Law and Economics-Charles W. Upton A Model of Liability

Can we Generalize Our examples show that liability rules are a matter of giving incentive. Can we generalize to allow for giving both parties incentives?

A Model of Liability Model 1 The Social Cost (SC) of an accident is given by SC = wx +p(x)A

A Model of Liability Model 1 The Social Cost (SC) of an accident is given by SC = wx +p(x)A Where –w= cost of each unit of precaution –x = units of precaution –p(x) = probability of accident [p’(x)<0] –A = cost of an accident

A Model of Liability Minimization The Social Cost (SC) of an accident is given by SC = wx +p(x)A Optimization requires that w=-p’(x)A Denote the optimal level of precaution as x*

A Model of Liability Two Rules of Liability No liability, meaning that the injurer has no responsibility for the accident. Strict liability, meaning that the injurer has liability for the accident no matter what he does.

A Model of Liability Two Rules of Liability No liability, meaning that the injurer has no responsibility for the accident. Strict liability, meaning that the injurer has liability for the accident no matter what he does. Query: does either rule provide all parties an incentive?

A Model of Liability No Liability Rule The victim will choose x to minimize PC = wx +p(x)A by setting w = -p’(x)A

A Model of Liability No Liability Rule The victim will choose x to minimize PC = wx +p(x)A by setting w = -p’(x)A The victim has optimal incentives to invest in precautions.

A Model of Liability No Liability Rule The victim will choose x to minimize PC = wx +p(x)A by setting w = -p’(x)A The victim has optimal incentives to invest in precautions. The injurer will choose x to minimize PC = wx by setting x =0

A Model of Liability No Liability Rule The victim will choose x to minimize PC = wx +p(x)A by setting w = -p’(x) The victim has optimal incentives to invest in precautions. The injurer will choose x to minimize PC = wx by setting x =0 The injurer has no incentive for precautions

A Model of Liability Strict Liability Rule Injured, victim gets D. PC = wx +p(x)[A-D] If D = A, then PC = wx Minimization means x =0

A Model of Liability Strict Liability Rule Injured, victim gets D. PC = wx +p(x)[A-D] If D = A, then PC = wx Minimization means x =0 The victim has no incentive to invest in precautions.

A Model of Liability Strict Liability Rule Injured, victim gets D. PC = wx +p(x)[A-D] If D = A, then PC = wx Minimization means x =0 The victim has no incentive to invest in precautions. The injurer will choose x to minimize PC = wx+ p(x)D by setting x =p’(x)D

A Model of Liability Strict Liability Rule Injured, victim gets D. PC = wx +p(x)[A-D] If D = A, then PC = wx Minimization means x =0 The victim has no incentive to invest in precautions. The injurer will choose x to minimize PC = wx+ p(x)D by setting x =p’(x)D If D = A, the injurer has optimal incentive for precautions

A Model of Liability Conclusion

A Model of Liability End ©2004 Charles W. Upton