Question

1. Suppose Al hires Joe to build him a house. At the time they signed the contract, Al valued the house at $500,000, it would cost Joe $200,000 to build the house, and they agree on a price of $300,000. After the contract is signed (but before any money changes hands), Joe’s costs go up to $350,000, and Joe considers breaching the contract.

a. Would Joe’s breach be efficient overall? Why or why not? What would expectation damages be (the number)?
b. Assuming he would have to pay expectation damages if he breached, describe Joe’s decision (with numbers) between performing the contract and breaching. Would his decision be efficient overall, and why or why not?
c. How high would Joe’s costs have to go to make him prefer to breach (and pay expectation damages) rather than perform the contract? Would this be an efficient breach? e. What would happen between Al and Joe if the judge ordered specific performance? Would this outcome be efficient, and why or why not?

Answer 1

ans...

a) The breach is not efficient because Al values the house at 500000 and by performing the contract he gets a surplus of $200000 (500000-300000). The amount lost by Joe by performing the contract is $50000 (350000-300000) . The surplus lost by Al due to breach of the contract is larger than the loss for Joe by performing the contract. So, although the breach of contract is efficient for Joe, it is not efficient overall.
The expectation damages are equal to the amount that would put the non breaching party at the level where he would have been had the contract been enforced. Therefore, the expectation damages will be equal to $200000 which is equal to the surplus Al would have got had the contract been enforced.

b) If Joe had to pay the expectation damages equal to $200000, he would have performed the contract since the loss incurred by him due to per formance is only $50000 which is lower by $150000 compared to the damage amount to be paid in case of breach. This will be efficient overall since the overall loss made by breach of contract (now solely by Joe) is higher than the loss made by Joe by enforcing the contract.

c) If the costs to Joe goes up to $500000 or more such that his loss from enforcing the contract is equal to or greater than he expectation damages to be paid, that is, $200000 or more. In such a situation, the breach will be efficient since the loss made by enforcing the contract is equal to or greater than the expectation damages to be paid.

e) If specific performance is ordered, the contract has to be enforced, so the house is sold to Al by Joe at $300000 even when the cost of Joe goes up to $350000. This will be efficient compared to payment of damages to Al since the loss made by Joe is only $50000 by performing the contract compared to $200000 by paying damages.