An economist view contract law as an arrangement which involves an agreement where parties undertake reciprocal promises. In economics this is simply known as a bilateral co-ordination arrangement. Over the years, contract law has attracted the attention of economic analysis which led to the development of three principles which are; transaction costs, incentives and incomplete contracts. The evolution of contract law through the lenses of economic analysis has led to our enhanced understanding of how market economies operate.
For record purposes it is essential to note that it was the economist who brought forth the concept of trade. There starting point was from the fact that all aspects of trade are voluntary. Economists therefore uncovered the thought that trade actually involves the search for necessary commodities. To add on to that the economists also formulated the concept of value which led to the conclusion that all trade is the reciprocated transfer of values and not objects. Economists further gave new meaning to contract by defining it as “an economic operation based on the subjective or objective equilibrium of the values that have been exchanged.” Based on the foregoing all contracts can be viewed as a transaction involving exchange of values.
Even as this essay provides an in depth analysis of contracts in the UK and economics, there is need to remember the importance of economic trade in the general theory of contract. This is because contracts involve the meeting of minds. The establishment of legally binding rules by a meeting of minds happens to be the common denominator in all contracts. In the event any contract or agreement lacks this element then it cannot be considered a contract.
Well renowned economists such as Smith and Walras have set the pace in economic analysis of contract law in the United Kingdom and all over the world. Their economic analysis is based on the operation of decentralized economies on the notions of the price and market system. Contract economics came to light in the late nineteenth century from a two-fold perspective which was the foundation of the Walrasian market theory. The Walrasian market theory had the following foundations:-
The above mentioned twofold foundations of the Walrasian market theory gives an explanation of the tremendous improvement of UK contract law and its main contribution to the essential reformation of all avenues of economic analysis. This ranges from the study of macroeconomic aggregates (for instance labor market) to that of interactions which are microeconomic.
Even though contract law is viewed from a simplistic perspective, there are four important issues which bring out the analytical power of economics:
2.1 Transaction cost theory
Transaction cost theory focuses on the modalities of economic agents that seek to understand their commitment constraints which are made to guarantee the returns of specific investments. This theory relies on safety measures to ensure protection of each party from the potential for behavior that is opportunistic and offers incentives to perform the transaction. In other words it places more effort on manipulation of the costs of breaking the contract.
Another plus for this theory is that is focuses on private conflict resolution measures. This is because commitments are specific and open-ended therefore resolution of conflict cannot be handled by outside authorities. It is such conditions which force the parties in the contract to agree beforehand on mechanisms of resolving disagreements.
Transaction cost theory offers agents a standard set of co-ordination rules which in turn free them from invention or reinvention within their relationships in the contracts. Another essential role played by this theory is that it provides reliability to sanctions thus providing an assurance on contractual obligations.
2.2 Incentive theory
Incentive theory is inspired by the hypothesis of Walrasian economic theory. The general assumption is that economic agents are equipped with contract knowledge which makes them sure of the structural pattern of the issues being confronted in the contract. These agents have access to information that is complete and tailored to the set preference. To make it easier for the agents there exist an incentive scheme which based on an institutional framework. The said framework is benevolent and competent thus ensuring that principal adheres to his commitment.
This theory begins from a canonical angle where a principal who is the under-informed party puts measures comprising of an incentive scheme to coerce the agent who is the informed party to provide information or implement behavior that is in line with the interests of the principal.
2.3 Incomplete contract theory
This is the most recent theory that seeks an examination of the impact of institutional framework on the contract design. In the incomplete contract theory, agents are viewed as personnel who have savage rationality. Oliver Hart opines that incomplete contract theory works towards enriching the economic analysis of contractual transactions by providing stimulating highlights of the law and economics. This is because incomplete contract theory is able to provide an account for the effect of institutional framework on the economic contractual practices.
Based on the foregoing, incomplete contract theory creates a link between the capabilities of judicial institutions to provide an evaluation of the nature of contracts that are implementable and the efficiency.
Instead of having contract law and economics on two different platforms, it is important to have the same combined so as to formulate proper operational structures. There various factors which are behind this combination of contract law and economics.
3.1 Human Actors
Herbert Simon states that,”Nothing is more fundamental in setting our research agenda and informing our research methods than our view of the human beings whose behavior we are studying.” Human actors possess a transaction cost that is brought out by human actors’ cognitive ability and their ability to foresee. Intertwining of economics and contract has been made possible by the fact that the parties involved normally think ahead and take note of the hazards which might affect the contract. Human actors normally take measures to ensure mitigation of contractual hazards by putting in place operational structures.
3.2 Unit of analysis
The contractual transaction is deemed as the basic unit of analysis. The approach taken by human actors in unit of analysis is whereby they have to identify the main essentials of transactions that might lead to various hazards that will intrude on both economic movement and contract theory.
Having realized contractual transaction falls under the basic unit of analysis there is a greater want for harnessing it for economic reasons. This is where governance as a concept comes in. In this situation governance serves as a means through which order is attained with respect to conflicts that might arise in future thus threatening to undo any mutual gains achieved. It is at this point that contract law is fused with economics for purposes of transcending technology.
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