101: Existence
→ see learning outcomes
no conflict of interest → only coordination ⇒ Cheap Talk
whenever no conflict of interest → no contract, cheap talk is enough
Spot transaction (apple at market, after that you want nothing more of the seller, can inspect the good)
no contract needed
Game Tree (utility/payoff for each person)
once viper is saved → conflict of interest (viper prefers to bite)
very bad equilibrium as farmer does not save viper
- viper could put muzzle, or remove tooth
Ex-Ante vs. Ex-Post perspective
- prefers giving warranty before, to incentivise buyer
- ex-post warranty is liability
Sequential Exchange → first mover is vulnerable / asymmetric information
- contract allow us to move beyond cheap talk
- liable to pay damage
- contract makes us able to credibly commit
102: Enforcement
Why does the state want to enforce contracts
- increases social welfare!
- assumes parties knows their interests and have level of experience/knowledge
- not enforced for infants/mentally ill / duress / misrepresentation → state does not enforce
- externalities that hurt 3rd person → not enforced
State facilitates transactions / exchange → allows division of labor, via trade
- the cheaper it is to trade, the more wealth
Why is contract structure important
- leaving money on the table ⇒ transaction costs
- by allowing warranty → they can trade
- since seller knows good is of quality, she can offer warranty for free
- value created
failure to find right contract → no transaction / high cost
103: Better Judge & Litigator
If contract is not performed → court and obtain legal remedy
- legal remedy eliminates inefficiency
Default compensation:
- expectation payment
- puts the aggrieved party in as good a position as without breach
Damages may be hard to quantify (emotional, reputational damage)
- court may award only fraction of cost
if the VC expects the court not to award as much damage → would still breach
Liquidated damages clause
- parties agree in advance a specified amount of money
- court only need to see that breach occurred → force payment
but Liquidated damages clause will not always be enforced (common law courts do not enforce if they seem overcompensatory → see it as penalty clause (not enforceable)).
- they might reduce to actual damages → breaching now attractive again
- so we have to make the judge understand that the liquidated damages were ex—ante correct!
- Counterfactual scenario
Should not strike down a clause because it looks excessive after the fact!
- might have been useful ex-ante