Exam 2 S2023--Key Version A
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Exam 2—Version A
Law & Economics
Instructor: Ruth Gilgenbach
Rutgers University New Brunswick
Spring 2023
1.
The classic legal framework under which contracts are studied is known as:
a.
Dynamic game theory
b.
Contract theory
c.
Bargain theory
d.
Game theory
e.
Adhesion theory
2.
Under the classic legal framework above, which elements are
not
required for a
contract to be enforced?
a.
Offer
b.
Consideration
c.
Acceptance
d.
These are all required for a contract to be enforced
3.
What is meant by “reciprocal inducement?”
a.
The promisor has to give something up for it to be a valid contract
b.
The promisee has to give something up for it to be a valid contract
c.
Both parties have to give something up for it to be a valid contract
d.
Neither party has to give anything up for it to be a valid contract.
e.
Both parties have to give something of approximately equal monetary
value for it to be a valid contract.
4.
Which of the following is not a purpose of contract law?
a.
Ensure that all contracts are fulfilled
b.
Encourage efficient investment in performance of the contract
c.
Encourage efficient investment in reliance
d.
Provide efficient default rules & regulations
e.
These are all purposes of contract law
Test Version A
1
Questions 5-10 refer to the following scenario: imagine that Alice has an opportunity to
make an investment but no money with which to do so.
Bob has some money, but does
not have access to the investment opportunity.
Alice makes the following offer to Bob: If
Bob lends Alice $200, she will make this investment and can double the money.
She will
then repay Bob $300, and keep $100 for herself.
Assume that this is a riskless
investment.
However, it’s possible for Alice to keep all of this money.
Assume that they
can only play this game once, and there are no contracts between Alice and Bob.
5.
Which of the following game trees represents the above-described game?
A:
B:
C:
D:
E:
None of the above
6.
If Bob gives the money to Alice, what is Alice’s best response and payoff?
a.
Keep all of the money, for a payoff (to Alice) of $500
b.
Keep all of the money, for a payoff (to Alice) of $400
c.
Give Bob $300, for a payoff (to Alice) of $100
d.
Give Bob $100, for a payoff (to Alice) of $300
Test Version A
2
7.
Which outcome is the most (Kaldor-Hicks) efficient?
a.
Bob gives the money to Alice; Alice splits the money as promised
b.
Bob gives the money to Alice; Alice keeps the money
c.
Bob does not give the money to Alice; Alice would keep the money if it
were given to her
d.
A and B are both equally efficient
e.
This game does not have an efficient outcome
8.
What is the Subgame Perfect Nash Equilibrium (SPNE) of this game?
a.
Bob does not give any money to Alice, and Alice would keep all of the
money if it were given to her.
b.
Bob gives Alice $200, and Alice returns $300 to Bob and keeps $100 for
herself
c.
Bob gives Alice $200, and Alice keeps all $400
d.
This game does not have a SPNE
e.
This game has several SPNE
9.
Now assume that Alice and Bob sign a contract where Alice is punished for
running off with Bob’s money.
The punishment is that if Alice runs off with this
money, Bob will sue her and will. Alice will have to pay Bob the $300 she
promised him, and each player must incur $25 in court costs and legal fees
associated with this lawsuit.
What is the new SPNE of this game?
a.
Bob does not give any money to Alice, and Alice would keep all of the
money if it were given to her.
b.
Bob gives Alice $200, and Alice returns $300 to Bob and keeps $100 for
herself
c.
Bob gives Alice $200, and Alice keeps all $400
d.
This game does not have a SPNE
e.
This game has several SPNE
10. Which of the following purposes of contract law is the above an example of?
a.
Encouraging efficient disclosure of information
b.
Securing efficient reliance
c.
Providing efficient default rules and regulations
d.
Encouraging cooperation
e.
None of the above
Test Version A
3
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11. Efficiency suggests which promises should be enforced?
a.
All promises should be enforced
b.
No promises should be enforced
c.
All promises that both parties want to be enforced
now
d.
All promises that both parties wanted to be enforceable at the time
when the promise was made
e.
All promises that have all of the necessary elements to be a proper
contract
Questions 12-14 refer to the following scenario. I am a knitter. Imagine that I
have agreed to sell you a custom sweater for $200.
Right now, the cost of yarn is
such that I can buy a sweater’s worth of yarn for $150, and there are no other
costs.
You’ve seen other sweaters I’ve made and you know that you would value
this sweater at $400. (Throughout, assume that you haven’t yet paid me for the
sweater)
12. If I were to breach this contract, what are the expectation damages?
a.
$0
b.
$150
c.
$200
d.
$300
e.
$500
13. Imagine that the price of yarn increases to $350.
If the penalty for breach is
expectation damages, do I breach, and would it be efficient for me to do so?
a.
I breach, and it is efficient for me to do so
b.
I breach, but it is not efficient for me to do so
c.
I do not breach, and it would not be efficient for me to breach
d.
I do not breach, but it would be efficient for me to breach
14. Now imagine that the price of yarn is still $350, but the penalty for breach is now
$25.
Do I breach, and would it be efficient for me to do so?
a.
I breach, but it is not efficient for me to do so
b.
I breach, and it is efficient for me to do so
c.
I do not breach, but it would be efficient for me to breach
d.
I do not breach, and it would not be efficient for me to breach
Test Version A
4
15. Imagine that a rich uncle promises his 18-year-old nephew that if the nephew
does not drink or smoke until his 21
st
birthday, the uncle will pay him $150,000.
Later, the uncle breaks this promise and does not pay his nephew.
The nephew
sues his uncle asking the court to make the uncle pay the promised $150,000.
Which of the following is true?
a.
It is unlikely that the court will force the uncle to uphold this promise
because it is missing the element of an
offer
b.
It is unlikely that the court will force the uncle to uphold this promise
because it is missing the element of
acceptance
c.
It is unlikely that the court will force the uncle to uphold this promise
because it is missing the element of
consideration
d.
It is unlikely that the court will force the uncle to uphold this promise
because it is missing the element of
fairness
e.
It is likely that the court will force the uncle to uphold this promise
because it features all of the necessary elements to be a valid contract.
Questions 16-22 refer to the following scenario. Imagine that I agree to build you an
airplane.
You will pay me $400,000; this plane is worth $750,000 to you.
You are
considering building a hangar in anticipation of receiving the plane from me in the
spring.
The hangar would cost $75,000 to build; the value of the plane + hanger is
$850,000.
At the time that we agreed to this contract, there was another similar plane
available for $500,000 from another seller. This $500,000 plane sold shortly after we
signed our contract. (Throughout, assume that you haven’t yet paid me for the plane)
16. If you do build the hangar, what are expectation damages excluding the benefit
of reliance?
a.
$50,000
b.
$100,000
c.
$250,000
d.
$350,000
e.
$450,000
17. If you do build the hangar, what are expectation damages including the benefit of
reliance?
a.
$50,000
b.
$100,000
c.
$250,000
d.
$350,000
e.
$450,000
Test Version A
5
18. How much are opportunity cost damages (assume you did not build the hangar)?
a.
$50,000
b.
$100,000
c.
$250,000
d.
$350,000
e.
$450,000
19. If you do build the hangar, how much are reliance damages?
a.
$50,000
b.
$75,000
c.
$300,000
d.
$400,000
e.
$500,000
20. Let p= the probability of me fulfilling the contract. For what level of p is reliance
efficient?
a.
p
≥
20%
(p
≥
1/5)
b.
p
≥
33.3%
(p
≥
1/3)
c.
p
≥
50%
(p
≥
1/2)
d.
p
≥
75%
(p
≥
3/4)
e.
p
≥
0%
(p
≥
0) (i.e. for any level of p)
21. Let p = the probability of me fulfilling the contract.
If you receive expectation
damages
including
the benefit of reliance, for what levels of p will you make
reliance investments?
a.
p
≥
20%
(p
≥
1/5)
b.
p
≥
33.3%
(p
≥
1/3)
c.
p
≥
50%
(p
≥
1/2)
d.
p
≥
75%
(p
≥
3/4)
e.
p
≥
0%
(p
≥
0) (i.e. for any level of p)
22. Let p = the probability of me fulfilling the contract.
If you receive expectation
damages
excluding
the benefit of reliance, for what levels of p will you make
reliance investments?
a.
p
≥
20%
(p
≥
1/5)
b.
p
≥
33.3%
(p
≥
1/3)
c.
p
≥
50%
(p
≥
1/2)
d.
p
≥
75%
(p
≥
3/4)
e.
p
≥
0%
(p
≥
0) (i.e. for any level of p)
Test Version A
6
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23. Which of the following statements are true?
a.
Expectation damages that exclude reliance will guarantee efficient
reliance
b.
Expectation damages that exclude reliance will guarantee efficient breach
c.
Expectation damages that include reliance will guarantee efficient breach
d.
Both A and B are correct
e.
Both A and C are correct
24. Cooter and Ulen suggest that courts should apply what type of default rules?
a.
Use the rules that the parties actually chose in the contract, and do not
fill any gaps
b.
Choose a rule that punishes all parties, so that in the future other people
will write better contracts
c.
Choose a rule that punishes the better-informed party for withholdling
information
d.
Use the rule that the parties would have wanted if they had chosen to
negotiate over the issue
e.
There is no such thing as a default rule.
25. Imagine that a family is purchasing a new house from a construction company.
There is a 50% chance that the cost of materials to build the house will increase
by $2000.
The construction company could pre-buy and store materials in a
warehouse at a cost of $400.
The family cannot do anything about this potential
increase in costs.
Who is the efficient bearer of this risk?
a.
The construction company
b.
The family
c.
The warehouse company
d.
No one is the efficient bearer of risk
e.
The family and the construction company are equally efficient bearers of
this risk
26. What is the difference between regulations and default rules?
a.
Default rules always apply, but you can contract around regulations.
b.
Regulations always apply, but you can contract around default rules
c.
Regulations only apply if the parties leave a gap in the contract, whereas
default rules always apply
d.
There is no difference between default rules and regulations—they’re
two terms for the same concept.
Test Version A
7
27. Imagine that Adam sells his car to Blair. Adam knows that the brakes do not
work.
Upon driving away with the car, Blair immediately gets into an accident
because the brakes do not work.
Blair would like to void the contract, meaning
that Adam would purchase the car back from her for the price she paid. Under
which grounds is this purchase most likely to be thrown out?
(Assume that this
transaction happens under a common law legal system).
a.
Fraud
b.
Failure to disclose a known danger
c.
There was no consideration given
d.
Unilateral mistake
e.
There is no legal theory to throw out this contract
28. What is an implication of the paradox of compensation in the context of contract
law?
a.
Any level of damages will always cause over-reliance
b.
It is impossible to set a single level of damages that gives both efficient
breach and efficient reliance
c.
Individuals save more money during recessions, which leads to a decrease
in aggregate demand
d.
A level of damages that gives you efficient breach will also give you
under-reliance (i.e. less than the optimal amount of reliance).
29. What is the rule that courts in the US use to determine whether or not to enforce
a contract that was predicated on a threat?
a.
The courts will never enforce a rule that was predicated on any threat
b.
The courts will always enforce a rule so long as a bargain was reached
(even if it was predicated on a threat)
c.
The courts will not enforce rules that were predicated on the threat of
physical violence, but will enforce rules that were predicated on other
threats
d.
The courts will not enforce rules that were predicated on a threat to
destroy value, but will enforce rules that were predicated on a threat
not to create new value
e.
The courts will enforce rules that were predicated on a threat to destroy
value, but will not enforce rules that were predicated on a threat not to
create new value
Test Version A
8
30. Which of the following is not ground to overturn a contract?
a.
Mutual mistake
b.
Fraud
c.
Failure to disclose a known danger
d.
There was no “meeting of the minds” about the good for sale under the
contract
e.
All of the above are grounds to overturn a contract
31. The defining feature of a “shrink-wrap” contract is that:
a.
It was signed between two parties with unequal bargaining power
b.
One party to the contract is a monopoly
c.
It could not be reviewed before signing it
d.
It was signed by a person who was incompetent to agree
e.
It is dramatically unfair
32. When is it least likely efficient for a court to use a penalty default rule to fill gaps
in a contract?
a.
When the gap was left because of high transaction costs associated with
filling it
b.
When the gap was left for strategic purposes
c.
When the gap was left because one part was withholding information
from the other party
d.
It is never efficient for a court to use a penalty default rule
e.
It is always efficient for a court to use a penalty default rule
33. Which term refers to a court-ordered remedy requiring the promisor to pay back
ill-gotten profits or gains?
a.
Expectation damages
b.
Disgorgement
c.
Consideration
d.
Specific performance
e.
Penalty default
Test Version A
9
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34. Which of the following is true?
a.
If the penalty for breach of contract is specific performance, and
transaction costs are high
1
a promisor will breach if and only if such
breach is efficient (that is, will breach if it is efficient for them to breach,
and will perform if it is not efficient for them to breach)
b.
If the penalty for breach of contract is expectation damages, and
transaction costs are high a promisor will breach if and only if such
breach is efficient (that is, will breach if it is efficient for them to breach,
and will perform if it is not efficient for them to breach)
c.
If the penalty for breach of contract is opportunity cost damages, and
transaction costs are high a promisor will breach if and only if such breach
is efficient (that is, will breach if it is efficient for them to breach, and will
perform if it is not efficient for them to breach)
d.
B and C are both true
e.
A, B, and C are all true
35. Which of the following statements about damages is true?
a.
Expectation damages are sometimes called positive damages because
they return the promisee to the level of wellbeing he or she would have
obtained absent the breach.
b.
Expectation damages are sometimes called negative damages because
they return the promisee to the level of wellbeing he or she had before
signing the contract.
c.
Reliance damages are sometimes called positive damages because they
return the promisee to the level of wellbeing he or she would have
obtained absent the breach.
d.
B and C are both true
e.
All of the above are true
f.
1 Throughout this problem, assume that “high” transaction costs are high enough to
prevent negotiation between the promisor and promisee
Test Version A
10
Questions 36-40 refer to the following:
Imagine the following scenario:
a family
farm is approached by a mining company who wants to mine their land.
The coal
is worth $50,000, and the mining company and family agree that the company
will pay $10,000 for the rights to mine the land.
However the family is only
willing to do this if the coal company agrees to restore the land to its original
condition, a process that will cost $15,000. If the land is unrestored, its resale
value is diminished by $500, but they will suffer from $20,000 of disutility from it
being unrestored.
36. What are the payoffs to each of the players (family and mining company) if
the
family agrees to sell the rights to the mining company,
and the mining company
restores the property to its original condition.
(For this and all following
questions in this series, the payoff will be listed as (Family, Mining Company))
a.
($10,000 , $25,000)
b.
($15,000 , $25,000)
c.
($10,000 , $20,000)
d.
($25,000 , $10,000)
e.
($25,000, $15,000)
37. What are the payoffs to each of the players (family and mining company) if: The
family doesn’t agree to sell the mining rights to the mining company.
a.
($10,000 , $25,000)
b.
($15,000 , $25,000)
c.
($25,000 , $10,000)
d.
($25,000, $15,000)
e.
($0, $0)
38. What are the payoffs to each of the players (family and mining company) if: The
family agrees to sell the rights to the mining company, but the mining company
refuses to restore the property to its original condition, and then the court grants
penalty damages in the amount of the family’s value of the restoration work.
a.
($10,000 , $25,000)
b.
($15,000 , $25,000)
c.
($10,000 , $20,000)
d.
($25,000 , $10,000)
e.
($25,000, $15,000)
Test Version A
11
39. How much cooperative surplus is available to the family and the coal company
(together) if they can reach an agreement to allow mining on the property.
a.
$60,000
b.
$45,000
c.
$35,000
d.
$15,000
e.
$1000
40. If the family and the mining company want to write a contract that will be (1)
likely to upheld by the courts and (2) will achieve the goal of having the mining
company do the restoration work as promised, which of the following contracts is
most likely to be successful in meeting these goals?
a.
The mining company pays the family $10,000 for the rights to mine the
coal, and promises to perform restorative work.
If the restoration work is
not performed, the mining company pays the family a penalty of $20,000.
b.
The mining company pays the family $10,000 for the rights to mine the
coal. If the restorative work is not performed, the mining company pays
the family a penalty of $500.
c.
The mining company pays the family $30,000 for the rights to mine the
coal. If the restoration work is performed, the family pays the mining
company a bonus of $20,000.
d.
A and C are equally likely to meet the two goals outlined
e.
A, B, and C are all equally likely to meet the two goals outlined
Test Version A
12
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