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George Mason School of Law

George Mason School of Law. Contracts II Warranties This file may be downloaded only by registered students in my class, and may not be shared by them F.H. Buckley fbuckley@gmu.edu. Conditions and Warranties. Damages . Damages only. Forfeiture. Promises Conditions Warranties

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George Mason School of Law

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  1. George Mason School of Law Contracts II Warranties This file may be downloaded only by registered students in my class, and may not be shared by them F.H. Buckley fbuckley@gmu.edu

  2. Conditions and Warranties Damages Damages only Forfeiture Promises Conditions Warranties Election

  3. Warranties • With a warranty a seller assumes a risk as to the product • The prior question is whether the risk should be born by the seller or the buyer

  4. Let’s say seller sells a whizbang $999.99 at Home Depot

  5. The whizbang50% chance of a whiz It might go whiz

  6. The whizbang50% chance of a whiz, 50% of a bang It might go whiz … or it might go bang …

  7. Evaluating risk: Expected Values • The expected monetary value of an accident is p*L

  8. Evaluating risk: Expected Values • The expected monetary value of an accident is p*L • where p is the probability of occurrence • And L is the cost of the accident on occurence

  9. Pascal’s Wager

  10. Pascal’s Wager

  11. Pascal’s Wager

  12. Pascal’s Wager Is there a flaw in the reasoning?

  13. Pascal’s Wager If so—he still had to invent probability theory to make it work

  14. Back to the Whizbang • So the expected monetary value for an accident with a 50 percent probability of a loss of $250 is $125

  15. Back to the Whizbang • So the expected monetary value for an accident with a 50 percent probability of a loss of $250 is $125 • We’d want to assign the risk to the least-cost risk avoider • Whether in contract or tort

  16. Back to the Whizbang • We’d want to assign the risk to the least-cost risk avoider • Contract or tort joined at the hip historically in the action on the case • Prosser at 660

  17. Who is the Least-Cost Risk Avoider • There are four ways of thinking about this

  18. Who is the Least-Cost Risk Avoider • There are four ways of thinking about this • Who can best fix the problem • Who knows best about it • Who is risk neutral and who risk averse • The large number diversified party

  19. The Least-Cost Risk Avoider • Seller sells a whizbang to Buyer for $1,000, with no warranties (or liability) as to bangs

  20. The Least-Cost Risk Avoider • Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs • EMV of a bang is (.5*-$250=) -$125

  21. The Least-Cost Risk Avoider • Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs • EMV of a bang is -$125 • So Buyer who pays $1000 for a whizbang is out (1,000 + 125 =) $1125

  22. The Least-Cost Risk Avoider • Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs • EMV of a bang is -$125 • Assume that seller (but not Buyer) can eliminate this risk at a cost of $100

  23. The Least-Cost Risk Avoider • Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs • EMV of a bang is -$125 • Seller (but not Buyer) can eliminate this risk at a cost of $100 • Do we see a Coasian bargain here? • How will the parties assign the risk?

  24. The Least-Cost Risk Avoider • Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs • EMV of a bang is -$125 • Seller (but not Buyer) can eliminate this risk at a cost of $100 • Seller is the least-cost risk avoider and buyer will pay seller to assume the risk

  25. The Least-Cost Risk Avoider • Assume that the expect cost of a bang is $125 • Seller (but not Buyer) can eliminate this risk at a cost of $100 • How will the parties assign the risk? • Buyer will pay seller to assume the risk • And what will this do to the purchase price?

  26. The Least-Cost Risk Avoider • Assume that the expect cost of a bang is $125 • Seller (but not Buyer) can eliminate this risk at a cost of $100 • How will the parties assign the risk? • Buyer will pay seller to assume the risk • What is the range of prices between which the parties will bargain?

  27. The Least-Cost Risk Avoider • Assume that the expect cost of a bang is $125 • Seller (but not Buyer) can eliminate this risk at a cost of $100 • How will the parties assign the risk? • Buyer will pay seller to assume the risk • Seller will not accept less than $100 and (risk-neutral) buyer will not pay more than $125

  28. The Least-Cost Risk Avoider • Assume that the expect cost of a bang is $125 • Seller (but not Buyer) can eliminate this risk at a cost of $100 • Let’s say that seller offers a warranty for the risk at a price of $110 • Buyer pays an extra $110 and saves a total of $125 (net of $15)

  29. The Least-Cost Risk Avoider • How it looks to buyer: • No warranty: 1,000 + 125 = $1125 • With the warranty: $1110

  30. Let’s flip thisBuyer as Least-Cost Risk Avoider • Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs • Assume that the expected cost of a bang is $125 • Buyer (but not Seller) can eliminate this risk at a cost of $100 • What happens now?

  31. Let’s flip thisBuyer as Least-Cost Risk Avoider • Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs • Assume that the expected cost of a bang is $125 • Buyer (but not Seller) can eliminate this risk at a cost of $100 • Buyer will spend $100 to eliminate a risk with an EMV of $125

  32. Let’s flip thisBuyer as Least-Cost Risk Avoider • Buyer’s options; • Take no care: 1000 + 125 = $1125 • Take care: 1000 + 100 = $1100

  33. The Least-Cost Risk Avoider • The parties will seek to assign the risk to the party who can most efficiently eliminate it.

  34. The Least-Cost Risk Avoider • The parties will seek to assign the risk to the party who can most efficiently eliminate it. • An application of the Coase Theorem: If bargaining is costless, does it matter how the law assigns the risk?

  35. The Least-Cost Risk Avoider • The parties will seek to assign the risk to the party who can most efficiently eliminate it. • An application of the Coase Theorem • And if bargaining isn’t costless?

  36. The Least-Cost Risk Avoider • You’re a judge. You have a pretty good idea who the least-cost risk avoider is. The parties have left the question of risk silent in their contract. How do you assign the risk?

  37. The Least-Cost Risk Avoider • “Mimicking the market”

  38. A second way of thinking about Least-Cost Risk Avoiders • Same example. But now neither party can eliminate the risk for less than $125. • On whom should the risk fall? Does it matter?

  39. A second way of thinking about Least-Cost Risk Avoiders • Same example. But now neither party can eliminate the risk for less than $125. • Suppose one party is in a better position to value the loss?

  40. A second way of thinking about Least-Cost Risk Avoiders • Same example. But now neither party can eliminate the risk for less than $125. • Suppose one party is in a better position to value the loss? • As between a manufacturer and a consumer, who is this likely to be?

  41. A second way of thinking about Least-Cost Risk Avoiders • Same example. But now neither party can eliminate the risk for less than $125. • Suppose one party is in a better position to value the loss? • Why does the ability to value the loss matter?

  42. A third way of thinking about Least-Cost Risk Avoiders • Suppose that seller is a large corporation and buyer is an impecunious consumer. Does that make a difference?

  43. A third way of thinking about Least-Cost Risk Avoiders • Suppose that seller is a large corporation and buyer is an impecunious consumer. Does that make a difference? • Do risk preferences matter?

  44. Are you an EMV’er? • An EMV’er always selects the payoff with the highest expected monetary value (p*O)

  45. Are you an EMV’er? • An EMV’er always selects the payoff with the highest expected monetary value (p*O) • Suppose I offer you a lottery ticket with a .5 probability of 0 and a .5 probability of $2. Would you pay me 50¢ for the ticket?

  46. Are you an EMV’er? • An EMV’er always selects the payoff with the highest expected monetary value (p*O) • Suppose I offer you a lottery ticket with a .5 probability of 0 and a .5 probability of $2. Would you pay me 50¢ for the ticket? • EMV = .5($2) = $1.00

  47. Are you an EMV’er? • An EMV’er always selects the payoff with the highest expected monetary value (p*O) • Suppose I offer you a lottery ticket with a .5 probability of 0 and a .5 probability of $10,002. Would you pay me $5,000.50 for the ticket?

  48. Are you an EMV’er? • An EMV’er always selects the payoff with the highest expect monetary value (p*O) • Suppose I offer you a lottery ticket with a .5 probability of 0 and a .5 probability of $10,002. Would you pay me $5,000.50 for the ticket? • EMV = .5($10,002) = $5,001

  49. Three kinds of people • EMV’ers are risk neutral • They always take the gamble with the highest EMV

  50. Three kinds of people • EMV’ers are risk neutral • Most people are risk averse • They’ll pass on some opportunities with a positive EMV

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