*George Mason School of Law

Contracts II

Capacity and Paternalism

F.H. Buckleyfbuckley@gmu.edu

What does it mean to choose badly?

Immoral choices Choices that Harm OthersSelf-defeating ChoicesI wanted x but somehow I chose not-x.*

What does it mean to choose badly?

Immoral choices Choices that Harm OthersSelf-defeating ChoicesCapacity and PaternalismWant of Consent: Fraud, Duress*

The want of capacity

Is there anything worse than being irrational?*

The Sleep of Reason*Goya, The sleep of reasonbrings forth monsters

But who is irrational here?*How much would you pay for your child? For what price would you sell her?

Economists have a narrow definition of rationality

With full capacity, free bargaining makes people better offProvided that we assume that their choices satisfy the assumptions of rational choice*

*Rational Choice: Six AssumptionsFull Information

*Rational Choice: Six AssumptionsFull InformationChoices are Freely Made

*Rational Choice: Six AssumptionsFull InformationChoices are Freely MadeNon-satiation

*Rational Choice: Six AssumptionsFull InformationChoices are Freely MadeNon-satiationCompleteness or comparability

*Rational Choice: Six AssumptionsFull InformationChoices are Freely MadeNon-satiationCompleteness or comparabilityNo third party effects (externalities)

*Rational Choice: Six AssumptionsFull InformationChoices are Freely MadeNon-satiationCompleteness or comparabilityNo third party effects (externalities)Perfect rationality: Transitivity and independence of irrelevant alternatives

*Rational Choice: Six Assumptions With all those assumptions, a strong presumption that our choices make us better off

*Rational Choice: Six AssumptionsFull Information (later)No mistakesNo misrepresentationsAnd no informational asymmetries

*Rational Choice: Six AssumptionsFull InformationChoices Are Freely Made (later)No duress

*Rational Choice: Six AssumptionsFull InformationChoices Are Freely MadeNon-satiationMore is always better

* AB Good 1 More is always better 0 Good 2 Non-satiation: B > A

* AB Good 1 More is always better 0 Good 2 Non-satiation: B > AXAXBXB > XAYBYAYB > YA

*Rational Choice: Six AssumptionsFull InformationChoices Are Freely MadeNon-satiationCompleteness or comparability

*No black holesComparability: No incommensurabilities

Time 1

0

Time 2

*

Sophies Choice

IncommensurabilityTragic Choices

*

Life choices Two roads diverged in a woodIncommensurabilityNon-comparable Choices

*Rational Choice: Six AssumptionsFull InformationChoices are Freely MadeNon-satiationCompleteness or comparabilityNo third party effects (externalities)

*MaryBessAnnRepresenting Anns utility on a third dimension.

(Please put on your 3-D glasses now.)Third party effects: Bargaining with a third person

*MaryBessAnnThe intersection of the three indifference curves in three dimensionalspace is the bargaining core

The bargaining lens in three dimensionsThird party effects: Bargaining with a third person

*

Paretian norms dont work if Coasian bargains are impossible

External Costs and Tort Law

What happens if third parties cant be joined?

*Do we then abandon the concept of efficiency?

A more relaxed standard: Kaldor-Hicks efficiency

A transformation is Kaldor-Hicks efficient when the winners could compensate the losers (Potential Pareto-Efficiency) and satisfy Paretian standardsBut nearly everything has third party effects

*It is proposed to abandon steel tariffs that impose costs of $10B on consumers but provide steel manufacturers with a gain of $1B.

The bankruptcy of a failing business imposes a cost to shareholders and employees of $1M, but provides a benefit of $5M to creditors.Examples of Kaldor-Hicks Efficiency

*MaryBessACExplaining Kaldor-Hicks:C is Pareto-inferior to A Moving from A to C makes Mary worse off

*MaryBessACBut C is Kaldor-Hicks Efficient to A 1. At C Bess is on IC and better off than she is at A on IAIAIC

*MaryBessABCC is Kaldor-Hicks Efficient to A 2. At C Bess could give up CB roses to move to B and be on IB, where she would still be better off than she was on IAIAIBIC

*MaryBessABCC is Kaldor-Hicks Efficient to A 3. At B Mary would be no worse off than at A.IAIBIC

*MaryBessABCKaldor-Hicks EfficiencyC is Pareto-inferior to A but Bess could make it Pareto-superior by transferring wealth to MaryIAIBICPotential Pareto-superiority

*Rational Choice: Six AssumptionsFull InformationChoices are Freely MadeNon-satiationCompleteness or comparabilityNo third party effects (externalities)Perfect rationality

*Perfect Rationality: Transitivity A Technical Definition

If A is preferred to B and B is preferred to C, then A is preferred to C

A}B, B}C A}C

} = is preferred to

*Relaxing the Rationality Assumption: Transitivity: A Technical Definition

If A is indifferent to B and B is indifferent to C, then A is indifferent to C

AB, BC AC

~ = is indifferent to

* AB Good 1 0 Good 2 We assume more is betterXAXBXB } XAYBYAYB } YA

*Transitivity: A}B, B}C A}C Good 1 0 Good 2 CB A

*Violation of Transitivity Indifference curves cant touch Good 1 a b c 0 Good 2 A violation of transitivityIf a ~ c and c~ b,then a ~ b.But b > a, so b } a

But how far does this take us?*Any intransitive preferences here?

*Relaxing the rationality assumption:Paternalism

Suppose that, lacking perfect rationality, we knew that our choices might harm us.

Might we not, in such cases, wish to let the paternalist choose for us?

*Relaxing the rationality assumption:Paternalism

The standard casesMinorsMental defectivesInebriatated, drugged

Capacity: Minors*Restatement 12(1): No one can be bound by contract who has not legal capacity to incur at least voidable contractual duties. Capacity to contract may be partial and its existence in respect of a particular transaction may depend upon the nature of the transaction or upon other circumstances.(2) A natural person who manifests assent to a transaction has full legal capacity to incur contractual duties thereby unless he is(a) under guardianship, or(b) an infant, or(c) mentally ill or defective, or(d) intoxicated

Restatement 14: Infants* Unless a statute provides otherwise, a natural person has the capacity to incur only voidable contractual duties until the beginning of the day before the person's eighteenth birthday.

Infants: Kiefer at 465

What happened?Who is bringing the action?

*

Infants: Kiefer

What happened?Who is bringing the action?Voidable at the option of the minorDisaffirming the contract

*

Infants: Kiefer

What about the mature 16 year old?Or the married person under the age of majority?

*

Infants: Kiefer

What about the immature 25 year-old? *

Infants: Kiefer

Bright line standards are both over- and under-inclusiveBut economize on screening costs*

Infants: Kiefer

Did the know that the was an emancipated minor?If not, who bears the risk?

*

Infants: Kiefer

Did the know that the was an emancipated minor?Should the have known?

*

Infants: Kiefer Did you never get carded?

*

Infants: Kiefer

Did the know that the was an emancipated minor?Contrast Restatement 14 and 15.

*

Restatement 15: Mental Illness*(1) A person incurs only voidable contractual duties by entering into a transaction if by reason of mental illness or defect (b) he is unable to act in a reasonable manner in relation to the transaction and the other party has reason to know of his condition.

Infants: Kiefer

What if the infant had lied about his age?

*

Infants: Kiefer

What if the infant had lied about his age?Wisconsin Loan at 467Whats the difference between estoppel and recovery in tort for fraud?Doenges-Long v. Gillen at 471

*

Merchant ProtectionWhat if he presents a fake ID?*

What about internet purchases?*

Merchant Protection

What about the age of majority clause in the contract?*

Merchant Protection

What about the age of majority clause in the contract?Why did the court say that this did not provide evidence of an intent to defraud?*

Merchant Protection

If the contract is properly disaffirmed by the minor, who is liable for depreciation?Halbman at 470*

Affirming the Contract

What if the minor doesnt disaffirm the contract on reaching the age of majority?Bobby Floars at 472*

Why an exception for necessities?*

Why an exception for necessities?

Are cars necessities?*

Capacity: The Mentally Ill*Restatement 12(1): No one can be bound by contract who has not legal capacity to incur at least voidable contractual duties. Capacity to contract may be partial and its existence in respect of a particular transaction may depend upon the nature of the transaction or upon other circumstances.(2) A natural person who manifests assent to a transaction has full legal capacity to incur contractual duties thereby unless he is(a) under guardianship, or(b) an infant, or(c) mentally ill or defective, or(d) intoxicated

Mental Illness 15(1). A person incurs only voidable contractual duties by entering into a transaction if by reason of mental illness or defect (a) he is unable to understand in a reasonable manner the nature and consequences of the transaction, or *

Mental Illness 15(1). A person incurs only voidable contractual duties by entering into a transaction if by reason of mental illness or defect (a) he is unable to understand in a reasonable manner the nature and consequences of the transaction, or (b) he is unable to act in a reasonable manner in relation to the transaction and the other party has reason to know of his condition. *

Mental Illness 15(1). A person incurs only voidable contractual duties by entering into a transaction if by reason of mental illness or defect (a) he is unable to understand in a reasonable manner the nature and consequences of the transaction, or (b) he is unable to act in a reasonable manner in relation to the transaction and the other party has reason to know of his condition. *

Mental Illness 15(2). Where the contract is made on fair terms and the other party is without knowledge of the mental illness or defect, the power of avoidance under Subsection (1) terminates to the extent that the contract has been so performed in whole or in part or the circumstances have so changed that avoidance would be unjust. In such a case a court may grant relief as justice requires.

*

Mental Illness

Whats the rationale for merchant protection here, but not for infants?*

Faber at 474*

FaberSo something was excessive here? I dont get it!*

Faber

Where are the standards of incompetency reviewed by the court?*

Faber

Standards of IncompetencyCapacity to understand: Paine v. Aldrich *

Faber

Standards of IncompetencyCapacity to understand: Paine v. Aldrich Loss of Control due to insane impulse in Newton v. Mutual Benefit*

Faber

Standards of IncompetencyCapacity to understand: Paine v. Aldrich Loss of Control due to insane impulse in Newton v. Mutual BenefitAbnormal Acts performed by a bipolar person*

Faber

Where did the onus of proof lie?*

Faber

Which party was in the better position to cure the problem?*

FaberHow would you have applied Restatement 15(1)(b)?A person incurs only voidable contractual duties by entering into a transaction if by reason of mental illness or defect (a) he is unable to understand in a reasonable manner the nature and consequences of the transaction, or (b) he is unable to act in a reasonable manner in relation to the transaction and the other party has reason to know of his condition. *

Faber

What remedy under 15(2)?Cf. Illus. 5: the need for restitutiton*

Is Faber consistent with Uribe at 478?

Should the have been on notice?*

Uribe

Suppose the contract had been set asideHow might this change the advice youd give a client who buys from an elderly seller?*

Intoxicated Persons

Restatement 16. A person incurs only voidable contractual duties by entering into a transaction if the other party has reason to know that by reason of intoxication (a) he is unable to understand in a reasonable manner the nature and consequences of the transaction, or (b) he is unable to act in a reasonable manner in relation to the transaction. *

Intoxicated Persons

Restatement 16. A person incurs only voidable contractual duties by entering into a transaction if the other party has reason to know that by reason of intoxication (a) he is unable to understand in a reasonable manner the nature and consequences of the transaction, or (b) he is unable to act in a reasonable manner in relation to the transaction. Recall Lucy v. Zehmer*

*

Infants, Mental defectives, drunks

Who are we forgetting?

*

Paternalisms questionable historySo you want to help victims? How about

Restrictions on women

Slavery

*

The New Paternalism

Unlike the old Paternalism, the new Paternalism does not discriminate

It is also based on better science

*The New Paternalism:When might our desires misfire?When might we agree to let the Paternalist second-guess our decisions?

Judgment Biases: Because we miscalculate what is good for us

Akrasia: Because we lack the strength of will to pursue what we know is good for us

Judgement Biases

Do we always calculate correctly?We should have to be monsters of calculation, like Laplaces Demon.*

Laplaces DemonAn intellect which at a certain moment would know all forces that set nature in motion, and all positions of all items of which nature is composed, if this intellect were also vast enough to submit these data to analysis, it would embrace in a single formula the movements of the greatest bodies of the universe and those of the tiniest atom.

For such an intellect nothing would be uncertain and the future just like the past would be present before its eyes. *

Our brains are not wired like Laplaces supercomputer

Instead we get through life by relying on heuristics or mental shortcuts:IntuitionsHunchesEmotions*

*Otherwise we couldnt walk and chew gum at the same timeGerald Ford

*Judgment Biases: Some readingsVern Smith, Nobel Address 2002Gigerenzer, Adaptive Thinking (2000)Sunstein, Behavioral Law and Economics (2000)

*Cognitive Paternalism: Judgment Biases

Even if our heuristics and hunches are satisfactory in average cases, they seem to mislead in anomalous cases.

*Cognitive Paternalism: Judgment Biases

Even if our heuristics and hunches are satisfactory in average cases, they seem to mislead in anomalous cases.

The case of judgment biases: The cognitive paternalist would de-bias us.

*

Some Judgment Biases

The Self-serving BiasWe process away any negative comments about ourselves, and relish positive ones.Great job, Brownie!

*Paternalism:Some Judgment Biases

The Availability BiasPauline Kael on the 1972 election

*

Some Judgment Biases

The Anchoring BiasI spin a roulette wheel and it comes up 25. Now I ask you how many African members there are in the UNI spin and it comes up 65. I ask a different group of people.

*

Some Judgment Biases

The Gamblers FallacyYou are at a casino. At the roulette table, the numbers are either red or black. Black has come up six times in a row. What is the probability that it will come up black on the next turn? (Assume a fair table.)

*

Some Judgment Biases

The Gamblers FallacyYou are at a casino. At the roulette table, the numbers are either red or black. Black has come up six times in a row. What is the probability that it will come up black on the next turn? (Assume a fair table.) 50%. (You thought the table had a memory?)

*

Some Judgment Biases

The Hindsight BiasYou watch a baseball game. The pitcher (ERA of 2.11) has given up two walks in the eighth inning. Should the manager take him out?

*

Some Judgment Biases

The Hindsight BiasYou watch a baseball game. The pitcher (ERA of 2.11) has given up two walks in the eighth inning. The manager leaves him in. The next batter up hits a home run. Idiot!, you say. I would have taken the pitcher out.

Judgment BiasesProbability Theory: Monty Hall *

Judgment BiasesProbability Theory: Monty Hall O.C.Youre a participant in a game show, facing three doors.

Monty tells you that, behind one of three doors, there is a new car, which youll get to keep if you pick the right door. The other two doors have goats behind them. Lets say you pick door 3.

*

Judgment BiasesProbability Theory: Monty HallMonty tells you that, behind one of three doors, there is a new car, which youll get to keep if you pick the right door. The other two doors have goats behind them. Lets say you pick door 3.

Monty knows the door behind which the prize is hidden. He now says Im going to help you. Im going to tell you that the prize is not behind door 1.

Do you stay with door 3 or do you switch to door 2?*

Judgment BiasesProbability Theory: Monty Hall You should always switch.

The probability associated with each door was 1/3. When Monty opened door 1, he did not change the 1/3 probability associated with door 3.

The probabilities sum to 1, so the probability associated with door 2 must be 2/3.*

*George Mason School of Law

Contracts II

Capacity and Paternalism

F.H. Buckleyfbuckley@gmu.edu

*The New Paternalism:When might our desires misfire?When might we agree to let the Paternalist second-guess our decisions?

Judgment Biases: Because we miscalculate what is good for us

Akrasia: Because we lack the strength of will to pursue what we know is good for us

*Do judgment biases justify Paternalism?

Do we underestimate small probability, high magnitude events? Mandatory catastrophic medical insurance

*Do judgment biases justify Paternalism?

Do we underestimate small probability, high magnitude events? Mandatory catastrophic medical insuranceAn asteroid will destroy all civilized life as we know it, and also Las Vegas

The Counter-revolution

The defense of heuristic thinking: Gerg GigerenzerLearningMarket ProcessesThe Paternalists Judgment Biases*

*Are our heuristics dumb?

Gigerenzers fast and frugal heuristics

Gerd Gigerenzer

*Are our heuristics dumb?

Gigerenzers fast and frugal heuristicsWhich city has more people:Sydney or Melbourne?

*Are our heuristics dumb?

Gigerenzers fast and frugal heuristicsTake the best cue

*Are our heuristics dumb?Gigerenzers ecological rationality: how well do our heuristics fit in the world we inhabit.Who cares if they go wrong in a psychological test if they on average serve us well?

*Are our heuristics dumb?

*Moral Heuristics?Our reaction to evil is unthinking and immediate.We dont have to calculate cost vs benefitOur moral judgments are coded with an emotional response *

Can the sleep of passion be troubling?*Is a very strong emotional attachment a sign of irrationality?

*Learning

Are some biases corrected through learning How to hit a curve ball.

*Market Processes

Can market processes help?Would inefficient heuristics tend to get excluded in markets?

*What about the Paternalist?

What about the Paternalists judgment biases?

*What about the Paternalist?

What about the Paternalists judgment biases?The hindsight bias and negligence liability?

*What about the Paternalist?

What about the Paternalists judgment biases?The anchoring bias and inefficient pollution regulations.

What does it mean to choose badly?

Self-defeating ChoicesCapacity and PaternalismJuddgment BiasesAkrasia: Weakness of the Will*

Lets Recall some contracts that arent enforced: Gambling*The game is poolstraight pool

Lets Recall some contracts that arent enforced: Drugs*

Lets Recall some contracts that arent enforced: Sex**

Can all these be explained as an effort to address akratic behavior?*

*

What is Akrasia: The non-ruledDor, Weak-willed St. Peter Denies Christ for the third time

Varieties of Akrasia

Overwhelming PassionSelf-deceptionDiscounting the futureThe Divided SelfReversal of preferences (?)*

*

1.Overwhelming passionThe Gambler

*1.Overwhelming passionThe Gambler I believed in my system ... within a quarter of an hour I won 600 francs. This whetted my appetite. Suddenly I started to lose, couldn't control myself and lost everything. After that I ... took my last money,and went to play ... I was carried away by this unusual good fortune and I risked all 35 napoleons and lost them all. I had 6 napoleons d'or left to paythe landlady and for the journey. In Geneva I pawned my watch.

When I see the green baize spread before me

F.M. Dostoyevsky

*1.Overwhelming passion: Phdre Racine, Phdre III.vPhdre, These, Hippolyte

*1.Overwhelming passionThe Hypomanic

*Varieties of Akrasia 2.Self-deception

Suppose I am self-deceived and have less will power than I think I have.

Might I then commit sins against which I thought myself strong?

*

2.Self-deception

Im going to have just one piece of the pie.

No way will I eat the whole thing!

*2.Self-deception

Tertius Lydgate and Rosamond Vincy

Can one be self-deceived?

Is it possible to be in love and not to know it?

To be not in love and not know it? George Eliot, Middlemarch

*Varieties of Akrasia 3.Discounting the Future

You have a choice between immediate consumption and saving for deferred consumption. How do you decide?*

*

3.Discounting the Future

You have a choice between immediate consumption and saving for deferred consumption. How do you decide?Do you prefer todays person to that of tomorrow?*

*

3.Discounting the Future

Dor, The Prodigal Son*

*Varieties of Akrasia4.The Divided SelfGozzoli, St. Augustine departing for MilanI was neither wholly willing not wholly unwilling. So I was in conflict with myself and was dissociated from myself.*

*

4.The Divided SelfI was neither wholly willing not wholly unwilling. So I was in conflict with myself and was dissociated from myself.*Is this more than a description of ambivalence? If its not, with which self do we take sides?

*Varieties of Akrasia? 5.Reversal of preferences

*Is this really self-deception?

*

5.Reversal of preferences?

*But with whom do we take sides?

*

Does Akrasia warrant a legal remedy?

*

Does Akrasia warrant a legal remedy?

The possibility of bad faith by the paternalistThe paternalists informational problemSelf-help and self-bindingThe value of autonomy

*The Counter-arguments1. Bad Faith

*The Counter-arguments2. The states informational problem

The State might easily get it wrong:Is addiction per se bad? Might it ever make sense ex ante to become an addict?

*Gary Becker: Rational and irrational addictionUtility0TimeGary Becker, Accounting for Tastes (1996)Preferences for commodities over timeAddiction: the more you consume,The more you want

*Gary Becker: Rational and irrational addictionUtility0ABTimeGary Becker, Accounting for Tastes (1996)classical musicOver time the preferencefor classical music increasesbut this is a benign addictionSubject suffers from withdrawalif music taken away from him

*Gary Becker: Rational and irrational addictionUtility0ABCTimeclassical musiccoffeeUnlike classical music, there comes a time when the subject would like to stop drinking coffee. Though he finds he cannot do so, his ex ante decision to start drinking coffee is still rational

*Gary Becker: Rational and irrational addictionUtility0ADBCTimeclassical musiccoffeehard drugsEx ante, the decision to start taking hard drugs is irrational

*The Counter-arguments2. The states informational problemCan the state distinguish between rational and irrational addiction?

Just how would you categorize the taste for the following:TobaccoIce creamLotteries

*The Counter-arguments3.Self-help

If we might be weak-willed, can we address the problem without the help of legal barriers?Social sanctionsSelf-binding

*The Counter-arguments Self-binding as a response to akrasia

Jon Elster, Ulysses and the Sirens (1984)

*Examples of self-binding

Marriage

Home purchases

*The Counter-arguments4.The value of autonomy

Even if autonomy is merely a means, things can matter as means.The abstract value of freedom

Autonomy strengthens self-control

*Paternalism (Capacity) and Perfectionism (Illegal Contracts)

Paternalism: Interfere with personal choices to make subject better off

Perfectionism: Interfere with personal choices to promote a moral goal

Note how these might overlap

*

PerfectionismPaternalismImpugning Individual ChoiceThe Paternalist seeks to make the subject better off, while the Perfectionist would vindicate a moral goal.

*

PerfectionismPaternalismImpugning Individual ChoiceThese overlap when making a person better off vindicates a moral goal

*

PerfectionismPaternalismImpugning Individual ChoiceAnd that will happen when the subject would not choose well for himself because his preferences are immoral.

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