The seller's behaviour
Suppose that the parties know that expectation damages of V (x*) will be awarded. 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, reasonable expectation damages of V (x*) induce efficient behaviour by the seller.
The buyer's behaviour
Given that the buyer is compensated an amount of V (x*) irrespective of the level of reliance that he actually chooses, the expected value of the contract to the buyer under expectation damages is:
For any xS, the buyer will choose precaution up to the point where private marginal benefit equals private marginal cost. But note now that in contrast to equation (8.14), the expression (8.22) depends on the probability p( xS). The buyer's optimal choice of reliance now satifies:
Given that the seller chooses xE = x* the buyer's reliance satisfies:
and so both the buyer and the seller behave efficiently. This result is exactly analogous to a rule of strict liability with a defence of contributory negligence in the bilateral model of accident law, where the due standard of care is chosen to be the efficient level of care. These expectation damages insure the 'victim' of the breach (the buyer) only to the extent that he behaves reasonably. Moreover, the buyer cannot influence these damages by his choice of reliance, so that there is no moral hazard issue. On the other side of the contract, the seller faces the full social costs of his actions, where those social costs are computed at the efficient point. Hence it is as if the seller effectively faces an efficient Pigouvian tax under this rule.