Economics of Tort Law

What is a tort?  Contract law: injury from a broken promise  Tort law: injury without any promises Intentional tort (≈ crime) Unintentional tort (accidents) “If someone shoots you, you call a cop. If he runs his car into yours, you call a lawyer.” Focus on efficiency: structure the law to provide the correct incentives to avoid/prevent harm

Example 1: Joe Potatoes Joe Potatoes has been driven to distraction by the escapades of his wife, Joan Potatoes. At the end of a hard night’s work at the loading dock, Joe is approached by Jim Bloggs. Suspecting that Jim has been romancing Joan, Joe insults and strikes him, breaking his nose. Bloggs subsequently sues for the injury to his reputation and his nose.

Example 2: Pheasant Hunting Three hunters go into the woods after pheasants. They are spread out in a straggling line about 25 yards apart, walking in the same direction. The hunter in the center flushes a bird that flies up, its wings pounding. The hunter to his left and right turn toward the bird in the middle and fire. The bird escapes, but the hunter in the middle is blinded by birdshot. One of the two hunters certainly caused the harm, but there is no way of determining which one of them it was. The victim sues both of them.

Example 3: Fuel Additives A manufacturer produces auto fuel additives that demand careful control over quality. If quality control is maintained at a high level, the chemical mixture in the product is correct, and it never causes damage to auto engines. If, however, quality control is relaxed and allowed to fall to a low level, some batches of the chemical mixture will be flawed. A few of the cars using the flawed batch will be harmed; specifically, the engine will throw a rod and tear itself to pieces. After the rod is thrown, as alert mechanic can detect the cause of the harm. The manufacturer determines that a high level of control costs more than the harm to some auto engines caused by a low level of quality control, so the manufacturer adopts a low level of quality control. The owner of the damaged car sues the manufacturer and asks for punitive damages.

Classroom Experiment  Victor Matheson (2005), “Rationality, Tort Reform and Contingent Valuation: A Classroom Experiment in Starting Point Bias.” College of the Holy Cross Working Paper

Focal Point Experiment Reference Point$10,000$1,000,000 Smallest Damages$100,000$500,000 Largest Damages$1,000,000$2,000,000 Median Damages$500,000$650,000 $1m or less5 out of 64 out of 6

Traditional Theory of Torts  Harm Perfect compensation? Tangible vs intangible losses  Causation “cause-in-fact”:but for A, would B have occurred?  If NO, then A is the cause-in-fact of B Proximate cause  Breach of duty (fault) Strict liability: only Harm and Causation matter Negligence: requires Harm, Causation, and Fault Can you sue for exposure to harm? Does smoking cigarettes cause cancer?

How do you determine fault?  Binary fault  Continuous fault not at fault if x ≥ at fault if x < Precaution (x) Legal standard: reasonable person Not at fault Negligent 0

A Trolley Folly “A tree fell on a moving trolley, injuring passengers. One of them sued. He succeeded in demonstrating that in order for the trolley to be where it was when the tree fell on it the driver had to have driven faster than the speed limit at some point during the trip. Breaking the law is per se negligence, so the driver was legally negligent whether or not his driving was actually unsafe. If he had not driven over the speed limit, the trolley would not have been under the tree when it fell, so, the plaintiff argued, the driver’s negligence caused the injury.” The court held that the driver’s negligence “had not caused the accident in the legally relevant sense.”

A Model of Optimal Precaution  Social Objective: minimize social costs of accidents Precaution costs Accident losses Administrative costs  Assumptions Rationality Litigation is costless No insurance available No safety regulation

 Define: x = level of precaution by injurer p(x) = probability of accident [p’(x) < 0] A = victim’s accident losses w = cost per unit of precaution A Model of Optimal Precaution Social Costs = wx + p(x)A What level of x will minimize Social Costs?

A Model of Optimal Precaution Precaution (x) $ wx p(x)A Social Costs = wx + p(x)A SC x* occurs where: w = -p’(x)A x* MC of precaution = MB of precaution

Examples of Accidents and Precaution AccidentInjurer’s precautionVictim’s precaution Faulty wiring causes house fire Manufacture wiring more carefully Fireproof the house Moving car hits parked car Drive more safelyPark car in safer location Car hits pedestrianDrive more safetyWalk more safely Software failsBetter design of softwareBack up data at risk Exploding pop bottleImprove quality controlHandle bottles carefully Medicine causes side effects Improve warning labelStudy warning on medicine

Incentives for Precaution  Tort liability gets injurer to internalize the harm they cause victims  3 Liability Rules No Liability Strict Liability Negligence rule

No Liability  Victim’s Incentives Victim bears full cost of accident Victim’s cost = w v x v + p(x v )A  Injurer’s Incentives Injurer faces no liability Injurer’s cost = w i x i  Choose x v *  Choose x i = 0

Strict Liability  Victim’s Incentives Victim receives damages of D Victim’s cost = w v x v + p(x v )[A-D] Victim’s cost = w v x v (if D = A)  Injurer’s Incentives Injurer’s cost = w i x i + p(x i )D  Choose x v = 0  Choose x i * Perfect compensation

No Liability vs Strict Liability  Unilateral precaution situations: When only victim can take precaution, NL is preferable When only injurer can take precaution, SL is preferable  Bilateral precaution situations? Legal RuleVictim’s PrecautionInjurer’s Precaution No liabilityEfficientZero Strict liabilityZeroEfficient Analogous to contract law where we should allocate risk to the low-cost avoider.

Simple Negligence Rule  Injurer’s Incentives if x < then D = A Injurer’s cost = w i x i + p(x i )D if x ≥ then D = 0 Injurer’s cost = w i x i

Simple Negligence Rule Precaution (x) $ wx = x* wx + p(x)A Injurer will choose x i * What will victim do?

Contributory Negligence  Negligent injurer can escape liability if victim was also negligent Victim has incentive to choose x v * Injurer has incentive to choose x i * I’m talking on my cell phone while driving, but drunk pedestrian stumbles into road Since injurer expects victim to take efficient precaution, injurer will minimize costs by being careful

Comparative Negligence  If both parties are negligent, they share the responsibility Injurer has incentive to choose x i * Victim has incentive to choose x v *

Liability Rule Summary Legal Rule Victim’s Precaution Injurer’s Precaution No liabilityEfficientZero Strict liabilityZeroEfficient “Any” negligence rule with efficient standards of care Efficient Warning: Activity levels also affect the likelihood of an accident

Legal RuleVictim Precaution Injurer Precaution Victim Activity Injurer Activity No Liability EfficientZeroEfficientToo High Strict Liability ZeroEfficientToo HighEfficient Simple Negligence Efficient Too High Contributory Negligence Efficient Too High Comparative Negligence Efficient Too High Strict Liability with CN Efficient Too HighEfficient Efficient Precaution and Activity Who bears “residual risk”?

Setting the Standard: The Hand Rule  United States v Carroll Towing Company (1947)  Hand Rule: if w < -p’A then injurer is negligent Have all cost-justified precautions been taken?  Case-by-case basis  Regulations  Social customs Since there are occasions when every vessel will break from her moorings, and since, if she does, she becomes a menace to those about her; the owner’s duty, as in other similar situations, to provide against resulting injuries is a function of three variables: (1) The probability that she will break away; (2) the gravity of the resulting injury, if she does; (3) the burden of adequate precautions. Possibly it serves to bring this notion into relief to state it in algebraic terms: if the probability be called P; the injury, L; and the burden, B; liability depends upon whether B is less than L multiplied by P: i.e., whether B < PL. Judge Learned Hand

Errors in Damage Awards  Random mistakes  Systematic mistakes  Strict Liability Random mistakes: no effect on precaution Systematic mistakes: x i varies directly with error  Negligence Rule Modest damage errors will not affect x i x i varies directly with errors in setting the legal standard

Administrative Costs Social Cost = wx + p(x)A + C  No Liability: saves on C but erodes incentive for precaution  Strict Liability: requires harm and cause Leads to more cases, but easier cases  Negligence: requires harm, cause, and fault Leads to fewer cases, but costlier cases

Exploding Pop Bottle Behavior of Firm Firm’s Cost of Production per unit Probability of Accident to Consumer Loss if Accident Expected Accident Loss Full Cost per unit Use Bottle40 cents1/100,000$10,00010 cents50 cents Use Can43 cents1/200,000$4,0002 cents45 cents When consumers have perfect information, the choice of liability rule is irrelevant; every rule generates efficient precaution and output Strict Liability is a substitute for perfect consumer information