1 George Mason School of Law Contracts I MW 600 – 740 Hazel 120 F.H. Buckley

2 Contracts I 1.Why Enforce Contracts

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

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

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

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

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

8 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

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 Hon. Richard Posner University of Chicago Economic Analysis of Law

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

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

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 16 “A promise is not intelligible naturally, nor antecedent to human conventions.”

David Hume 17 What does this mean?

David Hume 18 Imagine a world without contract law and without the word “promise” in its language

Could promising exist without promissory institutions? 19 The Kingdom of Tonga

The Queen of Tonga With the Queen Mother at the Coronation,

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 26 “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.”

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 non- conventional 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 31 My statement is like a pit I have dug in the road, into which you fall Charles Fried

Autonomy and Reliance  The unrelied-on promise  The bootstrapping problem 32

David Hume 33 So we’re back to me

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? 37 “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

Autonomy 38 “By doing this I can facilitate the projects of others…and we can facilitate each other’s projects. Charles Fried

Autonomy 39 Charles Fried Does this collapse into an economic argument? Fried says not

Autonomy 40 Charles Fried “The obligation to keep a promise is grounded not in arguments of utility but in respect or individual autonomy and in trust.”

Autonomy 41 Charles Fried But suppose people were happier in Tonga?

Does that mean that promissory societies are to be preferred? 42 A Tonga Beach

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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? 51 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

52 The possibility of defection destroys trust Your corn is ripe today, mine will be so tomorrow… (Hume’s Treatise III.ii.V)

53 Contracts in the State of Nature Hobbes, Leviathan (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.

54 The Prisoners’ Dilemma Underlies Hobbes’ Insight  A simple game that has become the dominant paradigm for social scientists since it was invented about  How the game works – and why didn’t it work for Dilbert

55 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).

56 Hollywood gets in the act Russell Crowe as John Nash in “A Beautiful Mind”

57 The need for poetic license

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

59 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

60 Cooperate Player 1 Modeling Two-party choice

61 Defect Player 1 Modeling Two-party choice

62 Cooperate Player 2 Modeling Two-party choice: Player 2

63 Defect Player 2 Modeling Two-party choice Player 2

64 CooperateDefect Cooperate Both cooperate Defect Player 2 Player 1 Modeling Two-party Choice Both Cooperate

65 CooperateDefect Cooperate Defect Both defect Player 2 Player 1 Modeling Two-party Choice Both Defect

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

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

68 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

69 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

70 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

71 Cooperate 3 Defect4 Player 1 Defection dominates for Player 1 What should he do if Player 2 cooperates? 

72 Defect Cooperate Defect0 Player 1 Defection dominates for Player 1 What should he do if Player 2 defects? 

73 CooperateDefect Cooperate3 Defect40 Player 1 Defection dominates for Player 1 

74 CooperateDefect Cooperate34 Defect Player 2 Defection dominates for Player 2 What should he do if Player 1 cooperates? 

75 CooperateDefect Cooperate Defect0 Player 2 Defection dominates for Player 2 What should he do if Player 1 defects? 

76 CooperateDefect Cooperate34 Defect0 Player 2 Defection dominates for Player 2  

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

78 Joint defection Can these gentlemen be acting efficiently? An inefficient honor code

79 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…

80 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."

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

82 The Tragedy of the Commons and the Law of the Sea )

83 War as a Prisoner’s Dilemma Problem So why doesn’t the Coase Theorem Work?

84 All we are saying is … Give Contracts a Chance Iranians employing the defect strategy

85 An application: Marriage Rembrandt, The Jewish Bride 1666 Marriage is more than a contract; it’s a covenant…

86 An application: Marriage Rembrandt, The Jewish Bride 1666 But it’s less than a contract if the parties have unilateral exit rights under no-fault divorce laws

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

88 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

89 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)

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

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

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

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

94 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?

95 Children as marriage-specific assets Divorce rate ——— Natality rate for married couples ———

96 Where Promises Can’t Be Relied on Akerlof, The Market for Lemons, 84 Q.J. Econ. 488 (1970)

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”)

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

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  What would you pay for one?

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  The trick: Seller’s willingness to sell is a signal

101 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?

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

Is there no cooperation without binding contracts?  Voting  No littering  Roadside politeness? 103

 It’s 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 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 106 Linux Mascot

Crowdsourcing 107

Bloggers vs. Mainstream Media 108

Gift Economies 109