contract law

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.[1]

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.

2. Economic Analysis

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.[2] The Walrasian market theory had the following foundations:-

• An empirical foundation which revolved around challenges related to restriction of competition in the market place which led to the introduction of economic thinking in contract law. The new economic thinking led its analysis on different varieties of inter-firm contracts such as long-term co-operation agreements and certain distributorship agreements.
• A theoretical foundation which sought implementing the economic analysis through new analytical tools that gave details on how economic agents decide the prices, properties and quantities of the commodities and resources being traded at the market place.

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.[3] 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:

• Economic analysis of contract law gives us the opportunity to reevaluate the characteristics of challenges related with economic co-ordination while improving our understanding of the operations and reasons for co-ordination mechanisms.
• Secondly, there is also the illumination of detailed aspects of contracts which depict co-ordination through authority, conflict resolution, routines and incentives.
• Thirdly an economic analysis of contracts brings clarity on the manner in which decision making structures are understood and implemented by agents.
• Lastly, highlighting the re-examination of contractual mechanisms aids in understanding changes in the framework of economic activity revolve around contracts.

[1] Bebchuk, L.A. and Shavell, S. “Information and the Scope of Liability for Breach of Contract: The Rule of Hadley v. Baxendale”, (1991) Journal of Law, Economics and Organization, 7(2): 284–312

[2] Collins, H. Regulating Contracts, (1999) London, Oxford University Press

[3] Crew, M.A. and Kleindorfer, P.R.“Price Caps and Revenue Caps: Incentives and Disincentives for Efficiency”, in M.A. Crew (ed.), Pricing and Regulatory Innovations under Increasing Competition, (1996) London, Kluwer Academic