1. Suppose A orders a machine from B for delivery several months from now. A incurs reliance expenditures of $10 that are fixed and independent of the measure of contract damages. Assume A’s reliance expenditures have scrap value equal to $10 and B’s cost of manufacture are not known at the time the contract is signed. The probability of B breaching is the same
(a) under the expectation and reliance measure of damages.
(b) under the zero damage and reliance measure of damages.
(c) under the zero damage and expectation measure of damages.
(d) under all three measures of damages.
(e) if the contract price is constant and independent of the measure of damages.
2. Suppose A agrees to buy X from B at a price of k but B breaches because another buyer C offers a higher price equal to m. Suppose further that A cannot not find a substitute for X because it is unique. This is an efficient breach if
(a) the value of X to A at the time of the breach less than m.
(b) if damages were set at the difference between m and k and B still chooses to breach.
(c) if damages were set at the difference between m and k plus A’s reliance expenditures and B still chooses to breach.
(d) B’s cost of manufacturing X is greater than k but less than m.
(e) the breach occurs before A incurs any reliance expenditures.
3. Let A contract to buy a custom made machine from B for $100 to be paid upon delivery. Delivery is expected in three months. A expects to earn $20 in profits after deducting the contract price and reliance of $10 and B expects to earn $10 in profits after deducting its expected costs. A’s reliance expenditures, however, turn out to be $40 not $10. According to the efficient breach/performance decision, the following statement can be made.
(a) A should breach if B’s costs are greater than $100 so that it is also a losing contract for B.
(b) Since this is a losing contract for A, it may be efficient for A but not B to breach.
(c) It is efficient for B to breach if its costs are greater than A’s negative lost profits plus the contract price of $100.
(d) It is efficient for B to breach if its costs are greater than $130.
(e) No general statement can be made about the efficient breach decision because the parties should not have entered a losing contract in the first place.
4. Assume the same facts as question #34 but add that B’s reliance (= the costs B would incur prior to A’s breach) are $60 and the cost of completing the machine is $80. (Therefore, this is a losing contract to B.) Assuming A contemplates breach because the value of having the machine declines, the efficient performance/breach decision requires A to pay damages of
(a) $20
(b) $40
(c) $60
(d) $80
(e) $100
5. B agrees to supply data processing services for A under a one year contract for $12,000. B anticipates that the cost of providing these services will equal $10.000. B’s actual costs are $8000, all of which B incurs during the first three months of the contract—i.e., B would incur no additional costs over the next 9 months. Six months after the contract is signed A cancels its contract. The efficient measure of damages is
(a) lost profits of $4000 since B’s costs of $8000 have already been incurred and therefore do not depend on whether or not A breaches the contract.
(b) expected profits of $2,000 plus one-half of B’s expected cost of $10,000.
(c) the contract price of $12,000.
(d) $5000 which equals the effective contract price for six months of service.
(e) none of the above.
6. Assume A’s expected recovery in a suit against B equals $1,000, and its cost of litigating the case to trial equals $200. B’s expected liability equals $900 and its cost of litigation equals $100. Assuming zero settlement cost,
(a) the parties will be indifferent between settling and litigating because A’s minimum settlement demand and B’s maximum offer both equal $800.
(b) the parties will be indifferent between settling and litigating only if they are risk neutral
(c) since the parties are mutually optimistic there will be no settlement.
(d) the parties will settle if they are risk averse.
(e) since A’s litigation cost exceeds B’s cost, A will benefit more than B from settling compared to the expected value of trial.
7. In comparing the American to the English Rule of fee shifting, economics predicts that
(a) plaintiffs are more likely to file lawsuits under the English rule because there is a positive probability that their litigation expenses will be shifted to the defendant.
(b) a settlement is more likely to be Pareto efficient under the American rule since neither party will act as if its legal fees will be shifted to the other party.
(c) society’s total litigation costs will fall under the English rule if the reduction in filings of frivolous (or low probability of the plaintiff prevailing) lawsuits more than offsets the greater incentive to file meritorious lawsuits.
(d) when the precedents governing a lawsuit are very clear, each party’s expected litigation costs will be lower under the English than American rule.
(e) the likelihood of settling will be lower under the English rule if the parties are mutually optimistic because expected litigation costs are lower than under the American rule.