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University of Toronto St. George
Donald Dewees

Economics 320F An Economic Analysis of Law Midterm Exam 24pmFall 2004University of Toronto Joanne RobertsPlease answer all parts of the exam in the exam booklet provided Nonprogrammable calculators are permitted This test will be marked out of 60 The marks for each question are noted throughout the exam Part 1 24 marks8 eachAnswer three of the following1 Define the concept of reliance and explain why we do not want to encourage excessive reliance in contractsSee pages 205210 of the text Parties to a contract may in relying on the contract being performed take actions in advance of performance of that contract which will enhance their own value of performance For example a retail store may advertise that they will be selling a new product after they have entered into a contract with a supplier for the delivery of that product The optimal level of reliance is that which maximizes the expected value of performance less production cost less the costs of reliance If it turns out at the time of performance that performance is not optimal then reliance expenditures will have been a waste Thus the optimal level of reliance will depend on the probability of performance Under the expectation measure of damages overreliance can occur because the buyer or promisee is implicitly insured by receipt of damages and will therefore view his investment in reliance as one with a certain payoff But if performance is uncertain this will lead the promisee to expend too much on reliance2 A contract is meant to be a mutually advantageous and voluntary exchangeIf it turns out that one party does not benefit as expected at contract time is it efficient for the contract to be enforcedSee pages 201205 of the textEfficiency requires maximizing the sum of the payoffs to the promisor and promiseeIf transaction costs are zero such that the contract is a complete contingent contract ie the parties specifically agreed about what should happen in each possible case then the contract should be enforcedWhere the contract is incomplete the usual case however then a contract should be enforced only where the cost of performing is less than the benefit If one party does not benefit as expected at contract time this does not necessarily mean that they do not benefit at all or that the total benefit to both parties does not exceed the costs of performance
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