Price Discrimination with Contract Terms The Lost Volume Problem

In a common commercial pattern, the seller of a standard product contracts with one buyer and then sells to another at the contract price after the initial buyer breaches. Sellers argue, and courts largely agree, that the seller could have served the contract buyer as well as the later buyer; hence, the seller is entitled to retain a down payment to the extent of, or sue to recover, the profit - price less cost - that it would have realized on the initial sale had that sale been completed. Some courts and many scholars disagree, arguing that resale of the contract product at the contract price is fully compensatory; consequently, the seller is not entitled to damages. In this paper, we show that sellers in these "lost volume" contexts may use non-refundable down payments and later transaction prices in an attempt to practice second degree price discrimination. Sellers select among combinations of low down payment and high transaction price - which maximize the number of contracts as these serve low-value buyers, who are relatively unlikely to trade and pay the transaction price but who would be deterred by a significant down payment - and combinations of high down payment and low transaction price - which maximize the likelihood of transaction given a contract and serve high value buyers, who are relatively undeterred by a high down payment as they expect to benefit from increased trade at the low transaction price. These disparate preferences sometimes enable sellers to induce separation among the buyers by offering contracts that differ in their down payment/transaction price combinations. As a positive matter, we identify a form of price discrimination that does not require the seller to vary either the quantity or the quality of goods sold to an individual buyer. As a normative matter, we argue that a rule enforcing price discrimination contracts - i.e., restricting sellers to retention only of the down payment - is preferable to any mandatory rule on the treatment of liquidated damages as well as to the current majority default rule, which permits sellers to recover lost profits when they exceed the down payment, or the current minority default rule, which permits sellers to recover nothing.