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1 George Mason School of Law Contracts I Bargaining Gains F.H. Buckley

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1 1 George Mason School of Law Contracts I Bargaining Gains F.H. Buckley fbuckley@gmu.edu

2 Last Day: A Challenge How to explain why we ought to perform our promises or contracts 2

3 What books did the Founders read? 3 Don Lutz, Origins of American Constitutionalism (1988)

4 What books did the Founders read? 4 The Bible

5 What books did the Founders read? 5 The Bible The celebrated Montesquieu

6 What books did the Founders read? 6 The Bible The celebrated Montesquieu Blackstone

7 What books did the Founders read? 7 Henry Fonda as Young Mr. Lincoln

8 Sir William Blackstone Why did the Founders read him? 8 This review of our situation may fully justify the observation of [Montesquieu] that [England] is the only country in the world where political and civil liberty is the direct end of its constitution. Commentaries I.1

9 Sir William Blackstone So where did English liberties come from? 9 But the systems of jurisprudence, in our courts both of law and equity, are now equally artificial systems, founded in the same principles of justice and positive law. Commentaries I.3

10 Blackstone was simply adopting what Sir Edward Coke had said 150 years before 10 Then the King said, that he thought the Law was founded upon reason, and that he and others had reason, as well as the Judges. To which it was answered by me, that true it was, that God had endowed his Majesty with excellent Science, and great endowments of nature; but his Majesty was not learned in the Lawes of his Realm of England, and causes which concern the life, or inheritance, or goods, or fortunes of his Subjects; they are not to be decided by naturall reason but by the artificiall reason and judgment of Law, which Law is an act which requires long study and experience, before that a man can attain to the cognizance of it; 12 Co. Rep. 63

11 Things which cannot be explained naturally, without artificial reason 11

12 Things which cannot be explained naturally, without artificial reason 12

13 Things which cannot be explained naturally, without artificial reason 13

14 How did IOUs get reified (turned into a species of private property)? 14

15 How did IOUs get reified (turned into a species of private property)? 15 UCC 3-201. Negotiation means a transfer of possession, whether voluntary or involuntary, of an instrument by a person other than the issuer to a person who thereby becomes its holder.

16 So what purposes do such legal fictions serve? We seem to need a justification from outside, in the consequences which flow from adopting the institution. 16

17 So what purposes do such legal fictions serve? Autonomous lives are happier ones but why this kind of autonomy? Why promissory games and not tiddleywinks? 17

18 A Natural Law account of promising? X is unnatural. It follows that we ought not to do x. 18

19 A Natural Law account of promising? Promise-breaking is unnatural. It follows that we ought not to break our promises. 19

20 Lets look at that… Promise-breaking is unnatural. Really? 20

21 A Natural Law account of promising? 21 No trustworthy primitive record can be read without perceiving that the habit of mind which induces us to make good a promise is as yet imperfectly developed, and that acts of flagrant perfidy are often mentioned without blame, and sometimes described with approbation. -- Ancient Law, 1861

22 And even if it were otherwise… Just what would that tell you? 22

23 Humes Challenge to Natural Lawyers The is-ought distinction 23 In every system of morality, which I have hitherto met with, I have always remark'd, that the author proceeds for some time in the ordinary ways of reasoning, and … makes observations concerning human affairs; when all of a sudden I am surpriz'd to find, that instead of the usual copulations of propositions, is, and is not, I meet with no proposition that is not connected with an ought, or an ought not. This change is imperceptible; but is however, of the last consequence. For as this ought, or ought not, expresses some new relation or affirmation, 'tis necessary that … a reason should be given; for what seems altogether inconceivable, how this new relation can be a deduction from others, which are entirely different from it.

24 Humes Challenge to Natural Lawyers To say that people generally act in a certain way is not to say that they ought to do so unless some value is independently attributed to the act. 24

25 Can one derive an ought from an is? John Searle thought so. Promising is an institution in our language under which those who promise ought to perform. It is the case that I have promised. Therefore I ought to perform 25

26 Can one derive an ought from an is? John Searle thought so. Promising is an institution in our language under which those who promise ought to perform. It is the case that I have promised. Therefore I ought to perform But suppose I think the institution an evilor morally indifferent one. 26

27 Can one derive an ought from an is? John Searle thought so. But suppose I think the institution an evilor morally indifferent one. If I promise and fail to perform I will weaken the institutionbut so what? The case of dueling 27

28 Lets turn the syllogism around Promising is a just institution and those who promise ought to perform. It is the case that I have promised. Therefore I ought to perform 28

29 After Hume, we distinguish positive and normative theories Positive theories explain what is Normative theories explain what out to be. 29

30 Posners Positive Thesis 30 The common law IS efficient

31 A Normative Thesis The common law ought to serve efficiency goals. 31

32 A Normative Thesis The common law ought to serve efficiency goals. Whoa… 32

33 A Normative Thesis But in the case of promising, is there anything else going on? 33

34 A Normative Thesis The institutions of promising and contract law promote trust and permit people to rely on each other. 34

35 A Normative Thesis The institutions of promising and contract law promote trust and permit people to rely on each other. And that results in a wealthier society. 35

36 A Normative Thesis The institutions of promising and contract law promote trust and permit people to rely on each other. And that results in a wealthier society. And that results in a happier society. 36

37 A Normative Thesis In which case, the normative theory of promising comes down to a form of utilitarianism Social and legal institutions should promote the happiness of their members. 37

38 Thats not to say you have to buy into this 38 Whats so good about happiness? It cant buy you money George E. Jessel

39 Charles Baudelaire 39 I feel sorry for you, Msieu, that you are so easily made happy.

40 But what value would we want our legislator to embrace? 40

41 41 Why Enforce Contracts: An Economic Analysis of Bargaining Gains

42 42 Modeling Bargaining Gains Indifference Curves The Budget Line Consumer Choice Beneficial Reliance The Edgeworth Box Function Pareto-Superiority and Pareto- Optimality

43 43 0 Two dimensional Commodity Space: Every point represents a combination of the two commodities X axis Y axis Commodity x Commodity y

44 44 0 Two dimensional Commodity Space: Every point represents a combination of the two commodities X axis Y axis A X* Y* 44

45 45 0 The Commodities: Dollars in Two Time Periods Dollars in Time 2 Dollars in Time 1 A X* Y* 45

46 46 Dollars in Time 1 0 Dollars in Time 2 Commodity space: Dollars consumed in two time periods More of both

47 47 The Budget Line: Allocating $100 between two periods Dollars in Time 1 100 0 Dollars in Time 2 The budget line in red represents every trade-off of $100 in two periods

48 48 Indifference Curves: Preferences about Consumption Dollars in Time 1 0 Dollars in T ime 2 An indifference curve represents a set of trade-offs to which the subject is indifferent

49 49 A C: Subject is willing to give up $BC in Time 2 for $AB in Time 1 Dollars in Time 1 0 Dollars in T ime 2 B C A

50 50 A C: Subject is willing to give up $BC in Time 2 for $AB in Time 1 Dollars in Time 1 Convexity (curve bends inward) assumes decreasing marginal utility 0 Dollars in T ime 2 B C A

51 51 Indifference Curves: Preferences about Consumption Dollars in Time 1 0 Dollars in T ime 2 One is better off the further one gets from the origin

52 52 Dollars in Time 1 0 Dollars in Time 2 More is better: I 2 > I 1 I1I1 I2I2 More is better

53 53 Dollars in Time 1 0 Dollars in Time 2 Ordinal Utility: We cant say how much better I 2 is than I 1 I1I1 I2I2 I3I3

54 54 Consumption Decision: Uncle Ebenezer gives David $100 I3I3 Time 1 I 2 I 1 100 I 2 I 1 0 Time 2

55 55 Consumption Decision: David has $100 and is best off at A Maximization subject to the constraint of the Budget Line I3I3 Time 1 I 2 I 1 100 50 A I 2 I 1 0 100 Time 2

56 56 Consumption Decision: David has $100 and is best off at A Maximization subject to the constraint of the Budget Line I3I3 Time 1 I 2 I 1 100 50 A I 2 I 1 0 100 Time 2 B C B is not feasible C is not optimal 56

57 57 Consumption Decision: David has $100 and is best off at A Maximization subject to the constraint of the Budget Line I3I3 Time 1 I 2 I 1 100 50 A I 2 I 1 0 100 Time 2 B B is not optimal 57

58 58 Consumption Decision: David has $100 and is best off at A Maximization subject to the constraint of the Budget Line I3I3 Time 1 I 2 I 1 100 50 A I 2 I 1 0 100 Time 2 C B C is not feasible B is not optimal 58

59 Ebenezer gives David another $100: The Shift to a New Budget Line 200 I 100 A 50, 50 50 I 100 0 59

60 A new Consumption Decision B 100, 100 100 I 200 A 50, 50 50 I 100 I DR 0 50 100 Time 1 Time 2 60

61 61 What happens when the donor promises to give in the future? Uncle Ebenezer doesnt have the $100 to give today but promises to give it to David in the next period What Should David Do?

62 62 What happens when the donor promises to give in the future? Uncle Ebenezer doesnt have the $100 to give today but promises to give it to David in the next period Davids election: to rely or not to rely on the promise in the first period

63 The good scenario: David relies and Ebenezer performs B 100, 100 100 I 200 A 50, 50 50 I 100 0 50 100 200 Reliance by David means spending $100 in period 1 63

64 B 100, 100 I 100 I DR 0 50 100 A bad scenario: Detrimental Reliance: David relies and Ebenezer breaches C 100,0 D A 50, 50 50 Time 1 David spends 100 in period 1 and now has nothing left to spend in period 2 64

65 B 100, 100 I 100 I DR 0 50 100 A bad scenario: Detrimental Reliance: David relies and Ebenezer breaches C 100,0 D A 50, 50 50 Time 1 What do we need to give David to make him as well off as he would be had the promise been performed? 65

66 B 100, 100 I 100 I DR 0 50 100 A bad scenario: Detrimental Reliance: David relies and Ebenezer breaches C 100,0 D A 50, 50 50 Time 1 The Expectation Interest is CB, or $100 66

67 B 100, 100 I 100 I DR 0 50 100 A bad scenario: Detrimental Reliance: David relies and Ebenezer breaches C 100,0 D A 50, 50 50 Time 1 What do we need to give David to make him as well off as he would have been had the promise not been made, or had he not relied? 67

68 B 100, 100 I 100 I DR 0 50 100 A bad scenario: Detrimental Reliance: David relies and Ebenezer breaches C 100,0 D A 50, 50 50 Time 1 The Reliance Interest is CD, or about $25 68

69 69 Fool me once…: Non-reliance: David assumes Ebenezer will breach Time 1 I 1 100 50 B I 1 0 100 Time 2 Now David spends only 50 in period 1

70 70 Fool me once…: Non-reliance: Ebenezer breaches: No harm, no foul Time 1 I 1 100 50 B I 1 0 100 Time 2 Now David spends only 50 in period 1

71 100 I 200 50 E 150, 50 0 100 150 Loss of Beneficial Reliance: David doesnt rely and Ebenezer performs I no- reliance Goetz and Scott, 89 Yale L.J. 1261 (1980) David spends only 50 in period 1 71 Where David is on performance

72 B 100, 100 100 I 200 50 E 150, 50 0 100 150 Loss of Beneficial Reliance: David doesnt rely and Ebenezer performs I no- reliance Goetz and Scott, 89 Yale L.J. 1261 (1980) David spends only 50 in period 1 Where David would have been had he relied 72

73 B 100, 100 100 I 200 50 E 150, 50 0 100 150 Loss of Beneficial Reliance: David doesnt rely and Ebenezer performs I no- reliance Goetz and Scott, 89 Yale L.J. 1261 (1980) 73

74 74 Enforceable Contracts provide the gains associated with beneficial reliance

75 Now: How parties gain from contracting 75 If one person does not lose, the other does not gain. St. Augustine

76 76 Modeling a Bargain: Mums and Roses 0 Mums Roses

77 77 Mums Mary Roses Two bargainers Mums Bess Roses

78 78 Mums Mary Roses Rotating Besss diagram I Roses Mums Bess

79 79 Mums Mary Roses Rotating Besss diagram II Roses Mums Bess

80 80 Rotating Besss diagram III Mums

81 81 Rotating Besss diagram IV Mums Bess Roses

82 82 Rotating Besss diagram V 0 0 Roses

83 83 Mary Edgeworth Box Function: Bargaining from endowment point A 0 Bess A 0

84 84 Edgeworth Box Function: Bargaining from endowment point A Mary Bess A 0 0

85 85 Edgeworth Box Function: Bargaining from endowment point A Mary Bess A 0 0 Roses bess Mums mary Mums bess Roses mary

86 86 Paretian standards Vilfredo Pareto (1848-1923) Pareto-superiority: A transformation from A to B is Pareto-superior if at least one person is better off and no one is worse off Pareto-optimality: No further Pareto- superior transformations are possible

87 87 Are these attractive moral standards? Paretian man is not an altruist He takes no interest in the other person

88 88 Are these attractive moral standards? The bourgeoisie … has pitilessly torn asunder the motley feudal ties … and has left remaining no other nexus between man and man than naked self-interest, than callous cash payment. It has drowned the most heavenly ecstasies of religious fervour, of chivalrous enthusiasm, of philistine sentimentalism, in the icy water of egotistical calculation.

89 89 Are these attractive moral standards? Whats so good about altruism?

90 90 Are these attractive moral standards? Altruists Sir William Beechey, Sir Francis Fords Children Giving a Coin to a Beggar Boy

91 91 Are these attractive moral standards? Altruists Which child is showing empathy?

92 92 Are these attractive moral standards? Altruists Who is showing empathy?

93 93 Are these attractive moral standards? Altruists Who is showing empathy?

94 94 Are these attractive moral standards? Altruists What happens to him tomorrow?

95 95 Are these attractive moral standards? Altruists Is sentiment a substitute for social and economic policies that reduce the distress that prompts sentimentality?

96 96 Are these attractive moral standards? Altruists Sentiment: I observe your distress and feel your pain Sentimentality: I observe the pain I feel at your distress and feel good about myself

97 97 Are these attractive moral standards? Heres another altruist Gericault, Portrait (Envy)

98 Is a complete lack of empathy an attractive quality for bargainers? 98

99 Defining Paretian Standards Pareto-superiority Pareto-optimality 99

100 100 B and C as Pareto-superior to A D and E as Pareto-inferior Mary Bess A B C D E Coleman, 8 Hofstra L.Rev. 905 (1980)

101 101 Are all bargaining gains exploited at F? The bargaining lens shrinks through bargaining Mary Bess A B C D E F

102 102 Are all bargaining gains exploited at G? The bargaining lens disappears when the indifference curves are tangent Mary Bess A B C D E F G

103 103 A ~ C, A ~ B Mary Bess A B C D E F G 103

104 104 A < F Mary Bess A B C D E F G 104

105 105 A < F < G Mary Bess A B C D E F G 105

106 106 G is on the contract curve and no further Pareto- Superior transformations are possible Mary Bess A B C D E F G 106

107 107 Mary The Contract Curve: All possible Pareto-optimal contracts represented at the points of tangency Bess A B C D E F G

108 108 Further Readings Blackstones Commentaries, Book I, chapter 1 Of the Absolute Rights of Individuals, at lonang.com Goetz and Scott, Enforcing Promises: An Examination of the Basis of Contract, 89 Yale LJ 1261 (1980) 108

109 109 Contract Law in the State of Nature III.State of Nature.ppt 109


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