Law and Economics-Charles W. Upton

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The Waffle Shop

• Yvonne owns a waffle shop. She wants to expand the shop and contracts with Xavier for an addition to be ready at the start of the school year.

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The Waffle Shop

• Yvonne owns a waffle shop. She wants to expand the shop and contracts with Xavier for an addition to be ready at the start of the school year. – Xavier has a problem. The more he spends on

precaution, the greater the probability of the job being done.

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The Waffle Shop

• Yvonne owns a waffle shop. She wants to expand the shop and contracts with Xavier for an addition to be ready at the start of the school year. – But Yvonne also has a problem. She faces two

revenue functions for September, depending on how much food she orders and whether Xavier is finished on time.

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Assumptions

• X = Xavier’s expenditures on precaution

• Y = Amount of food Yvonne orders.

• Rnot(y) = Yvonne’s revenue function, not ready

• Rready(y) = Yvonne’s revenue function, ready

• P(x) = Probability of facility being ready

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The correct problem to solve is to choose x and y to maximize

p(x)Rready(y) + (1-p(x))Rnot(y) - y - x

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The correct problem to solve is to choose x and y to maximize

p(x)Rready(y) + (1-p(x))Rnot(y) - y - x

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The correct problem to solve is to choose x and y to maximize

p(x)Rready(y) + (1-p(x))Rnot(y) - y - x

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The correct problem to solve is to choose x and y to maximize

p(x)Rready(y) + (1-p(x))Rnot(y) - y - x

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The correct problem to solve is to choose x and y to maximize

p(x)Rready(y) + (1-p(x))Rnot(y) - y - x

and that problem has a solution

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p(x)Rready(y) + (1-p(x))Rnot(y) - y – x

p’(x)[Rready (y) - Rnot (y)] - 1 = 0

p(x)R’ ready(y)+ (1-p(x))R’not (y) -1 = 0

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p(x)Rready(y) + (1-p(x))Rnot(y) - y – x

p’(x)[Rready (y) - Rnot (y)] - 1 = 0

p(x)R’ ready(y)+ (1-p(x))R’not (y) -1 = 0

Let x* and y* be the optimal levels

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• If his damages are

Rready (y*) - Rnot (y*)

• Xavier will minimize

P(x) [Rready (y*) - Rnot (y*)]-x

and come to the right solution

Xavier

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• If her compensation is

Rready (y*) - Rnot (y*)

• She will maximize

p(x)Rready(y) + (1-p(x))Rnot(y) – y +[1-p(x)] [Rready (y*) - Rnot (y*)]

and come to the right solution

Yvonne

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Conclusion

• Use perfect expectation damages assuming reasonable reliance.

• If– You can measure reasonable reliance

• Else people get interested in other alternatives

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The Chart

Can you measure expectation

damages assuming reasonable reliance

accurately?

Yes

Do it

NoAlternatives

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Alternatives

Can you measure opportunity cost

damages assuming reasonable reliance

accurately?

Yes

Do it

NoAlternatives

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Alternatives

Can you measure reliance damages

assuming reasonable reliance

accurately?

Yes

Do it

NoAlternatives

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Alternative Damages

• Restitution

• Disgorgement

• Liquidated Damages– Contract-specified damages

• Specific Performance

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Alternative Damages

• Restitution• Disgorgement

• Liquidated Damages– Contract-specified damages

• Specific Performance

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Alternative Damages

• Restitution

• Disgorgement• Liquidated Damages

– Contract-specified damages

• Specific Performance

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Alternative Damages

• Restitution

• Disgorgement

• Liquidated Damages– Contract-specified damages

• Specific Performance

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Alternative Damages

• Restitution

• Disgorgement

• Liquidated Damages– Contract-specified damages

• Specific Performance

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End

©2004 Charles W. Upton