Promises and prices.

• Author: Craswell, Richard
• Position: 'Contract as Promise' at 30: The Future of Contract Theory

1. PRICES IN THE ABSTRACT A. When Prices are Likely to Rise B. Evaluating Price Effects II. PRICES AND SPECIFIC INDIVIDUALS A. Punitive Damages (Amitabh) B. Non-Pecuniary Losses (Ira and George) C. Mitigation of Damages (Theresa) D. Consequential Damages (Rick) E. Sale to Another Buyer (Bithiah) III. PRICES IN NON-ECONOMIC ANALYSES IV. HOW PRICES GET DISMISSED A. Impermissible Choices B. Default Rules 1. Choosing a Default Rule 2. Default Rules in Economic Analysis C. Tacit Understandings D. Deductive Logic 1. Buyers Who Don't Want to Speculate 2. Remedies and Universalizability E. The Entailments of a Promise F. The Scope of Contract Law G. Impermissible Rationales 1. What Transparency Requires 2. Default Rules and Transparency H. Cultural Effects V. CONCLUSION What sanctions should the law inflict on those who break their contracts? Would it matter if more severe sanctions were likely to cause prices to rise? What if most contracting parties prefer higher sanctions and higher prices, or what if they prefer lower sanctions and lower prices? And whatever the answer to these questions might be, why do economists and philosophers think about these issues so differently?

   Of course, when I speak of "economists" I mean something closer to "most economists, though not necessarily all of them; and including the many lawyers (like me) who do not have advanced degrees but who use economics in their scholarship." An analogous but even broader qualification should be presumed whenever I speak of "philosophers." Indeed, on the issues I discuss here, many philosophers of a utilitarian or welfarist persuasion will be closer in spirit to my "economists" than they will be to other professional philosophers. So, too, will contractualist philosophers such as T.M. Scanlon. (1)

   However the two groups are defined, though, they bring very different perspectives to issues of contract theory. In particular, the two groups differ markedly in the relevance they assign to the effects that contract law can have on prices. In this essay, I try to illuminate these differences in two respects.

   First, rather than analyzing prices in entirely theoretical terms (as economists typically do), Section II discusses five concrete examples in which named individuals have particular reasons for caring about prices. This puts economics and philosophy on something closer to an even footing, since many analyses in philosophy similarly focus on the interests of individual parties.

   Second, Sections III and IV look more closely at various philosophers' analyses of contract law, to see exactly where the parties' reasons for caring about prices drops out of the analysis. This is not as easy as it might sound, for very few authors argue explicitly that prices shouldn't matter. Instead, when non-economists exclude prices from their analysis, they often do so merely by omission, or by adopting premises whose consequences are not immediately obvious--these are the steps that Sections III and IV seek to illuminate. In doing so, I focus especially on recent work by Seana Shiffrin, for she is one of the few philosophers to discuss price effects at any length. (2) But Sections III and IV also examine the work of other non-economists to show the variety of ways in which prices can end up being excluded.

   Before proceeding, I must acknowledge my debt to Charles Fried's Contract as Promise (3) While I disagree with some aspects of that book, (4) I have also learned a great deal from it, as well as from the legacy that (thirty years later) is now apparent. During the 1980s, just as I was beginning my own academic career, Contract as Promise sparked a remarkable interest among legal scholars in questions about the morality of promises (e.g., why are promises binding?), and also in questions about the relation between morality and law (to what extent do the moral aspects of promises limit the rules that contract law may legitimately adopt?). Under the latter heading, Contract as Promise also gave focus to some of the debates about the place of economics in contract theory (e.g., do the moral aspects of promises ever require that contract law depart from whatever rule would be efficient?). These questions have been central to contracts scholarship over the past thirty years. And those years would have been far less interesting if Contract as Promise had never been written.

1. PRICES IN THE ABSTRACT

   1. When Prices are Likely to Rise

      I begin with the standard (and highly abstract) economic analysis. Suppose that we were considering whether to change contract law in some way that would increase (on average) the damages sellers had to pay if they broke their contracts. (5) As this is an abstract analysis, I will not even specify which legal doctrine might produce this change, for the same economic analysis can be applied regardless. Thus, it will not matter (for present purposes) whether the increased damages result from more frequent use of punitive damages, or from abolishing the mitigation doctrine, or from changes in the way that nominally compensatory damages are measured (e.g., by more frequent awards of cost-of-completion damages), or even from narrowing the situations in which the seller's nonperformance would be legally excused.

      The reason these doctrines can be lumped together, at least for purposes of abstract economics, is that each of these proposed changes would likely cause sellers' average liability costs to rise. As a result, economic theory predicts that each change would cause sellers' prices to rise as well. Indeed, in economic analyses of contract law, this prediction of higher prices has been standard for more than thirty years. (6) To most economists, then, it will be entirely uncontroversial.

      To be sure, there are a few conditions under which higher liability costs may not translate into higher prices. For one, as Bruce Ackerman famously emphasized, (7) sellers will not be able to raise prices if both of the following conditions hold: (1) marginal buyers of the product place no value whatsoever on the benefit of being able to collect a larger damage award; and (2) sellers are unable to exit the market, or to otherwise reduce their total sales, in response to the increase in liability costs. Markets that satisfy both conditions are rare, and no confirmed cases have ever been found. If such markets do exist, though, the analysis in this essay simply will not apply.

      Another case where sellers might be unable to raise their prices involves sanctions limited to certain kinds of breaches: specifically, breaches that some sellers could entirely avoid committing at no cost or sacrifice to themselves. After all, sellers who entirely avoid such breaches will never be held liable, and thus will not have to worry about higher liability costs. And if avoiding those breaches is itself costless, these sellers will not have to worry about avoidance costs either, so they can continue to operate at the same costs as before.

      However, these conditions too will rarely be satisfied, if only because of the difficulty of defining any subset of breaches that sellers could costlessly avoid with certainty. Even if the higher sanctions were limited to, say, "willful" breaches, it is not clear that sellers can always succeed in avoiding what a court might later label a willful breach. It is even less clear that such liability can be avoided without incurring other costs. (8)

      In short, it is not the case that every change in contract law will necessarily produce a change in sellers' prices. In this essay, though, I will focus on the more usual situation where price effects are likely, for these are the situations in which economics and philosophy most typically diverge. More specifically, while economists and philosophers may agree that price effects will be present in a given case, they are apt to disagree about the normative significance (or insignificance) of those effects.

   2. Evaluating Price Effects

      I focus on the normative evaluation of price effects because, in economics, higher prices are not necessarily bad for buyers. True, higher prices leave buyers with less money, and that, by itself, may be undesirable. But buyers also get something in return for their money, when the accompanying legal change allows them to collect a larger remedy (on average) in the event of breach. And while some buyers might not consider that extra benefit to be worth the higher price, others might be quite happy to accept the combined package of a higher price and a larger remedy. This point is sometimes overlooked by judges, who leap to the conclusion that higher prices must leave buyers worse off, and who therefore treat the price effect as an argument against changing the legal rule. (9) But this leap is unwarranted without analyzing what it is that buyers get for the price they have to pay.

      Indeed, there are a number of reasons why reasonable actors might sometimes prefer to pay a higher price for their contract, if doing so allows them to collect a more generous remedy in the event of a breach. (10) For one thing, paying for such a remedy might get the buyer a more reliable product or service, if the larger sanctions give sellers greater incentive to reduce the number of preventable defects. (11) And even for those defects that are not practicably preventable, paying for a higher remedy could give buyers additional insurance, which would be particularly valuable if private insurance is unavailable, and if the law's usual damage remedy provides less insurance than buyers want. (12) Higher prices might also correct for some kinds of imperfect information, if the higher prices reflected (as they might in a strict-liability regime) the cost of risks that consumers would otherwise underestimate. (13) And in any situation where enforcement of legal rules is less than perfect, buyers might prefer to pay higher prices (up to a point) to cover the extra penalties needed to increase...