Ann is trying to sell her car. Bob test-drives it and offers to buy it for $4,00

Question

Ann is trying to sell her car. Bob test-drives it and offers to buy it for $4,000, and Ann accepts, but the transaction won't take place for a wekk. Suppose Bob values the car at $5,200.

Even though she's agreed to sell the car to Bob, Ann could continue to look for another buyer who was willing to pay more; her liability if she reaches her contract with Bob will determine her incentives to do so.

(a) What is the chnage in social surplus (how much new total surplus is created or destoryed) if Ann breaches her contract with Bob and sells the car to a new buyer who values the car at $4,000? What if the new buyer values the car at $6,000?

(b) What would Ann owe Bob for breaching the contract under each of the following liaibility rules?

(i) Opportunity cost damages? (Assume another car of equal value was available for $4,400 when the contract was signed, but is no longer available)

(ii) Expectation damages?

(iii) Expectation damages plus punitive/damages in the same amount?

(c) For each of the three rules listed above, would Ann breach the contract only when it's efficient to breach, more often than that, or less often than that? Why?

(d) Suppose it is costly for Ann to continue to search for another buyer. Under expectation damages, will Ann continue to search more than, less than, or the efficient amount? What about under opportunity cost damages?

(e) Under a remedy of Specific Performance, Bob could force Ann to deliver him the car at the agreed-upon price, that is, Ann would not have the option to breach and pay damages. This makes Specific Performance similar to injuntive relief in property law. Explain whether a Specific Performance rule is more likely to be efficient when transaction costs are high or low, and why.

Explanation / Answer

Ann & Bob A Change in social surplus if Ann decides to sell her car to a new buyer Since Bob valued the car at $5200, Ann's breach of contract results in the destruction of a social surplus of $1200. If the new buyer values the car at $6000, a social surplus of $1200 is crreated. If the new buyer values the car at $4000, no social surplus is crreated or destroyed. B What would Ann owe Bob? $ (i) Opportunity cost damages 400 Another car of equal value was available for $4400 (ii) Expectation damages If the contract had been performed, Bob would have a car worth $5200 for paying $4000 What Bob now has is nothing Since Bob valued the car at $5200, Bob might reasonably expect to find another car for $5200 Expectation damages payable to Bob would be 1200 with which Bob can find another car of the same value as Ann's (iii) Expectation damages plus punitive damages in the same amount 2400 C For each of the three rules listed above, Ann would breach the contract only when it is efficient to breach (i) Opportunity cost damages Ann would breach the contract because she loses only $400. (ii) Expectation damages Ann would not breach the contract because she loses $1200. (iii) Expectation plus punitive damages Ann would not breach the contract because she loses $2400. D Ann is forced to find another buyer Under expectation damages, Ann would search for more than the efficient amount Under Opportunity Cost damages, Ann would search for less than the efficient amount. E Remedy of specific performance Bob could force Ann to sell him the car at a price of $4000 A Specific Performance rule is more likely to be efficient when transaction costs are low because the party required to perform finds it less expensive to perform rather than to risk damages. For the same reason, the party required to perform would rather risk damages than perform because transaction costs are high.

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