ECONOMIC ANALYSIS OF CONTRACT LAW FROM THE INTERNAL POINT OF VIEW

Economic analysis of law has traditionally assumed that legal rules are or ought to be designed to maximize social welfare taking as given that legal subjects are like Holmes's "bad man" rational, self interested agents who care about complying with the law only insofar as noncompliance exposes them to the risk of sanctions. But while it is plausible to suppose that some legal subjects are, like Holmes's bad man, "externalizers" of legal rules, it is likely that others regard the law from the "internal point of view"-that is, they are "internalizers" of legal rules who are motivated to conform to legal rules regardless of the consequences of defiance. In this Article, I ask what specific doctrinal implications for contract law follow when we assume that there are both internalizers and externalizers in the subject population while keeping the standard economic framework otherwise intact. I analyze several contract law phenomena: the expectation principle, according to which a victim of a breach of contract is entitled to her expectation, and no more than her expectation; the penalty doctrine and stipulated damages clauses; the doctrine of willful breach; and the doctrine of contract modification. The resulting analysis shows that internalizers respond to these doctrines differently from externalizers such that the prescriptive implications of economic analysis for the design of contract law doctrines may change once we recognize that there are both internalizers and externalizers in the subject population. For example, the presence of internalizers in the subject population provides a justification for punishing some "willful breaches" more harshly than ordinary breaches. It also helps to justify the modern doctrine of contract modification.