Ch 8 Economics Theory of Contract law | Cooter & Ulen part 2 | law and economics

An Economic Theory of Contract Enforcement
Economic efficiency would require that a promise be enforced if both the promisor and the
promisee wanted enforceability when the promise was made. (Contrast this with the bargain
theory’s answer to the first question.) Changing contract law in this manner would be Pareto
efficient. In this section, we replace the bargain theory with a more responsive theory of
contracts.
A. Cooperation and commitment
1. Deferred exchange is a central feature of contracts (promises). In those cases where the
passage of time is not an issue, enforceability of promises is not an issue.
2. In the case of deferred exchange various risks arise. Thus, the issue of enforceability
arises.
3. The thrust of the game theory example in the text is that cooperation is productive, i.e.,
new value is created, while appropriation is redistributive. Assuming a lack of
enforceability, many promises that would be productive would not be entered into due
to the risks involved. In the terminology of contracts we can think of cooperation as
performance of the terms of the contract and appropriation as breach of contract. Note
that this does not imply that breach is never efficient; a point we consider further
below. The first purpose of contract law is to enable people to convert games with
inefficient solutions into games with efficient solutions. Stated differently, people will
have an incentive to enter into promises that create value. In addition, having an
enforceable contract converts some games with a non-cooperative solution into games
with a cooperative solution. The concept of credible commitments is critically
important here.