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Chapter 13: Problem 6

Which remedy is more likely to achieve efficiency: expectation damages or restitution damages? Explain.

Short Answer

Expert verified
Expectation damages are more likely to achieve efficiency as they align incentives with economic benefits.

Step by step solution

01

Understand Expectation Damages

Expectation damages aim to put the injured party in the position they would have been in if the contract had been performed as expected. This includes covering the expected benefits from the contract.
02

Understand Restitution Damages

Restitution damages focus on restoring to the injured party any benefits they have conferred to the breaching party. It aims to prevent the breaching party from being unjustly enriched.
03

Analyze Efficiency of Expectation Damages

Expectation damages are more likely to achieve efficiency because they incentivize parties to perform or efficiently breach. When breaching results in compensation that mirrors expected contract benefits, parties are encouraged to breach only if gains exceed prior contract costs to both parties.
04

Analyze Efficiency of Restitution Damages

Restitution damages prioritize fairness by preventing unjust enrichment but do not directly encourage efficient outcomes. They return the status quo but may not compensate fully for expected benefits, leading to an efficiency loss if the injured party cannot realize their expected advantages.
05

Compare and Conclude

Comparing both, expectation damages create an economic incentive for the contract to be performed or breached efficiently by compensating expected gains. Restitution addresses fairness rather than economic efficiency directly, potentially hindering contract efficiency when expected benefits are not recovered.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Expectation Damages
Expectation damages are a type of legal remedy in contract law designed to ensure that the injured party receives what they were promised in the contract. If a contract is not fulfilled as planned, expectation damages aim to compensate the injured party by putting them in the financial position they would have been if the contract was performed as expected. This includes all benefits and profits they anticipated from the contract.

The importance of expectation damages lies in their ability to promote efficient contract behavior. By promising compensation that reflects the expected contract benefits, parties are motivated to fulfill contracts or only breach them when it's economically beneficial for all involved. This principle ensures that breaches only occur to streamline resources, contributing to overall economic efficiency.
Restitution Damages
Restitution damages serve a different purpose compared to expectation damages. They focus on returning to the injured party any benefit provided to the breaching party under the contract. The goal of restitution is to prevent unjust enrichment of the breaching party rather than ensuring the injured party receives what they expected from the contract.

This remedy is rooted in fairness. It aims to void the unjust advantage gained by the party who breaks the contract. However, since restitution does not necessarily account for the expected benefits the injured party would have received, it might fall short in achieving full economic efficiency. While restitution restores a balance, it might not fully recognize the injured party's expectations, potentially leading to inefficiency.
Economic Efficiency
Economic efficiency in contract remedies revolves around the idea of maximizing the total benefits generated by contractual agreements. When remedies are aimed at achieving economic efficiency, they align with how resources can be distributed to maximize value.

Expectation damages often align more closely with economic efficiency. By encouraging parties to only breach contracts when the benefits of breaching outweigh the costs of fulfilling the contract, these damages ensure that resources are used most effectively. Conversely, restitution damages emphasize fairness rather than efficiency, as they do not motivate parties to consider the total economic implications of their actions as directly.
Injured Party
The injured party in a contract breach is the person or entity that suffers a loss due to another party's failure to fulfill their contractual obligations. Ensuring that the injured party is adequately compensated is a primary goal of contract law remedies, such as expectation and restitution damages.

Fixing the loss experienced by the injured party involves understanding the nature of the benefits they were promised. Expectation damages focus on compensating them for lost benefits, while restitution aims to return what they contributed to the breaching party. The choice between these remedies can significantly affect how well the injured party recovers from the breach and how contracts are structured in the future.
Contract Breach
A contract breach occurs when a party involved in a contractual agreement fails to deliver on any part of their obligation without a lawful excuse. This breach can lead to legal consequences and calls for remedies to address the resulting losses.

Evaluating the best remedy for a contract breach involves balancing between rectifying the loss experienced by the injured party and promoting future contractual honesty and efficiency. Expectation damages encourage maintaining economic incentives and avoiding breaches unless necessary for greater efficiency. Meanwhile, restitution focuses on fairness and preventing any unjust advantage gained through the breach. Both remedies have their roles in managing the consequences of a contract breach effectively.

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Most popular questions from this chapter

Suppose that Shtinki Corporation operates a chemical plant, which is located on the Hudson River. Downstream from the chemical plant is a group of fisheries. The Shtinki plant emits some byproducts that pollute the river, causing harm to the fisheries. The profit Shtinki obtains from operating the chemical plant is a positive number \(X\). The harm inflicted on the fisheries due to water pollution is measured to be \(Y\) in terms of lost profits. If the Shtinki plant is shut down, then Shtinki loses \(X\) while the fisheries gain \(Y\). Suppose that the fisheries collectively sue Shtinki Corporation. It is easily verified in court that Shtinki's plant pollutes the river. However, the values \(X\) and \(Y\) cannot be verified by the court, although they are commonly known to the litigants. Suppose that the court requires the fisheries' attorney (player 1) and the Shtinki attorney (player 2 ) to play the following litigation game. Player 1 is supposed to announce a number \(y\), which the court interprets as the fisheries' claim about their profit loss \(Y\). Player 2 is to announce a number \(x\), which the court interprets as a claim about \(X\). The announcements are made simultaneously and independently. Then the court uses Posner's nuisance rule to make its decision. \({ }^{9}\) According to the rule, if \(y>x\), then Shtinki must shut down its chemical plant. If \(x \geq y\), then the court allows Shtinki to operate the plant, but the court also requires Shtinki to pay the fisheries the amount \(y\). Note that the court cannot force the attorneys to tell the truth. Assume the attorneys want to maximize the profits of their clients. (a) Represent this game in the normal form by describing the strategy spaces and payoff functions. (b) For the case in which \(X>Y\), compute the Nash equilibria of the litigation game. (c) For the case in which \(X

Consider a contractual setting in which the technology of the relationship is given by the following underlying game: Suppose an external enforcer will compel transfer \(\alpha\) from player 2 to player 1 if (N, I) is played, transfer \(\beta\) from player 2 to player 1 if (I, N) is played, and transfer \(\gamma\) from player 2 to player 1 if \((\mathrm{N}, \mathrm{N})\) is played. The players wish to support the investment outcome (I, I). (a) Suppose there is limited verifiability, so that \(\alpha=\beta=\gamma\) is required. Assume that this number is set by the players' contract. Write the matrix representing the induced game and determine whether (I, I) can be enforced. Explain your answer. (b) Suppose there is full verifiability, but that \(\alpha, \beta\), and \(\gamma\) represent reliance damages imposed by the court. Write the matrix representing the induced game and determine whether (I, I) can be enforced. Explain your answer.

Consider the following two-player team production problem. Each player \(i\) chooses a level of effort \(a_{i} \geq 0\) at a personal cost of \(a_{i}^{2}\). The players select their effort levels simultaneously and independently. Efforts \(a_{1}\) and \(a_{2}\) generate revenue of \(r=4\left(a_{1}+a_{2}\right)\). There is limited verifiability in that the external enforcer (court) can verify only the revenue generated by the players, not the players' individual effort levels. Therefore, the players are limited to revenue-sharing contracts, which can be represented by two functions \(f_{1}:[0, \infty) \rightarrow[0, \infty)\) and \(f_{2}:[0, \infty) \rightarrow[0, \infty)\). For each player \(i, f_{i}(r)\) is the monetary amount given to player \(i\) when the revenue is \(r\). We require \(f_{1}(r)+f_{2}(r) \leq r\) for every \(r .\) Call a contract balanced if, for every revenue level \(r\), it is the case that \(f_{1}(r)+f_{2}(r)=r\). That is, the revenue is completely allocated between the players. A contract is unbalanced if \(f_{1}(r)+f_{2}(r)

Discuss a real-world example of a contractual situation with limited verifiability. How do the parties deal with this contractual imperfection?

Consider a two-player contractual setting in which the players produce as a team. In the underlying game, players 1 and 2 each select high (H) or low (L) effort. A player who selects H pays a cost of 3 ; selecting \(\mathrm{L}\) costs nothing. The players equally share the revenue that their efforts produce. If they both select \(\mathrm{H}\), then revenue is 10 . If they both select \(\mathrm{L}\), then revenue is 0 . If one of them selects \(\mathrm{H}\) and the other selects \(\mathrm{L}\), then revenue is \(x\). Thus, if both players choose \(\mathrm{H}\), then they each obtain a payoff of \(\frac{1}{2} \cdot 10-3=2\); if player 1 selects \(\mathrm{H}\) and player 2 selects \(\mathrm{L}\), then player 1 gets \(\frac{1}{2} \cdot x-3\) and player 2 gets \(\frac{1}{2} \cdot x\); and so on. Assume that \(x\) is between 0 and 10 . Suppose a contract specifies the following monetary transfers from player 2 to player \(1: \alpha\) if \((\mathrm{L}, \mathrm{H})\) is played, \(\beta\) if \((\mathrm{H}, \mathrm{L})\) is played, and \(\gamma\) if \((\mathrm{L}, \mathrm{L})\) is played. (a) Suppose that there is limited verifiability in the sense that the court can observe only the revenue \((10, x\), or 0\()\) of the team, rather than the players' individual effort levels. How does this constrain \(\alpha, \beta\), and \(\gamma\) ? (b) What must be true about \(x\) to guarantee that \((\mathrm{H}, \mathrm{H})\) can be achieved with limited verifiability?
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