ECON 1450 – Professor Berkowitz Lectures on Chapter 2 Tort Law Area of Common Law concerned with accidental injuries Potential defendant engages in activity that puts the plaintiff at risk Example – medical malpractice More examples – product liabilities, workplace accidents, environmental accidents

Key issues Example of medical malpractice Obstetrician delivers babies There is always some risk involved in delivering babies We do not want the obstetrician to go out of business or to practice “defensive” medicine We want the obstetrician to take all “cost-justified steps to minimize the resulting cost”…. Tort law designed to give potential defendants the correct incentives Tort Law is a private remedy (versus public remedies such as OSHA regulations, fines for speeding, etc)

Social Function of Tort Law Compensate victims Primary goal – deter unreasonably risky behavior

Institutional Details Plaintiff has the burden of proof 1) Prove that plaintiff sustained damages AND 2) Prove that defendant was the cause One 1) and 2) are established, then plaintiff must prove the defendant was at fault

Prove Plaintiff was the cause Cause-in-fact and the “but for test” – 2 or more simultaneous causes?? – Complementary plaintiffs – Remote cause? Proximate Cause

Liability Rules If harm and causality are established, then Liability rule divides up damages between the injurers and victim (plaintiff) No liability rule – “caveat emptor” Strict liability Negligence rule

Basic Model of Torts x = $ investment in precaution P(x) = probability of an accident: P’ 0 D(x) = severity of accident: D’ 0 Interpretation – there are increasing marginal costs and declining marginal benefits

Expected Damages (ED) ED(x) = P(x)D(x) ED’ = P’D + PD’ < 0 (interpret) ED’’ = P’’D + 2P’D’ + PD’’ > 0 (interpret) There is a diminishing MB of precaution Let x = cost of precaution Then, 1 = MC of precaution

Social optimum Choose x: Min D(x)P(x) - x FOC: D’P + DP’ = 1 (interpret) SOC: D’’P + 2D’P’ + DP’’ > 0 (interpret) GRAPHIC REPRESENTATION (see figure 2.1 in Micelli) The socially efficient outcome is x* where MB = MC.

Positive Analysis No liability (caveat emptor) - inefficient because the injurer sets x = 0 Strict liability – efficient Partial liability – inefficient Negligence rule – “the due standard”

Strict Liability and Negligence Both rules are efficient (socially optimal), i.e., injurer always chooses x* Administrative costs – cost per case – strict liability is cheaper Administrative costs – total cases – negligence is cheaper

Errors in due standard Let x ds denote the due standard Impact on negligence: suppose x ds < x*, then injurer is too risky; If x* < x ds < x~, then injurer is “too cautious”; If x ds ≥ x~ then injurer is efficient, where x ds = P(x*)D(x*) + x*!!! Strict liability is always efficient

Courts Errors in calculating damages to victim If court is too generous then it gives the plaintiff αP(X)D(X), where α > 1 If the court is too stingy then, α < 1 Then, the injurer is too cautious when α > 1 and too risky when α < 1 Negligence – as long as α is too far below 1, then injurer chooses for α x**- the intution is that at some point court awards are so cheap that the injurer assumes full liability

Bilateral Care Victim should also be responsible for being sufficiently cautious Then x = precaution by injurer, y = precaution by victim, and P(x,y) = probability of an accident, when D(x,y) = severity of an accident There are diminishing marginal benefits of x and y

Bilateral care, continued p x 0, p y 0 D x 0, D y 0 (ED) x 0, (ED) y 0 Social optimum is choose x + y, in order to minimize x + y + ED(x,y) = x + y + p(x,y)D(x,y) FOC: D x p + Dp x = 1 FOC: D y p + Dp y = 1

No liability versus strict liability No liability - Injurer chooses x = 0, and victim chooses y: min y + p(0,y)D(0,y)… while y > 0 is chosen it is inefficient because x = 0! Strict liability – victim chooses y = 0, and injurer choose x: min x + p(x,0)D(x,0)….while x>0 is chosen, it is inefficient because y = 0! Reality check – do victims really choose y=0??

Getting caveat emptor to be efficient Make the injurer cover the full amount of the victim’s damages BUT do compensate the victim for full damages! Injurer chooses x: min x + p(x,y)D(x,y) Victim chooses x: min y + p(x,y)D(x,y) Law does not work this way – in practice, victim take what the injurer pays and so y = 0

Negligence in bilateral care model Let x ds = x*, so that injurer has the following pay-offs X + p(x,y)D(x,y) if x < x* X if x ≥ x* Does the victim choose y* (socially efficient outcome)????

Victim does choose y* Nash equilibrium (expectations are rational) – victim rationally anticipates that x=x* and then chooses y: min y + p(x*,y)D(x*,y), so that y=y*! Negligence is efficient because it allows the injurer to avoid liability by paying x*, and Imposes actual liability on victim

Reality check on negligence With this rule, victim is NOT compensated for damages As long as the due standard is met, nobody is negligent In reality, due standard may be off, there are differing costs of caution for different people, and the injurer may not have the money to pay x = x*

The Hand Rule and the Due Standard How is the due standard set?? Judge Learned Hand – United States versus Carroll Towing Co. (1947 – 2 nd Circuit) P = probability that barge breaks away L = extent of injury B = burden of adequate precaution If B by the “hand rule” the barge owner was negligent!

Reasonable person standard Injurers 1, 2 and 3 have differential costs of care: c1 < c2 = 1 < c3 Stories – Doctors at UPMC in Pittsburgh versus Doctors in Haiti Efficient for differential care: x1* > x2* > x3* Because of administrative costs, law in general does not differentiate – applies a uniform standard based on the “reasonable person”

Problems with reasonable person standard c1 < c2 = 1 < c3, and c2 = 1 is average Set due standard at x* for the average person Type c1 will under-invest Type c3 will meet the due standard if c3 not too much higher than 1, will meet the due standard and be too cautious… When c3 is sufficiently greater than 1, however, this person is socially efficient (behaves as if strictly liable)

Contributory negligence Bilateral model – NOW victim also must the due standard if he/she wants to recover for damages Butterfield versus Forrester (1809) Suppose the due standard for injurer and victim is set correctly – then, this rule is efficient

Contributory negligence Simple negligence rule – “Negligence with contributory negligence” Strict liability – “Strict liability with contributory negligence”

Negligence with contributory negligence Law established x due and y due – and – suppose these are set at the “efficient” levels If x ≥ x*, injurer is off the hook (victim has to cover costs), if x < x* and y < y*, injurer is still off the hook and if x < x* and y ≥ y*, the injurer compensates the victim GET EFFICENT OUTCOME – injurer and victim have rational expectations about each other (Nash equilibrium argument)

Strict Liability with Contributory Negligence In this case only victim’s standard of care matters If y ≥ y*, the injurer must pay the victim, and If y < y*, the injurer is off the hook Get efficient outcome (Nash equilibrium argument)

Comparative Negligence Goes beyond “all or nothing” rules This rule divides damages based on relative fault of victim and injurer Curran (1992) – 44 as of 1992 have some form of this rule Exercise 2.2 – shows how this rule can be efficient in a bilateral care setup

Negligence Pure comparative negligence combines negligence with contributory negligence and simple negligence Combination – generalizes case of x < x* and y < y* Prove social efficiency when due standard is efficient

Activity Levels Number of activities = a B(a) = benefits of activities: B’ > 0, B’’ < 0 example – numbers of railroads built Choose a, x: maximize B(a) – a[x + P(x)D(x)] x* minimizes costs Properties of a* (optimal activity level)

Activity Levels and Rules No liability – inefficient Strict liability – efficient Negligence – with an efficient due standard (x*) is inefficient

Punitive damages Relevant when court determines that injurers activities are intentional and/or reckless Deter potential injurers Unilateral care model α = 1/3 (for example) = probability that a guilty injurer will be found liable (for example, the case is complex, the courts are under- staffed, etc)

Punitive damages, cont’d Choose x: min x + p(x)αD(x) = min x + p(x)(1/3)D(x) Injurer therefore choose x~(α=1/3) < x* R = punitive damages awarded by the court in the event of a successful conviction Then, p(x)α{D(x) + R} = p(x)D(x): R = ((1- α)/α) D(x) = 2D(X) when α = 1/3 See exercise 2.3

Judgment proof problems Injurer found liable but lacks assets to pay damages Incentive issue – an injurer who anticipates he will be judgment proof in the future may take too little precaution today Strict liability – injurer anticipate going bankrupt will under-invest in precaution

Judgment proof, cont’d Negligence can be efficient Suppose x ds = x*, and α <= 1 is the probability of being in business in the near future Choose x: Min x + αp(x)D(x) if x < x* and Choose x if x >= x* Then, as long as α is not too small, due standard is met!