Restitution damages

Under restitution damages, the seller returns any payments that have been made to him by the buyer. Since we have assumed that the buyer paid the price up front, this means that:

Note that the level of damages does not depend on the level of reliance taken by the buyer.

The seller's behaviour

Suppose that the parties know that restitution damages will be awarded. The expected value of the contract to the seller is:

The seller will choose precaution up to the point where private marginal benefit equals private marginal cost:

Since the buyer would never enter into the contract if the price paid plus the cost of reliance exceeded the value of the reliance, we must have P < V(xB) for all xB. This then means that:

And so

Since p'(xS) is negative, and since p"{xS) > 0, this means that xRest < x*, which means that the seller again underinvests in precaution (and so breaches the contract too frequently, compared to the efficient breach frequency).

The buyer's behaviour

The expected benefit of the contract to the buyer is now:

Now the buyer's first-order condition is:

Note that this means that given the seller's investment in care, the buyer actually invests efficiently. However, given that the seller underinvests in care, the buyer will also underinvest in reliance.

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