Law and Economics Exam #2

1. The classic legal framework under which contracts are studied is known as:

a. Repeated game theory
b. Contract theory
c. Bargain theory
d. Nash theory

c. Bargain theory

2. Imagine that a rich uncle learns that his nephew graduated from university with honors. Upon learning this, the uncle promises the nephew a free trip around the world. Later, the uncle breaks this promise and does not send his nephew around the world. The nephew sues his uncle asking the court to make the uncle pay for a trip around the world. Which of the following is true?

a. It is unlikely that the court will force the uncle to uphold this promise because it is missing the element of an offer
b. It is unlikely that the court will force the uncle to uphold this promise because it is missing the element of acceptance
c. It is unlikely that the court will force the uncle to uphold this promise because it is missing the element of consideration
d. It is likely that the court will force the uncle to uphold this promise because it features all of the necessary elements to be a valid contract.

c. It is unlikely that the court will force the uncle to uphold this promise because it is missing the element of consideration

3. Which of the following describes expectation damages? Expectation damages are:

a. The amount of benefit the promisee could reasonably expect from the performance of the contract
b. The amount of damages meant to make the promisee as well off as he would have been if the promise had been fulfilled
c. The amount of damages meant to make the promisor internalize all of the costs of breach of contract against the promise.
d. A and B only .
e. A, B and C.

e. A, B and C.

4. The defining feature of a "shrink-wrap" contract is that

a. It is dramatically unfair
b. It could not be reviewed before agreeing to it
c. It is a take-it-or-leave-it offer
d. It was signed by someone who is not competent to agree to it

b. It could not be reviewed before agreeing to it

5. Efficiency requires that which promises be enforced, assuming that there are no externalities to individuals other than the promisor and promisee?

a. All promises should be enforced
b. All promises that feature reciprocal inducement should be enforced
c. No promises that feature reciprocal inducement should be enforced
d. All promises that the promisor and promisee wanted to be enforceable when it was actually made should be enforced
e. All promises that the promisor and promisee actually want to be enforced should be enforced.

d. All promises that the promisor and promisee wanted to be enforceable when it was actually made should be enforced

6. The defining feature of a contract of adhesion is that

a. It is dramatically unfair
b. It could not be reviewed before agreeing to it
c. It is a take-it-or-leave-it offer
d. It was signed by someone who is not competent to agree to it

c. It is a take-it-or-leave-it offer

7. Which of the following is not a purpose of contract law?

a. Encourage efficient investment in performance of the contract
b. Ensure that all contracts are fulfilled
c. Foster lasting relationships between parties
d. Provide efficient default rules & regulations
e. These are all purposes of contract law

b. Ensure that all contracts are fulfilled

Questions 8- 14 refer to the following scenario. Imagine that I agree to build you an airplane. You will pay me $350,000; this plane is worth $600,000 to you. You are considering building a hangar in anticipation of receiving the plane from me in the spring. The hangar would cost $50,000 to build; the value of the plane + hanger is $750,000. At the time that we agreed to this contract, there was another similar plane available for $500,000 from another seller. This $500,000 plane sold shortly after we signed our contract. (Throughout, assume that you haven't yet paid me for the plane)

8. If you do not build the hangar, what are expectation damages?
a. $50,000
b. $100,000
c. $250,000
d. $350,000
e. $400,000

c. $250,000

Questions 8- 14 refer to the following scenario. Imagine that I agree to build you an airplane. You will pay me $350,000; this plane is worth $600,000 to you. You are considering building a hangar in anticipation of receiving the plane from me in the spring. The hangar would cost $50,000 to build; the value of the plane + hanger is $750,000. At the time that we agreed to this contract, there was another similar plane available for $500,000 from another seller. This $500,000 plane sold shortly after we signed our contract. (Throughout, assume that you haven't yet paid me for the plane)

9. If you do build the hangar, what are expectation damages excluding the benefit of reliance?

a. $50,000
b. $100,000
c. $250,000
d. $350,000
e. $400,000

c. $250,000

Questions 8- 14 refer to the following scenario. Imagine that I agree to build you an airplane. You will pay me $350,000; this plane is worth $600,000 to you. You are considering building a hangar in anticipation of receiving the plane from me in the spring. The hangar would cost $50,000 to build; the value of the plane + hanger is $750,000. At the time that we agreed to this contract, there was another similar plane available for $500,000 from another seller. This $500,000 plane sold shortly after we signed our contract. (Throughout, assume that you haven't yet paid me for the plane)

11. How much are opportunity cost damages?

a. $50,000
b. $100,000
c. $250,000
d. $350,000
e. $400,000

b. $100,000

Questions 8- 14 refer to the following scenario. Imagine that I agree to build you an airplane. You will pay me $350,000; this plane is worth $600,000 to you. You are considering building a hangar in anticipation of receiving the plane from me in the spring. The hangar would cost $50,000 to build; the value of the plane + hanger is $750,000. At the time that we agreed to this contract, there was another similar plane available for $500,000 from another seller. This $500,000 plane sold shortly after we signed our contract. (Throughout, assume that you haven't yet paid me for the plane)

12. If you do build the hangar, how much are reliance damages?

a. $50,000
b. $100,000
c. $300,000
d. $400,000

a. $50,000

Questions 8- 14 refer to the following scenario. Imagine that I agree to build you an airplane. You will pay me $350,000; this plane is worth $600,000 to you. You are considering building a hangar in anticipation of receiving the plane from me in the spring. The hangar would cost $50,000 to build; the value of the plane + hanger is $750,000. At the time that we agreed to this contract, there was another similar plane available for $500,000 from another seller. This $500,000 plane sold shortly after we signed our contract. (Throughout, assume that you haven't yet paid me for the plane)

13. Let p= the probability of me fulfilling the contract. For what level of p is reliance efficient?
p≥12.5% (p≥1/8)
p≥20% (p≥1/5)
p≥33.3% (p≥1/3)
p≥50% (p≥1/2)
p≥0% (p≥0)

C. p≥33.3% (p≥1/3)

Questions 8- 14 refer to the following scenario. Imagine that I agree to build you an airplane. You will pay me $350,000; this plane is worth $600,000 to you. You are considering building a hangar in anticipation of receiving the plane from me in the spring. The hangar would cost $50,000 to build; the value of the plane + hanger is $750,000. At the time that we agreed to this contract, there was another similar plane available for $500,000 from another seller. This $500,000 plane sold shortly after we signed our contract. (Throughout, assume that you haven't yet paid me for the plane)

14. Let p = the probability of me fulfilling the contract. If you receive expectation damages including the benefit of reliance, for what levels of p will you make reliance investments?
p≥12.5%
p≥20%
p≥33.3%
p≥50%
p≥0%

E. p≥0%

15. Which of the following statements are true?

a. Expectation damages that include reliance will guarantee efficient breach
b. Expectation damages that exclude reliance will guarantee efficient reliance
c. Expectation damages that exclude reliance will typically cause too much breach
d. Both A and B are correct
e. A, B and C are all correct.

e. A, B and C are all correct.

Which of the following rankings of damages is correct?

Expectation damages ≥ reliance damages ≥ opportunity cost damages
Expectation damages ≥ opportunity cost damages ≥ reliance cost damages
Reliance damages ≥ expectation damages ≥ opportunity cost damages
Opportunity cost damages ≥ reliance damages ≥ expectation damages
There is no consistent ranking of damages like this

Expectation damages ≥opportunity cost damages ≥ reliance cost damages

Questions 8- 14 refer to the following scenario. Imagine that I agree to build you an airplane. You will pay me $350,000; this plane is worth $600,000 to you. You are considering building a hangar in anticipation of receiving the plane from me in the spring. The hangar would cost $50,000 to build; the value of the plane + hanger is $750,000. At the time that we agreed to this contract, there was another similar plane available for $500,000 from another seller. This $500,000 plane sold shortly after we signed our contract. (Throughout, assume that you haven't yet paid me for the plane)

10. If you do build the hangar, what are expectation damages including the benefit of reliance?

a. $50,000
b. $100,000
c. $250,000
d. $350,000
e. $400,000

d. $350,000
e. $400,000

17. Which of the following is not typically grounds to overturn a contract?

a. Mutual mistake
b. Fraud
c. Failure to disclose a known danger
d. Unilateral Mistake
e. All of the above are grounds to overturn a contract

d. Unilateral Mistake

What term refers to a court-ordered remedy requiring the promisor to perform the contract as written?

a. Expectation damages
b. Specific performance
c. Penalty default
d. Disgorgement

b. Specific performance

19. A prenuptial agreement is an agreement between soon-to-be-spouses before they get married which specifies what will happen to their assets and other issues in the event of divorce. What role does a prenuptial agreement play in general?

a. It provides alternate rules to the default rules used in divorce
b. It unites knowledge and control
c. It provides consideration
d. All of the above
e. A and C only

a. It provides alternate rules to the default rules used in divorce

20. When is it most likely efficient for a court to use a penalty default rule to fill gaps in a contract?

a. When the gap was left because of high transaction costs associated with filling it
b. When the gap was left for strategic purposes
c. When the gap was left because the parties were unaware of the need to fill it
d. It is never efficient for a court to use a penalty default rule
e. It is always efficient for a court to use a penalty default rule

b. When the gap was left for strategic purposes

21. Which of the following is true
a. Specific performance can lead to efficient breach if transaction costs are low
b. The only way to get efficient breach is expectation damages
c. Expectation damages can lead to efficient breach if transaction costs are low
d. All of these statements are true
e. A and C are true

e. A and C are true

21. Which of the following is true

a. Specific performance can lead to efficient breach if transaction costs are low
b. The only way to get efficient breach is expectation damages
c. Expectation damages can lead to efficient breach if transaction costs are low
d. All of these statements are true
e. A and C are true

e. A and C are true

22. Which of the following can be contracted around?

a. Injunction
b. A default rule
c. A regulation
d. A and B, but not C
e. A, B and C

d. A and B, but not C

23. Which of the following is a purpose of contract law?

a. To assure socially optimal prices for goods
b. To prevent breach
c. To ensure breach
d. To secure efficient investment in performance, even if that investment is not readily observable by the promisee
e. All of these are purposes of contract law

d. To secure efficient investment in performance, even if that investment is not readily observable by the promisee

24. What is meant by "reciprocal inducement?"

a. The promisor has to give something up for it to be a valid contract
b. The promisee has to give something up for it to be a valid contract
c. Neither party has to give anything up for it to be a valid contract
d. Both parties have to give something up for it to be a valid contract
e. There is no such thing as reciprocal inducement.

d. Both parties have to give something up for it to be a valid contract

25. In the case of Alaska Packers' Association v. Domenico (where the fishing captain hired a crew in Seattle at a wage of $50 plus $0.02 for every fish caught, but once the crew got to Alaska, they refused to work unless the captain paid $100. The captain agreed, but once in Seattle he only paid them the original, lower amount), which of the following is true?

a. The court ruled in favor of the captain, saying that because the crew had already agreed to work for $50, no new consideration was given by the crew for the promise of the higher wage
b. The court ruled in favor of the captain, saying that because the crew had already agreed to work for $50, no new consideration was given by the captain for the promise of the higher wage
c. The court ruled in favor of the captain, saying that the contract was a contract of adhesion and was therefore unenforceable
d. The court ruled in favor of the crew and forced the captain to pay the higher amount

a. The court ruled in favor of the captain, saying that because the crew had already agreed to work for $50, no new consideration was given by the crew for the promise of the higher wage

26. What is the rule that courts in the US use to determine whether or not to enforce a contract that was predicated on a threat?

a. The courts will never enforce a rule that was predicated on any threat
b. The courts will always enforce a rule so long as a bargain was reached (even if it was predicated on a threat)
c. The courts will not enforce rules that were predicated on the threat of physical violence, but will enforce rules that were predicated on other threats
d. The courts will not enforce rules that were predicated on a threat to destroy value, but will enforce rules that were predicated on a threat not to create new value
e. The courts will enforce rules that were predicated on a threat to destroy value, but will not enforce rules that were predicated on a threat not to create new value

d. The courts will not enforce rules that were predicated on a threat to destroy value, but will enforce rules that were predicated on a threat not to create new value

27. What type of remedy is designed to make the promisee as well off as if the contract had been performed?

a. Specific performance
b. Expectation damages
c. Reliance damages
d. Opportunity cost damages

b. Expectation damages

28. What type of remedy is designed to make the promisee as well off as if the contract had been never been signed?

a. Specific performance
b. Expectation damages
c. Reliance damages
d. Opportunity cost damages
e. There are no damages that are designed to do this

c. Reliance damages

Questions 29-32 refer to the following: Imagine the following scenario: a family farm is approached by a mining company who wants to mine their land. The coal is worth $100,000, and the mining company and family agree that the company will pay $40,000 for the rights to mine the land. However the family is only willing to do this if the coal company agrees to restore the land to its original condition, a process that will cost $30,000. If the land is unrestored, its resale value is diminished by $1000, but they will suffer from $50,000 of disutility from it being unrestored.

29. What are the payoffs to each of the players (family and mining company) if: The family doesn't agree to sell the mining rights to the mining company. (For this and all following questions in this series, the payoff will be listed as (Family, Mining Company))
a. ($0, $0)
b. ($0, $100,000)
c. ($40,000, $30,000)
d. (-$1,000, $59,000)
e. ($-9,000 , $59,000)

a. ($0, $0)

Questions 29-32 refer to the following: Imagine the following scenario: a family farm is approached by a mining company who wants to mine their land. The coal is worth $100,000, and the mining company and family agree that the company will pay $40,000 for the rights to mine the land. However the family is only willing to do this if the coal company agrees to restore the land to its original condition, a process that will cost $30,000. If the land is unrestored, its resale value is diminished by $1000, but they will suffer from $50,000 of disutility from it being unrestored.

30. Suppose that the family agrees to sell the rights to the mining company, only if the mining company agrees to restore the land to its original condition. The mining company agrees, but after they finish mining, the company refuses to restore the property to its original condition. What are the payoffs to each party if the court grants liquidated damages.

a. ($0, $0)
b. ($0, $100,000)
c. ($40,000, $30,000)
d. (-$1,000, $59,000)
e. ($-9,000 , $59,000)

e. ($-9,000 , $59,000)

Questions 29-32 refer to the following: Imagine the following scenario: a family farm is approached by a mining company who wants to mine their land. The coal is worth $100,000, and the mining company and family agree that the company will pay $40,000 for the rights to mine the land. However the family is only willing to do this if the coal company agrees to restore the land to its original condition, a process that will cost $30,000. If the land is unrestored, its resale value is diminished by $1000, but they will suffer from $50,000 of disutility from it being unrestored.

31. Now suppose that instead of liquidated damages the court orders specific performance. What are the payoffs to each party?
a. ($0, $0)
b. ($0, $100,000)
c. ($40,000, $30,000)
d. (-$1,000, $59,000)
e. ($-9,000 , $59,000)

c. ($40,000, $30,000)

Questions 29-32 refer to the following: Imagine the following scenario: a family farm is approached by a mining company who wants to mine their land. The coal is worth $100,000, and the mining company and family agree that the company will pay $40,000 for the rights to mine the land. However the family is only willing to do this if the coal company agrees to restore the land to its original condition, a process that will cost $30,000. If the land is unrestored, its resale value is diminished by $1000, but they will suffer from $50,000 of disutility from it being unrestored.

32. If the family and the mining company want to write a contract that will be (1) likely to be upheld by courts and (2) will achieve the goal of having the mining company do the restorative work as promised, which of the following contracts is most likely to be successful in meeting these goals?

a. The mining company pays the family $70,000 for the rights to mine the coal. If the restorative work is performed, the family pays the mining company $30,000.
b. The mining company pays the family $40,000 for the rights to mine the coal. If the restorative work is not performed, the mining company has to pay the family an additional $30,000.
c. The mining company pays the family $40,000 for the rights to mine the coal. If the restorative work is not performed, the mining company has to pay the family an additional $50,000.
d. These are all equally likely meet the two goals outlined above.

a. The mining company pays the family $70,000 for the rights to mine the coal. If the restorative work is performed, the family pays the mining company $30,000.

33. In the classic legal framework under which contracts are studied, which of the following is required for a contract to be enforced?

a. Negligence
b. Motive
c. Opportunity
d. Offer

d. Offer

34. Which of the following statements about breach is true?

a. If damages are below expectation damages, the promisor will not breach often enough
b. If damages are below expectation damages, the promisor will breach exactly the efficient amount
c. If damages are below expectation damages, the promisor will breach too often
d. It is never efficient for the promisor to breach
e. It is always efficient for the promisor to breach

c. If damages are below expectation damages, the promisor will breach too often

Questions 31-33 refer to the following scenario: Suppose that Alice and Beatrix are playing the trust game—if Alice gives Beatrix $100, Beatrix can double it to $200. Beatrix promises to return $150 to Alice, and to keep $50 for herself. However, it's possible for Beatrix to keep the entire $200. Assume for now that they can only play the game once, and there are no contracts between Alice and Beatrix.

35. If Alice gives Beatrix the money, what is Beatrix's best response and payoff
a. Keep all the money, for a payoff (to Beatrix) of $200
b. Keep all the money, for a payoff (to Beatrix) of $300
c. Give Alice $150 for a payoff (to Beatrix) of $50
d. Give Alice $50 for a payoff (to Beatrix) of $150

a. Keep all the money, for a payoff (to Beatrix) of $200

Questions 31-33 refer to the following scenario: Suppose that Alice and Beatrix are playing the trust game—if Alice gives Beatrix $100, Beatrix can double it to $200. Beatrix promises to return $150 to Alice, and to keep $50 for herself. However, it's possible for Beatrix to keep the entire $200. Assume for now that they can only play the game once, and there are no contracts between Alice and Beatrix.

36. What is the Subgame Perfect Nash Equilibrium outcome of this game?
a. Alice gives Beatrix her money, and Beatrix returns $150 to Alice
b. Alice gives Beatrix her money, and Beatrix keeps all of the money if Alice gives it to her
c. Alice does not give any money to Beatrix, and Beatrix keeps all of the money if Alice gives it to her
d. This game does not have a Subgame Perfect Nash Equilibrium
e. This game has several Subgame Perfect Nash Equilibria

c. Alice does not give any money to Beatrix, and Beatrix keeps all of the money if Alice gives it to her

Questions 31-33 refer to the following scenario: Suppose that Alice and Beatrix are playing the trust game—if Alice gives Beatrix $100, Beatrix can double it to $200. Beatrix promises to return $150 to Alice, and to keep $50 for herself. However, it's possible for Beatrix to keep the entire $200. Assume for now that they can only play the game once, and there are no contracts between Alice and Beatrix.

37. Now assume that Alice and Beatrix sign a contract where Beatrix is punished for running off with Alice's money. The punishment is that Beatrix has to pay Alice the $150 that Alice gave her, but both parties also have to pay $10 in court costs and legal fees. What is the new Subgame Perfect Nash Equilibrium in this game?

a. Alice gives Beatrix her money, and Beatrix returns $150 to Alice
b. Alice gives Beatrix her money, and Beatrix keeps all of it
c. Alice does not give any money to Beatrix
d. This game does not have a Subgame Perfect Nash Equilibrium
e. This game has several Subgame Perfect Nash Equilibria

a. Alice gives Beatrix her money, and Beatrix returns $150 to Alice

38. The trust game illustrates which of the purposes of contract law?

a. Contract law enables people to cooperate by turning games with non-cooperative solutions into games with cooperative solutions.
b. Contract law provides efficient default rules and regulations
c. Contract law encourages efficient breach
d. Contract law encourages efficient reliance
e. Contract law encourages efficient investment in performance

a. Contract law enables people to cooperate by turning games with non-cooperative solutions into games with cooperative solutions.

39. What is an implication of the paradox of compensation in the context of contract law?

a. Any level of damages will always cause over-reliance
b. Individuals save more money during recessions, which leads to a decrease in aggregate demand
c. A level of damages that gives you efficient breach will also give you under-reliance (i.e. less than the optimal amount of reliance).
d. It is impossible to set a single level of damages that gives both efficient breach and efficient reliance

d. It is impossible to set a single level of damages that gives both efficient breach and efficient reliance

40. Imagine that a seven-year old child wanders over to his parents' computer and sees their eBay account open. He does a "buy it now" transaction for a decommissioned World War 2 tank. Which of the following is the best argument for why the promisor shouldn't have to pay the promisee?

a. The contract was signed out of necessity
b. There was no consideration given by both parties
c. The promisor were not legally competent to agree
d. The contract was signed under duress
e. The contract was not written down.

c. The promisor were not legally competent to agree