Richard Craswell

Precontractual Investigation as an Optimal Precaution Problem

A PROMISE often requires the promisor to exercise care in seeing that the promise is carried out. However, it is sometimes even more important for the promisor to take care earlier, in deciding whether to make the promise. Consider the following examples: CASE 1. S promises to build a house for B on Bs land, so B turns down an offer to sell his land and buy another site with a house already on it. Two weeks later, S discovers that it is impossible to build on Bs land (except at a prohibitive cost), as the ground is too hard to sink a proper foundation. By this time, the other site B was considering has already been sold, and no other acceptable site is available. CASE 2. S submits the low bid of

Deterrence and Damages: The Multiplier Principle and its Alternatives

8,000 for Bs construction project, so B turns down the other bidders, including the next-lowest bid of

Chapter 1 Contract Law

10,000. Two weeks later, S discovers a mistake in her calculations: it will actually cost her

Kaplow and Shavell on the Substance of Fairness

15,000 to do the job. By this time, the other bidders have accepted jobs elsewhere and are no longer available. CASE 3. S agrees to sell B her land, so B has an architect draw up plans for a building on the site. Two weeks later, S changes her mind, realizing that she does not really want to sell her land for any price that B would be willing to pay. Bs architectural plans are specific to that site, so B will have to pay for new plans if he acquires some other piece of property. In each case, interesting questions can be asked about whether S

Damage Multipliers in Market Relationships

When enforcement is imperfect, so the probability that any given violation will be punished is less than 100%, it is often said that the ideal penalty (insofar as deterrence is concerned) equals the harm caused by the violation multiplied by one over the probability of punishment. In most contexts where enforcement is imperfect, however, the probability of punishment will decline with any improvement in a defendants behavior. If so, the deterrent effect will differ depending on whether the multiplier is calculated (1) case by case, to reflect each defendants actual probability of punishment, or (2) on an average basis, to reflect the average probability of punishment facing all defendants. The deterrent effect will also be different if the law uses (3) a constant fine, based on the average probability of punishment and the average harm. This paper analyzes the deterrent effects of all three regimes (focusing on the latter two, which are much more common in real legal systems). Under the latter two regimes, optimal deterrence generally is not achieved by following the conventional wisdom, and setting the expected punishment equal to the expected harm divided by the probability of punishment. Under the second regime, optimal penalties will be (weakly) lower than this benchmark; under the third regime, optimal penalties could be either higher or lower. The paper also discusses the administrative differences between the regimes, such as the informational demands they place on the legal system, or the effect of each regime on risk-aversion and on litigation costs.

Freedom of Contract

Abstract This chapter surveys major issues arising in the economic analysis of contract law. It begins with an introductory discussion of scope and methodology, and then addresses four main topics that correspond to the major doctrinal divisions of the law of contracts. These divisions include freedom of contract (the extent of private power to create binding obligations), formation of contracts (the procedural mechanics of exchange, and the rules that govern pre-contractual behavior), contract interpretation (the consequences that follow when agreements are ambiguous or incomplete), and enforcement of contractual obligations (the choice between private and public enforcement, and the legal remedies that follow from breach of contract). In each of these sections, we provide an economic analysis of relevant legal rules and institutions, and of the connections between legal arrangements and corresponding topics in microeconomic theory, such as welfare economics and the theory of contracts.

Passing on the Costs of Legal Rules: Efficiency and Distribution in Buyer-Seller Relationships

Louis Kaplow and Steven Shavell argue that “fairness” should be disregarded when choosing legal rules. One of their arguments, which rests on the Pareto principle, purports to apply to any theory of fairness, whatever its substance. But Kaplow and Shavell also make many other arguments criticizing the substance of particular fairness theories, as those theories have been applied to particular fields of law. This paper argues that this second set of arguments—the ones that focus on the substance of particular fairness theories—represents the more significant part of Kaplow and Shavells analysis. That is, while the first argument may not succeed in refuting any theory of fairness, regardless of its content, their criticisms based on the substance of particular fairness theories still have considerable force.

Contract Law, Default Rules, and the Philosophy of Promising

It is sometimes said that the optimal sanction is the external harm caused by the offense multiplied by one over the probability of punishment. Prior analyses have identified several factors that could raise or lower this optimal multiplier. This article identifies an additional adjustment when victims are customers of the offender and the sanction is paid to victims in the form of damages. In these market relationships, higher sanctions translate into higher prices for customers. If customers are risk-neutral, this will not matter; but if customers are risk-averse, higher sanctions increase the variance of their returns (even if third-party insurance is available). If customers are risk-averse, the optimal number of violations and the optimal quantity of purchases could also change. The net effect could either raise or lower the optimal multiplier, but simulations suggest reductions on the order of 4-40 percent.