Consider the following contractual relation between B and S. (10) B's value of the widget, denoted by v, is uncertain at the time of contracting. Assume that v will be either $90 or $150 or $170 with an equal probability. S's cost to produce the widget is $100 (c = $100). S's reliance expenditure is $10 (e = $10). Contract says that S is to deliver a widget to B at p = $130. Assume that B promises to pay S the contract price $130 (not paid in advance). Assume that if the contract is not completed, reliance expenditure has no value. Note: I will clarify the timing of the model again. Initially, B and S sign the contract. S chooses reliance e. Then, B observes the actual value of v, and decides whether to breach or not. If B breaches the contract, S does not incur the production cost $100 at all. The presumption is that for S, there are two types of costs, (1) the cost he incurs before B's breach decision that is captured in e, and (2) the extra cost he should incur to complete the contract that is captured in c.

(a) Describe the efficient performance / breach decision by B.

(b) Assume that the court awards expectation damages for breach of contract. Suppose that v turns out to be $90. Will B want to breach or perform the contract? Explain your answer. Now, modify the model so that we can study a variable reliance case. Assume that c(e) = 100 when e = 10, and c(e) = 91 when e = 17.

(c) Find out the efficient level of reliance (Assume that performance / breach decision will be made efficiently)

(d) Assume that the court awards expectation damages for breach of contract. What level of reliance will S choose to maximize his own expected payoff?

(e) Suppose that the court awards restitution damages for breach of contract. What would be the equilibrium level of reliance by S?