Suppose that the value of a contract to a buyer, V, is a function of her investment in nonsalvageable reliance, R. Specifically, the buyer can invest either $100 or $200 with the resulting impact on V as follows:
R V
$100 $400
$200 $550
The contract price, payable on performance, is $75.
(a) Assume initially that performance of the contract will occur with certainty. What level of reliance maximizes the buyer’s net return from the contract?
(b) Now suppose that the buyer anticipates a breach of the contract with probability .5, in which case her reliance investment is lost (though she does not have to pay the price). What choice of reliance maximizes the buyer’s expected return in this case (ignoring damages)?
(c) What level of reliance will the buyer choose under unlimited expectation damages? How does your answer compare to your answers in (a) and (b)? Explain.