Econ 522 Economics of Law Dan Quint Fall 2009 Lecture 16

1  HW2 due now  Midterm Thursday Logistics

2  Tort law  Harm, causation, breach of duty  Strict liability rule  No need to prove negligence (breach of duty), just harm and causation  Versus negligence rule  Need to prove all three elements  Today: economic model of torts Last Thursday…

3 Precaution

4  The more carefully I drive, the less likely I am to hit you  Duh  But, driving more carefully is also more costly to me  Must be some efficient level of care Precaution

5  The more carefully I drive, the less likely I am to hit you  Duh  But, driving more carefully is also more costly to me  Must be some efficient level of care  What determines how carefully I drive is what I think will happen if I hit you  Tort law creates incentives  The essence of tort law is to use liability to get injurers to internalize the externalities their actions cause Precaution

6  Unilateral harm – only one victim  Precaution – costly actions that make accident less likely  Could be taken by either victim or injurer  We’ll focus on one at a time  Notation  x – the level of precaution that is taken  w – the cost of each “unit” of precaution  so total cost of precaution is wx  p(x) – probability of an accident, given precaution x  p is decreasing in x  A – cost of accident (to victim)  so expected cost of accidents is p(x) A Model of unilateral harm x level of precaution w marginal cost of precaution p(x) probability of an accident A cost of an accident

7 Model of unilateral harm x level of precaution w marginal cost of precaution p(x) probability of an accident A cost of an accident Precaution (x) $ p(x) A (Cost of Accidents) wx (Cost of Precaution) wx + p(x) A (Total Social Cost) x* (Efficient Level of Precaution)

8 efficient precaution:min x { wx + p(x) A } w + p’(x) A = 0 w= – p’(x) A  Under reasonable assumptions (p(x) convex)…  x < x*  w < – p’(x) A  MSB of precaution greater than MSC  more precaution efficient  x > x*  w > – p’(x) A  MSC of precaution greater than MSB  less precaution efficient  x = x*  MSB = MSC Model of unilateral harm x level of precaution w marginal cost of precaution p(x) probability of an accident A cost of an accident marginal social cost of precaution marginal social benefit of precaution

9 Model of unilateral harm x level of precaution w marginal cost of precaution p(x) probability of an accident A cost of an accident x $ p(x) A wx wx + p(x) A x*x < x*x > x*

10  We haven’t yet said who is taking precaution  Some cases, only injurer can reduce accidents  Some cases, victim can too  Model works fine for either one (unilateral precaution)  Under most conditions, works fine when both parties take precaution (bilateral precaution)  Next: consider effect of different liability rules on precaution Model of unilateral harm

11  No liability  Strict liability  Negligence Effect of liability rules on precaution

12  Victim precaution  Private cost to victim: wx + p(x) A  Victim sets w = – p’(x) A  Rule of no liability leads to efficient level of victim precaution  Injurer precaution  Private cost to injurer: wx  Injurer sets x = 0  Rule of no liability leads to inefficiently low level of injurer precaution Rule 1: No Liability

13 Effect of liability rules on precaution ZeroEfficientNo Liability Injurer precaution Victim precaution

14  Perfect compensation: damages D = A  Victim precaution  Private cost to victim: wx + p(x) (A – D) = wx  Victim sets x = 0  Social cost is wx + p(x) A, efficient level satisfies w = – p’(x) A  Strict liability leads to inefficiently low level of victim precaution  Injurer precaution  Private cost to injurer: wx + p(x) D = wx + p(x) A  Injurer sets x efficiently  Strict liability leads to efficient level of injurer precaution Rule 2: Strict Liability

15 Effect of liability rules on precaution EfficientZeroStrict Liability ZeroEfficientNo Liability Injurer precaution Victim precaution

16  When it is the injurer who can take precautions, a rule of strict liability is more efficient  When it is the victim who can take precautions, a rule of no liability is more efficient  Each rule works well for one incentive, poorly for other  Similar to paradox of compensation we already saw  What about bilateral precaution?  Negligence rule may allow us to get both incentives right So for accidents with unilateral precaution…

17  Legal standard of care x n  Injurer is liable for damages if precaution level was below the legal standard of care  x < x n  D = A  x  x n  D = 0  So on our graph from before, private cost to injurer is…  wx + p(x) Afor x < x n  wxfor x  x n Rule 3: Negligence

18 Injurer precaution under a negligence rule x level of precaution w marginal cost of precaution p(x) probability of an accident A cost of an accident x $ p(x) A wx wx + p(x) A x n = x*  If legal standard of care is set to efficient level (x n = x*), negligence rule leads to efficient injurer precaution Private cost to injurer

19 Effect of liability rules on precaution Efficient Negligence, with x n = x* EfficientZeroStrict Liability ZeroEfficientNo Liability Injurer precaution Victim precaution

20  Rule we just saw: injurer is liable if he was negligent, not liable if he was not  But we can consider both whether injurer was negligent…  …and whether victim was negligent…  …when determining whether injurer owes damages (and how much) For bilateral precaution, different ways to implement a negligence rule

21 For bilateral precaution, different ways to implement a negligence rule NoYesNo Negligence with Defense of Contributory Negligence Yes No Simple Negligence Both parties negligent? Only injurer negligent? Only victim negligent? Neither party negligent? Does injurer owe victim damages when…

22 For bilateral precaution, different ways to implement a negligence rule NoYesNoYes Strict Liability with Defense of Contributory Negligence PartialYesNo Comparative Negligence NoYesNo Negligence with Defense of Contributory Negligence Yes No Simple Negligence Both parties negligent? Only injurer negligent? Only victim negligent? Neither party negligent? Does injurer owe victim damages when…

23  When standard of care (for both injurer and victim) is set at the efficient level…  …any of these negligence rules lead to efficient level of precaution by both parties  Simple negligence  Negligence with a defense of contributory negligence  Comparative negligence  Strict liability with a defense of contributory negligence Here’s the cool part…

24 Even in a setting with bilateral precaution… Efficient Any negligence rule with efficient legal standard of care EfficientZeroStrict Liability ZeroEfficientNo Liability Injurer precaution Victim precaution

25 (I mentioned, with bilateral precaution, things occasionally get more complicated…)  Redundant precaution – either party could take precaution, efficiency only requires one of them  If precaution is continuous, any negligence rule still leads to efficient precaution level by both  When precaution is discontinuous, not always  Driver can fasten seatbelt, or car company can design seatbelt that buckles itself (more costly)  Simple negligence: car company might be liable if designed manual seatbelt and driver didn’t use it, so car company might design automatic belt  Negligence with defense of contributory negligence: car company escapes liability, so designs manual belt, rational driver uses it  But as long as precaution is continuous, no problem

26 So far, our results seem to favor negligence rules… but… Efficient Any negligence rule with efficient legal standard of care EfficientZeroStrict Liability ZeroEfficientNo Liability Injurer precaution Victim precaution  Up next: activity levels  Steven Shavell, “Strict Liability Versus Negligence”

27 Good luck on Thursday!