We can now examine the efficiency properties of various damage measures for breach of contract, beginning with expectation damages. In the event of the contract being breached, expectation damages put the buyer of the good or service in the same position that they would have been in had the contract been performed. In our example, the buyer has already prepaid the purchase price and has also invested in reliance. Hence, these are both sunk costs at the time the seller breaches or performs the contract. For any xB, the buyer expects to receive V(xB) if the contract is performed. This means that for any xB, expectation damages here are:
Note that the level of damages depends on the level of reliance taken by the buyer.
The seller's behaviour
Suppose that the parties know that expectation damages will be awarded in the event of a breach. The expected value of the contract to the seller is:
For any xB, the seller will choose precaution up to the point where private marginal benefit equals private marginal cost:
But note that this expression is the same as the efficiency condition for efficient precaution as outlined earlier in (8.11). In other words, expectation damages induce efficient behaviour by the seller.