2. 1 George Mason School of Law Contracts I Why Enforce Contracts F.H. Buckley fbuckley@gmu.edu

3. Next Day  Contract Law in the State of Nature 2

4. 3 Contracts I 1.Why Enforce Contracts

5. 4 Contracts I 1.Why Enforce Contracts 2.Where Contracts Should Not Be Enforced

6. 5 Contracts I 1.Why Enforce Contracts 2.Where Contracts Should Not Be Enforced 3.Formation of Contracts

7. 6 Contracts I 1.Why Enforce Contracts 2.Where Contracts Should Not Be Enforced 3.Formation of Contracts 4.Consideration

8. 7 Contracts I 1.Why Enforce Contracts 2.Where Contracts Should Not Be Enforced 3.Formation of Contracts 4.Consideration 5.Relational Contracts

9. 8 A Law and Econ Perspective Tony Kronman’s Comment Dean Henry Manne, George Mason Insider Trading and the Stock Market 1965

10. 9 A Law and Econ Perspective Le mot de Tony Kronman Ronald Coase, U. of Chicago The Problem of Social Cost 1960 Dean Henry Manne, George Mason Insider Trading and the Stock Market 1965 9

11. 10 A Law and Econ Perspective Le mot de Tony Kronman Ronald Coase, U. of Chicago The Problem of Social Cost 1960 Dean Henry Manne, George Mason Insider Trading and the Stock Market 1965 Hon. Richard Posner University of Chicago Economic Analysis of Law 1973 10

12. 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 11

13. A Preliminary Question  Who cares if we enforce contracts?  The nihilism of the 1970s: What’s wrong with this contract? Consumerism: It’s always Williams v. Walker-Thomas 12

14. The Young Lawyers ABC 1970-71 13

15. 14 So why enforce contracts?  Casebook suggests two principles An “Autonomy Principle” The Efficiency Norms of Law and Economics

16. Autonomy  How am I more free if I subject myself to fetters? 15

17. Autonomy  How am I more free if I subject myself to fetters?  Ex post vs. ex ante 16

18. Promising and Efficiency Norms  The benefit afforded by promissory institutions is a greater assurance of performance Which is strengthened when contractual sanctions are added to moral ones. 17

19. Promising and Efficiency Norms  The benefit afforded by promissory institutions is a greater assurance of performance  So why is that important? 18

20. Promising and Efficiency Norms  The benefit afforded by promissory institutions is a greater assurance of performance  So why is that important? Let’s assume that contract enforceability has something to do with societal wealth 19

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23. Heritage Ranking of Economic Freedom 1 Hong Kong89.70.0 2 Singapore87.21.1 3 Australia82.5-0.1 4 New Zealand82.30.2 5 Switzerland81.90.8 6 Canada80.80.4 7 Ireland78.7-2.6 8 Denmark78.60.7 9 United States77.8-0.2 10 Bahrain77.71.4 22

24. Where does contract law come in?  What is the relationship between promising and wealth? 23

25. Where does contract law come in?  What is the relationship between promising and wealth?  Between enforceable promises and wealth? 24

26. Where does contract law come in?  What is the relationship between promising and wealth?  Between enforceable promises and wealth?  How about bare promises without contract enforcement? 25

27. David Hume Does the sanction provided by non-legal promissory institutions suffice? 26 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

28. 27 The possibility of defection destroys trust Hobbes, Leviathan 14.18 (1651)  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.

29. 28 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

30. 29 The paradox of the PD game  While cooperation is collectively rational, defection is individually rational.

31. 30 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).

32. 31 Hollywood gets in the act Russell Crowe as John Nash in “A Beautiful Mind”

33. 32 The need for poetic license

34. 33 Modeling PD games  Game theoretic problems: payoffs for each player depend on actions of both

35. 34 Modeling PD games  Game theoretic problems: payoffs for each player depend on actions of both  Two possible strategies: A party cooperates when he performs value- increasing promises, and defects when he breaches

36. 35 Cooperate Player 1 Modeling Two-party choice

37. 36 Defect Player 1 Modeling Two-party choice

38. 37 Cooperate Player 2 Modeling Two-party choice: Player 2

39. 38 Defect Player 2 Modeling Two-party choice Player 2

40. 39 CooperateDefect Cooperate Both cooperate Defect Player 2 Player 1 Modeling Two-party Choice Both Cooperate

41. 40 CooperateDefect Cooperate Defect Both defect Player 2 Player 1 Modeling Two-party Choice Both Defect

42. 41 CooperateDefect Cooperate Player 1 cooperates, Player 2 defects Defect Player 2 Player 1 Modeling Two-party Choice Sucker’s payoff for Player 1

43. 42 CooperateDefect Cooperate Defect Player 1 defects, Player 2 cooperates Player 2 Player 1 Modeling Two-party Choice Player 1’s temptation to defect

44. 43 CooperateDefect Cooperate Joint cooperation Player 1: sucker’s payoff Defect Player 2: Sucker’s payoff Joint defection Player 2 Player 1 Bargains as a Prisoner Dilemma game Cooperation: Promise and Perform Defect: Promise and Breach

45. 44 CooperateDefect Cooperate3, 3-1, 4 Defect4, -10, 0 Player 2 Player 1 Plugging in payoffs First number is payoff for Player 1, Second number is payoff for Player 2

46. 45 Cooperate 3 Defect4 Player 1 What should Player 1 do if he knows Player 2 will cooperate?

47. 46 Cooperate 3 Defect4 Player 1 What should Player 1 do if he knows Player 2 will cooperate? 

48. 47 Defect Cooperate Defect0 Player 1 What should Player 1 do if he knows Player 2 will defect?

49. 48 Defect Cooperate Defect0 Player 1 What should Player 1 do if he knows Player 2 will defect? 

50. 49 CooperateDefect Cooperate3 Defect40 Player 1 Defection dominates for Player 1 

51. 50 CooperateDefect Cooperate34 Defect Player 2 What should Player 2 do if he knows Player 1 will cooperate?

52. 51 CooperateDefect Cooperate34 Defect Player 2 What should Player 2 do if he knows Player 1 will cooperate? 

53. 52 CooperateDefect Cooperate Defect0 Player 2 What should Player 2 do if he knows Player 1 will defect?

54. 53 CooperateDefect Cooperate Defect0 Player 2 What should Player 2 do if he knows Player 1 will defect? 

55. 54 CooperateDefect Cooperate34 Defect0 Player 2 Defection dominates for Player 2  

56. 55 CooperateDefect Cooperate Defect 0 Player 2 Defection dominates for both Players

57. 56 CooperateDefect Cooperate Both cooperate Player 1 cooperates, Player 2 defects Defect Player 1 defects, Player 2 cooperates Both defect Player 2 Player 1 Modeling Two-party Choice

58. 57 Joint Cooperation Everyone promises and performs I’m worried about Tessio… The food is better at the Tattaglias…

59. 58 Joint defection Can these gentlemen be acting efficiently? An inefficient honor code

60. 59 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…

61. 60 Defector’s Payoff Defector breaches, sucker performs Gov. Earl K. Long "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." "I can make them voting machines sing Home Sweet Home."

62. 61 CooperateDefect Cooperate Both cooperate Player 1 cooperates, Player 2 defects Defect Player 1 defects, Player 2 cooperates Both defect Player 2 Player 1 Modeling Two-party Choice

63. 62 PD games help to explain why we do dumb things  Over-fish lakes and oceans  Pollute  Arms race  Fail to exploit bargaining gains

64. 63 Joint Defection The Tragedy of the Commons and the Law of the Sea )

65. 64 How about promises without contract law?  You want to buy a 1956 Ford…

66. 65 Promises without contract law  You want to buy a 1956 Ford…  Of the remaining 1956 Fords, half are worth nothing (“lemons”) and the other half are worth $5000 (“beauts”)

67. 66 Promises without contract law  You want to buy a 1956 Ford…  Of the remaining 1956 Fords, half are worth nothing (“lemons”) and the other half are worth $5000 (“beauts”)  The seller tells you it’s a beaut.

68. 67 Promises without contract law  You want to buy a 1956 Ford…  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

69. 68 Promises without contract law  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?

70. 69 Promises without contract law  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 Akerlof, The Market for Lemons, 84 Q.J. Econ. 488 (1970)

71. 70 Promises without contract law  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?

72. 71 Contract Law as a solution  Suppose that the defector is penalized through legal sanctions so that the incentive to defect disappears.

73. 72 What if contracts are prohibited?

74. 73 What if contracts are prohibited? Rembrandt, The Jewish Bride 1666 Marriage is more than a contract; it’s a covenant…

75. 74 What if contracts are prohibited? Rembrandt, The Jewish Bride 1666 But it’s less than a contract if the parties have unilateral exit rights under no-fault divorce laws

76. 75 Marriage, Divorce, Natality  What did no-fault divorce do to the cost of matrimonial fault?

77. 76 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

78. 77 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? Bring and Buckley, 18 Int. Rev. Law & Econ. 325 (1998)

79. 78 Marriage, Divorce, Natality  How would you expect the parties to react to the increased probability of divorce?

80. 79 Marriage, Divorce, Natality  How would you expect the parties to react to the increased probability of divorce? Fewer marriages

81. 80 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

82. 81 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

83. 82 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?

84. 83 Children as marriage-specific assets Divorce rate 1965-83 ——— Natality rate for married couples 1965-83 ———

85. 84 Absent legal barriers, will the parties always write a binding contract?  The Coase Theorem: Parties will enter a binding contract to exploit all bargaining games unless prevented from doing so by transaction costs

86. 85 Absent legal barriers, will the parties always write a binding contract?  The Coase Theorem: Parties will enter a binding contract to exploit all bargaining games unless prevented from doing so by transaction costs

87. So what are transaction costs? 86  Give examples of things that get in the way of bargaining

88. So what are transaction costs? 87  Too many parties? Eg, pollution

89. So what are transaction costs? 88  Emergencies? No time to bargain

90. So what are transaction costs? 89  Information processing problems?

91. 90 War as a Prisoner’s Dilemma Problem So why doesn’t the Coase Theorem Work? Uccello, Battle of San Romano

92. 91 War as a Prisoner’s Dilemma Problem The Coase Theorem and Informational Problems Irwin McDowell First Manassas July 21, 1861

93. 92 War as a Prisoner’s Dilemma Problem The Absence of a Bargaining Space

94. 93 War as a Prisoner’s Dilemma Problem Agent Misbehavior Sir Charles Napier: “peccavi!”

95. 94 All we are saying is … Give Contracts a Chance Iranians employing the defect strategy

96. Is there no cooperation without binding contracts? 95

97. Cooperation without Law?  Voting 96

98. Cooperation without Law?  Voting  No littering 97

99. Cooperation without Law?  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… 98

100. 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… 99

101. Open Source Software 100 Linux Mascot

102. Crowdsourcing 101

103. Bloggers vs. Mainstream Media 102

104. 103 George Mason School of Law Contracts I Bargaining Games F.H. Buckley fbuckley@gmu.edu