CONTRACTS – Exceptions To Coase’s Theorem October 24, 2006

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CONTRACTS – Exceptions To Coase’s Theorem October 24, 2006. Exceptions to the Theorem of Coase Asymmetric Information. Coase Theorem Exceptions To Coase Theorem Transaction Costs - October 17, 2006 Asymmetric Information - October 24, 2006 Empty Core - October 31, 2006. - PowerPoint PPT Presentation

Text of CONTRACTS – Exceptions To Coase’s Theorem October 24, 2006

  • CONTRACTS Exceptions To Coases TheoremOctober 24, 2006

  • Exceptions to the Theorem of CoaseAsymmetric Information

    Coase TheoremExceptions To Coase TheoremTransaction Costs - October 17, 2006Asymmetric Information - October 24, 2006Empty Core - October 31, 2006

  • Exceptions to the Theorem of CoaseAsymmetric InformationCOLOUR CODE FOR GRAPHSMarginal Cost Curve for Agent (firm, individual) under a strict liability ruleMarginal Cost Curve for Agent (firm, individual) under a no liability ruleMarginal Cost Curve for Agent (firm, individual) under a negotiated contract that follows the Theoem of CoaseDemand Curve for the Agents outputMarginal Revenue Curve

  • Exceptions to the Theorem of CoaseAsymmetric InformationCOLOUR CODE FOR GRAPHSExpected Marginal Cost Curve for Agent (firm, individual)

  • Exceptions to the Theorem of CoaseAsymmetric InformationCOLOUR CODE FOR GRAPHS (cont)Average Cost Curve for Agent (firm, individual) with no transaction costsAverage Cost Curve for Agent (firm, individual) with transaction costsProfit of Agent (firm, individual) Portion of profit traded in exchange for property rights Portion of profit lost due to a trade in property rightsPortion of profit lost due to transaction costs

  • CONTRACTS Terms And Conditions

  • Exceptions to the Theorem of CoaseAsymmetric InformationRules that compensate for market failures

    (a)moral hazard (b)adverse selection(Cooter p. 267)

  • Exceptions to the Theorem of CoaseAsymmetric Information Approximate Taxonomy High TransactionLow Transaction Costs Costs

    PERFECT INFORMATIONIMPERFECT INFORMATIONDAMAGESINJUNCTIONDAMAGESINJUNCTION

  • Exceptions to the Theorem of CoaseAsymmetric InformationThe injunction is the optimal liability" rule if the property rule is strict liabilityIllegal Labour StrikesInfringement of Intellectual Property Rights

  • Exceptions to the Theorem of CoaseAsymmetric Information - InjunctionWhen the relevant economic information is not symmetrically known, then the injunction might serve to more "clearly" assign a property right, instead of damages Why? Injunctions are clearer and simpler because the determination of damages in the courts can be both imprecise and uncertain when information is asymmetric.How long will the illegal strike last?How many copies of Cold Play were downloaded?

  • Exceptions to the Theorem of CoaseAsymmetric Information InjunctionThe measurement of damages inflicted upon the recipient of pollution may not be reliably verifiableHere the state (or court) might choose to impose an injunction against the polluter so that the polluter will take its own initiative to internalize the pollution.

  • Exceptions to the Theorem of CoaseAsymmetric Information - InjunctionIt may be less costly for the polluters to internalize the pollution than to incur the transaction costs to ascertain the true level of harm in damages.studiesexpertshiring lawyersgoing to court

  • Exceptions to the Theorem of CoaseAsymmetric Information - InjunctionHowever, such injunctions still work best when transaction costs are relatively low enough to reach private agreements. McKie v. KVP

  • CONTRACTS Terms And Conditions

  • Exceptions to the Theorem of CoaseAsymmetric Information When information is asymmetric, parties to contracts still communicate information.

    Two models:Agent To Principal SignallingPrincipal To Agent - Screening

  • Exceptions to the Theorem of CoaseAsymmetric Information - SignallingFormation Of ContractsPrincipal Makes An Offer To An AgentAgent Accepts The OfferPerformance Of The ContractAgent Sends ASignal to the Principal

  • Exceptions to the Theorem of CoaseAsymmetric Information - SignallingSignalling games include agents choosing credentials to signal their ability, without any formal contract offer from principals.

    EXAMPLE: Voluntary submission of transcripts

  • Exceptions to the Theorem of CoaseAsymmetric Information - Signalling

    A signaling game is an adverse selection game where the informed party (agent) is the first mover.

    Another Example: A seller offers a warranty on a product sold What is the signal? Longer the warranty the lower the cost the seller expects to pay if the product needs to be replaced

  • CONTRACTS Terms And Conditions

  • Exceptions to the Theorem of CoaseAsymmetric Information - ScreeningFormation Of ContractsPrincipal makes more than one kind of offer tothe Agent.Each Agent type self-selects their optimal choice of offerPerformance Of The Contract

  • Exceptions to the Theorem of CoaseAsymmetric Information - ScreeningScreening games include agents choosing those contracts that provide them maximum recovery at least cost.

    EXAMPLE: Insurance contracts

  • Exceptions to the Theorem of CoaseAsymmetric Information - ScreeningIf a principal does not know which agent type is present, he or she writes more than one type of contract to sort the agent types

    EXAMPLE: Suppose an agent does not want to disclose their entire wealth.

    This low disclosure agent can choose cheaper insurance with more limited coverage.

  • Exceptions to the Theorem of CoaseAsymmetric Information - ScreeningA major part of contract theory is default rules. Contracts are usually incomplete and therefore a court or legislature must fill gaps.This involves sub-agencies

  • Exceptions to the Theorem of CoaseAsymmetric Information - ScreeningIf a court anticipates that more than one contract type could appear in court on a breach of contract issue, it can write different rules to match each contract type.

    EXAMPLE: Suppose an agent does not want to disclose their entire wealth to a security agent.

    This low disclosure agent has, in effect chosen a lower recovery rule for damages.

  • Exceptions to the Theorem of CoaseAsymmetric Information - ScreeningA principal in a private bilateral contract relationship writes a contract that may serve to sort or separate agents into more efficient contractsA court in a private bilateral agency relationship writes a rule that may serve to sort or separate contracts into more efficient outcomes

  • Exceptions to the Theorem of CoaseAsymmetric Information - Screening.PRINCIPAL

    AGENTPRINCIPAL

    AGENTCourt (as a Principal) imposes a rule with choices on a Principal Agent contract

  • CONTRACTS Terms And Conditions

  • Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145Agent Accepts The OfferCourt Imposes A Rule with Choiceson a Principal and an AgentPrincipal Makes An Offer To An AgentPerformance Of The ContractAgent Accepts The OfferSub-Agency

  • Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145

    In Hadley v. Baxendale, a court established a rule which attempted to avoid adverse selection results in breach of contract cases

  • Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145

    Hadley owned a gristmillHadley entered into a contract with Baxendale, a carrier, to carry a broken crankshaft to engineers to Greenwich for repair

  • Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145

    Repair of the crankshaft was delayed several daysAs a result, Hadleys mill was shut down while awaiting return of the repaired shaft

  • Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145Hadley claimed profits lost during the shutdown periodTrial court rules in Hadleys favourThis was reversed in the Court of AppealThis court established or reaffirmed the primary rule of contract law: ... that the amount which would have been received if the contract had been kept, is the measure of damages if the contract is broken."

  • Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145The Court of Appeal held Hadleys lost profits were not recoverable Hadley had not made full disclosure to Baxendale about his reliance on the damaged crankshaft in order to emphasize the urgency of the problem

  • Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145Only what is disclosed to Baxendale can be included in the recovery of damages:Now, if the special circumstances under which the contract was actually made were communicated by the plaintiffs to the defendants, and thus known to both parties, the damages resulting from the breach of such a contract, which they would reasonably contemplate, would be the amount of injury, which would ordinarily follow from a breach of contract under these circumstances so known and communicated.

  • Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145However, Baxendale was still liable for some damages due to his inattention to the delivery of the crankshaft:But, on the other had, if these special circumstances were wholly unknown to the party breaking the contract, he, at the most, could only be supposed to have had in his contemplation the amount of injury which would arise generally, and in the great multitude of cases not affected by any special circumstances, from such breach of contract.

  • Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145So the Court of Appeal established two rules for recovery (or two (2) branches of the rule)Recovery of damages is lower when Hadley chooses not to disclose the nature of his reliance in the crankshaftRecovery of damages is higher had Hadley chosen to disclose the nature of his reliance in the crankshaft

  • Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145Agent Accepts The OfferCourt Imposes A Rule with Choic