebook suggests two principles
 The Efficiency Norms of Law and
Economics
 An “Autonomy Principle”
11
Autonomy
 How am I more free if I subject
myself to fetters?
12
Autonomy
 How am I more free if I subject
myself to fetters?
 Ex post vs. ex ante
13
Autonomy
 Does my personal freedom expand
when I have the freedom to bind
myself?
 Rousseau: people must be forced to be
free
 Now: must people be free to be forced?
14
Autonomy
 Let’s assume that we’re persuaded
that, on autonomy grounds, people
should be able to fetter themselves
by contract
 Problem: could promising and
contract law exist without background
institutions or conventions?
15
David Hume
“A promise is
not intelligible
naturally, nor
antecedent to
human
conventions.”
16
David Hume
What does this
mean?
17
David Hume
Imagine a world
without contract
law and without
the word
“promise” in its
language
18
Could promising exist without
promissory institutions?
The Kingdom of Tonga
19
The Queen of Tonga
With the Queen Mother at the Coronation, 1953
20
Tonga
Where People Don’t Promise
 There is no word for “promise” in
Tonganese
21
Tonga
Where People Don’t Promise
 There is no word for “promise” in
Tonganese
 “I intend to do x, but if I change my
mind, well, then was then, now is now.”
22
Tonga
Where People Don’t Promise
 There is no word for “promise” in
Tonganese
 “I intend to do x, but if I change my
mind, well, then was then, now is now.”
 In such a place, is an autonomy analysis
of promises intelligible?
23
Tonga
Where People Don’t Promise
 Could one create a promissory obligation
in Tonga with a private act of will?
24
Tonga
Where People Don’t Promise
 Could one create a promissory obligation
in Tonga with a private act of will?
 Is it meaningful to talk of a promise to
oneself?
 If so can one forgive oneself?
25
David Hume
“The will alone is
never suppos'd to
cause the obligation,
but must be
express'd by words
or signs, in order to
impose a tye upon
any man.”
26
Hume didn’t think that all
morality is conventional
 Non-conventional Natural vs.
Conventional Artificial duties
 So a natural law explanation of
promising would not work
27
Hume didn’t think that all
morality is conventional
 Non-conventional Natural vs.
Conventional Artificial duties
 Can you suggest some examples of
non-conventional rules?
28
Some examples of nonconventional rules?
 Consider: “You think that killing x is
wrong, but that’s just because you
have a convention that x count as
people.”
 Is that persuasive?
29
Autonomy and Reliance
 How about a more modest argument
for promissory obligations, based on
promisee reliance?
30
Autonomy and Reliance
My statement is like a
pit I have dug in the
road, into which you
fall
Charles Fried
31
Autonomy and Reliance
 The unrelied-on promise
 The bootstrapping problem
32
David Hume
So we’re back to
me
33
Autonomy
 So if the autonomy argument has
purchase, it must explain why
promissory institutions should exist.
 Otherwise, no problems with Tonga.
34
Autonomy
 So why is it desirable that promissory
institutions exist?
 Can’t breach a contract without them
 And I can’t slide home without the game
of baseball
35
Autonomy
 So why is it desirable that promissory
institutions exist?
 Can’t breach a contract without them
 And I can’t slide home without the game
of baseball
 So how to come up with an argument for
either institution, without attributing
some outside value to the game?
36
Autonomy: What is Fried Saying?
“In order that I be as
free as possible … it is
necessary that there
be a way in which I
can commit myself.”
Charles Fried
37
Autonomy
“By doing this I can
facilitate the projects
of others…and we can
facilitate each other’s
projects.
Charles Fried
38
Autonomy
Does this collapse
into an economic
argument?
Fried says not
Charles Fried
39
Autonomy
“The obligation to keep
a promise is grounded
not in arguments of
utility but in respect
or individual autonomy
and in trust.”
Charles Fried
40
Autonomy
But suppose people
were happier in Tonga?
Charles Fried
41
Does that mean that promissory
societies are to be preferred?
A Tonga Beach
42
43
44
The Humean Account of Promising
 Assumes that happiness is desirable,
that institutions which promote
happiness are morally desirable.
45
The Humean Account of Promising
 Such theories evaluate institutions
according to their consequences
(“consequentialism”)
46
The Humean Account of Promising
 Such theories evaluate institutions
according to their consequences
(“consequentialism”)
 Utilitarianism is one version of
consequentialism.
47
The Humean Account of Promising
 Assumes that happiness is desirable,
that institutions which promote
happiness are morally desirable.
 Assumes that people are happier in
societies with promissory institutions.
48
The Humean Account of Promising
 Assumes that happiness is desirable,
that institutions which promote
happiness are morally desirable.
 Assumes that people are happier in
societies with promissory institutions.
 Grounds a duty to perform one’s
promises in the duty to support
benign institutions.
49
Promising and Contract Law
 The benefit afforded by promissory
institutions is a greater assurance of
performance
 Which is strengthened when
contractual sanctions are added to
moral ones.
50
David Hume
Does the sanction provided by non-legal
promissory institutions suffice?
Men being naturally
selfish, or endow'd only
with a confin'd
generosity, they are not
easily induc'd to perform
any action for the
interest of strangers,
except with a view to
some reciprocal
advantage
51
The possibility of defection
destroys trust
52
Your corn is ripe today, mine will be so
tomorrow… (Hume’s Treatise III.ii.V)
Contracts in the State of Nature
Hobbes, Leviathan 14.18 (1651)
53

If a covenant be made wherein neither of the parties
perform presently, but trust one another, in the
condition of mere nature (which is a condition of war of
every man against every man) upon any reasonable
suspicion, it is void…

For he that performeth first hath no assurance the other will
perform after, because the bonds of words are too weak to
bridle men's ambition, avarice, anger, and other passions,
without the fear of some coercive power; which in the
condition of mere nature, where all men are equal, and
judges of the justness of their own fears, cannot possibly be
supposed. And therefore he which performeth first doth
but betray himself to his enemy.
The Prisoners’ Dilemma
Underlies Hobbes’ Insight
 A simple game that has become the
dominant paradigm for social
scientists since it was invented about
1960.
 How the game works – and why
didn’t it work for Dilbert
54
The paradox of the PD game
 While cooperation is collectively
rational, defection is individually
rational.
 The undersupply of cooperation is
“the tragedy of the commons.”
Garrett Hardin, The Tragedy of the
Commons (1968).
55
Hollywood gets in the act
Russell Crowe as John Nash
in “A Beautiful Mind”
56
The need for poetic license
57
Modeling PD games
 Game theoretic problems: payoffs for
each player depend on actions of both
58
Modeling PD games
 Game theoretic problems: payoffs for
each player depend on actions of both
 Two possible strategies: A party
cooperates when he performs valueincreasing promises, and defects
when he breaches
59
Modeling Two-party choice
Cooperate
Player 1
60
Modeling Two-party choice
Player 1
Defect
61
Modeling Two-party choice:
Player 2
Player 2
Cooperate
62
Modeling Two-party choice
Player 2
Player 2
Defect
63
Modeling Two-party Choice
Both Cooperate
Player 2
Cooperate
Cooperate
Player 1
Defect
64
Both
cooperate
Defect
Modeling Two-party Choice
Both Defect
Player 2
Cooperate
Defect
Cooperate
Player 1
Defect
65
Both defect
Modeling Two-party Choice
Sucker’s payoff for Player 1
Player 2
Cooperate
Cooperate
Player 1
Defect
66
Defect
Player 1
cooperates,
Player 2
defects
Modeling Two-party Choice
Player 1’s temptation to defect
Player 2
Cooperate
Cooperate
Player 1
Defect
67
Player 1
defects,
Player 2
cooperates
Defect
Modeling Two-party Choice
Player 2
Cooperate
Defect
Cooperate
Both
cooperate
Player 1
cooperates,
Player 2
defects
Defect
Player 1
defects,
Player 2
cooperates
Both defect
Player 1
68
Bargains as a Prisoner Dilemma game
Cooperation: Promise and Perform
Defect: Promise and Breach
Player 2
Cooperate
Joint
Cooperate
cooperation
Player 1
Defect
69
Player 2:
Sucker’s
payoff
Defect
Player 1:
sucker’s
payoff
Joint
defection
Plugging in payoffs
First number is payoff for Player 1,
Second number is payoff for Player 2
Player 2
Player 1
70
Cooperate
Defect
Cooperate
3, 3
-1, 4
Defect
4, -1
0, 0
Defection dominates for Player 1
What should he do if Player 2 cooperates?
Cooperate
Cooperate

Player 1
Defect
71
3
4
Defection dominates for Player 1
What should he do if Player 2 defects?
Defect
Cooperate

Player 1
Defect
72
-1
0
Defection dominates for Player 1
Cooperate
Player 1
Defect
73
Cooperate
Defect
3
-1


4
0
Defection dominates for Player 2
What should he do if Player 1 cooperates?
Player 2
Defect
74
Defect
3
4

Cooperate
Cooperate
Defection dominates for Player 2
What should he do if Player 1 defects?
Player 2
Cooperate
Defect
-1
0
Defect
75

Cooperate
Defection dominates for Player 2
76
Cooperate
Defect
Cooperate
3

4
Defect
-1

Player 2
0
Joint Cooperation
Everyone promises and performs
The food is
better at
the
Tattaglias…
77
I’m
worried
about
Tessio…
Joint defection
Can these gentlemen be acting efficiently?
An inefficient honor code
78
Sucker’s payoff
Sucker performs, other party defects
GONERIL
Hear me, my lord;
What need you five and
twenty, ten, or five,
To follow in a house where
twice so many
Have a command to tend
you?
REGAN
What need one?
KING LEAR
O, reason not the need…
79
Defector’s Payoff
Defector breaches, sucker performs
"I can make them voting machines sing
Home Sweet Home."
"Don't write anything you can phone.
Don't phone anything you can talk.
Don't talk anything you can whisper.
Don't whisper anything you can smile.
Don't smile anything you can nod.
Don't nod anything you can wink."
Gov. Earl K. Long
80
PD games help to explain why we do
dumb things
 Over-fish lakes and oceans
 Pollute
 Arms race
 Fail to exploit bargaining gains
81
The Tragedy of the Commons
and the Law of the Sea
)
82
War as a Prisoner’s Dilemma Problem
So why doesn’t the Coase Theorem Work?
83
All we are saying is …
Give Contracts a Chance
Iranians employing
the defect strategy
84
An application: Marriage
Marriage is more
than a contract;
it’s a covenant…
Rembrandt, The Jewish Bride 1666
85
An application: Marriage
But it’s less
than a contract
if the parties
have
unilateral
exit rights
under
no-fault
divorce laws
Rembrandt, The Jewish Bride 1666
86
Marriage, Divorce, Natality
 What did no-fault divorce do to the cost of
matrimonial fault?
87
Marriage, Divorce, Natality
 What did no-fault divorce do to the cost of
matrimonial fault?
 Under fault, the straying party pays if he wants a
divorce—or if his spouse seeks one
 So fault is costly in a fault regime
88
Marriage, Divorce, Natality
 What did no-fault divorce do to the cost of
matrimonial fault?
 So how do you think no-fault divorce laws
affected divorce levels?

89
Bring and Buckley, 18 Int. Rev. Law & Econ. 325 (1998)
Marriage, Divorce, Natality
 How would you expect the parties to
react to the increased probability of
divorce?
90
Marriage, Divorce, Natality
 How would you expect the parties to
react to the increased probability of
divorce?
 Fewer marriages
91
Marriage, Divorce, Natality
 How would you expect the parties to
react to the increased probability of
divorce?
 Fewer marriages
 Increased female participation in the labor
force
92
Marriage, Divorce, Natality
 How would you expect the parties to
react to the increased probability of
divorce?
 Fewer marriages
 Increased female participation in the labor
force
 Increased human capital investments by
women
93
Marriage, Divorce, Natality
 How would you expect the parties to
react to the increased probability of
divorce?
 Fewer marriages
 Increased female participation in the labor
force
 Increased human capital investments by
women
 And what about kids?
94
Children as marriage-specific assets
25
20
15
Series1
Series2
10
5
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
Divorce rate 1965-83 ———
Natality rate for married couples 1965-83 ———
95
Where Promises Can’t Be Relied on
Akerlof, The Market for Lemons, 84 Q.J. Econ. 488 (1970)
96
The Market for Lemons
What would you pay?
 Of the remaining 1956 Fords, half are
worth nothing (“lemons”) and the
other half are worth $5000 (“beauts”)
97
The Market for Lemons
What would you pay?
 Of the remaining 1956 Fords, half are
worth nothing (“lemons”) and the
other half are worth $5000 (“beauts”)
 The seller knows which kind of car he
has but you can’t tell them apart
98
The Market for Lemons
What would you pay?
 Of the remaining 1956 Fords, half are
worth nothing (“lemons”) and the
other half are worth $5000 (“beauts”)
 The seller knows which kind of car he
has but you can’t tell them apart
 What would you pay for one?
99
The Market for Lemons
What would you pay?
 Of the remaining 1956 Fords, half are
worth nothing (“lemons”) and the
other half are worth $5000 (“beauts”)
 The seller knows which kind of car he
has but you can’t tell them apart
 The trick: Seller’s willingness to sell is
a signal
100
The Market for Lemons
What would you pay?
 Of the remaining 1956 Fords, half are
worth nothing (“lemons”) and the
other half are worth $5000 (“beauts”)
 The seller knows which kind of car he
has but you can’t tell them apart
 Question: Is the seller satisfied with
this result?
101
Contract Law as a solution
 Suppose that the defector is
penalized through legal sanctions so
that the incentive to defect
disappears.
102
Is there no cooperation without
binding contracts?
 Voting
 No littering
 Roadside politeness?
103
 It’s 1998. There are two plans for an
online dictionary. One is Encarta,
promoted by Microsoft, whoich hires
editors. The other relies on
individuals to submit entries for free…
104
Wikeconomics
 It’s 1998. There are two plans for an
online dictionary. One is Encarta,
promoted by Microsoft, which hires
editors. The other relies on
individuals to submit entries for free…
105
Open Source Software
Linux Mascot
106
Crowdsourcing
107
Bloggers vs. Mainstream Media
108
Gift Economies
109