Welfarist:

Law & Economics

Contract
Law

Economics
 Questions to Ponder

Can concepts in Economics use

to illuminate contract law?

If Yes, how? If No, why?

 Definitions

A contract is a meeting of minds between

two persons whereby one binds himself,
with respect to the other, to give something
or to render some service (Art. 1305, Civil
Code; Edilberto Alcantara v. Cornelio B. Rita,
Jr., GR 136996, Dec. 14, 2001)
 Definitions
Economics is the science of wealth (Smith,
An Inquiry into Nature and Causes of Wealth of
Nations [1776])

Economics is a science which studies human

behaviour as a relationship between ends and
scarce means which have alternative uses
(Robbins, An Essay on the Nature and
Significance of Economic Science [1932])
 Assumptions

1. Individuals conform to the rationality

assumptions of economic theory

2. Contract law promotes efficiency

 First Assumption

Individuals have preferences over states of

the world; their behavior conforms to their
preferences; these preferences are
consistent; and that they can be represented
as utility functions.
 First Assumption
1. Pareto efficient if and only if there is no
other rule that would induce behavior such
that no person was worse off and at least one
person in society was better off. (emphasis
supplied)
2. Wealth-maximizing wealth is the sum of
the equivalent variations of the individuals
in the society.
3. Evaluation of legal rules should be welfarist,
and would depend only on the well-being of
the individuals in a society.
 Second Assumption
1. Ex ante perspective: that parties
voluntarily invoke in order to arrange
their affairs.
2. Ex post perspective: (i) Efficient the
rules are ex post efficient by giving the
promisor the option to pay the
promisees valuation or perform; and (ii)
Inefficient - the rules are inefficient when
the result in an obligation costs the
obligor more than it benefits the obligee.
 Expectation Damages

Performance - Ex post efficient.

Breach - GR: ex post Inefficient. Exception:
can be ex post efficient in the form of
default rules.
 Default Rules
Rules wherein the parties can contract
around by prior agreement (Ayres and
Gertner, Filling Gaps in Incomplete Contracts:
An Economic of Default Rules[1989])
Supplying standard contract terms that the
parties would otherwise have to adopt by
express agreement (R. Posner, Impossibility
and Related Doctrines in Contract Law: An
Economic Analysis [1977])
 Without Default Rules

AB is a burger Company. There is a contract

that they should deliver the goods to those
who franchised in their company every 4th
Monday of July. Y is a franchiser. On the 4th
Monday of July, AB was scheduled to
deliver the goods to Y. Unfortunately, AB
was not able to deliver the goods.
 With Default Rules
AB is a burger Company. There is a contract
that they should deliver the goods to those
who franchised in their company every 4th
Monday of July. Y is a franchiser. On the 4th
Monday of July, AB was scheduled to
deliver the goods to Y. Fortunately, AB was
not able to deliver the goods. However, by
express agreement they entered into a
default rule that when AB cannot deliver, he
will pay twice the worth of the undelivered
goods.
 Failure of Economics in Contract
Law
1. Contract doctrines do not appear to
conform to the predictions of simple
economic models of the contracting
promise.
2. More complex models usually make
indeterminate predictions about the
doctrines of contract law.
3. Transaction costs interfering with
optimal contracts is ambiguous.