… [T]here are substantial benefits from stipulating damages. When these benefits exceed the costs of negotiating them, the parties will stipulate damages, adjusting the contract price accordingly. With such clauses, both parties reach preferred positions, economic activity is increased, and goods are produced at lower costs. Since the net benefits appear to be positive, it seems difficult to explain why stipulated damage clauses are not strictly enforced. Are the courts in error? Alternatively, are there costs associated with these clauses that we have yet to consider?

An important cost of stipulated damage clauses … results from activities that may induce breach and from activities to prevent breach inducement, both of which waste scarce resources. Consider, for example, a contract to build a bridge with a stipulated damage clause of $500 for each day of delay beyond a specified completion date chosen to correspond with the first day that the purchaser expects to use the bridge. If the clause is carefully drafted, the $500 will closely approximate the expected damage to the purchaser from actual delay. Suppose, however, that during construction (or, for that matter, even at the time of the initial contract) the cost of delay to the purchaser becomes zero because the bridge could not be used until much later than originally planned. Since the producer's breach would now actually improve the purchaser's position, the purchaser has an incentive to undertake activities to cause delay as long as the additional expected revenues from creating delay ($500 multiplied by the number of days of delay) exceed the additional costs.