Econ 522 Economics of Law Dan Quint Fall 2009 Lecture 15

1  HW2 due Tuesday (11 a.m. sharp)  Second midterm next Thursday (Nov 5) Logistics

2 On the topic of illegal contracts…

3 Let’s recap our story so far…

4  Efficiency  Maximizing total surplus realized by everyone in society  Scarce resources are owned by whoever values them most  Actions are taken if social benefit exceeds social cost  Design a legal system that leads to efficient outcomes  Once we set up the rules, we don’t expect people to act based on what’s efficient  We expect people to do whatever’s in their own best interest  So the goal is set up the rules such that people acting in their own best interest will naturally lead to efficiency Our story so far

5  Coase gives us one way to do that  As long as property rights are clearly defined and tradeable, and there are no transaction costs, people have incentive to trade until each resource is efficiently owned  So initial allocation of rights doesn’t matter for efficiency  But if there are transaction costs, we may not get efficiency this way  Led us to two normative views of the legal system:  1. Minimize transaction costs (“lubricate” private exchange)  2. Allocate rights as efficiently as possible  Tradeoff between injunctive relief and damages Our story so far

6  Property law works well for simultaneous trade  Contracts allow for non-simultaneous trade  Contract law can…  Enable cooperation  Encourage efficient disclosure of information  Secure optimal commitment to performance  Secure efficient reliance  Supply efficient default rules and regulations  Foster enduring relationships Our story so far

7  Property law works well when transaction costs are low enough to get voluntary trade  Contract law works well when transaction costs are low enough that we can agree to a contract, but high enough that we may not want to renegotiate the contract later  What about when transaction costs are too high to agree to anything in advance?  This is tort law Our story so far

8 Tort law

9  Tort, noun. from French word meaning injury  Contract law: situations where someone harms you by breaking a promise they had made  Tort law: situations where someone harms you without having made any promises  “If someone shoots you, you call a cop. If he runs his car into yours, you call a lawyer.” Tort law

10  Question: how to structure the law to get people to behave in a way that leads to efficient outcomes?  Deliberate harms: make punishment severe (criminal law)  Accidental harms: trickier  Goal isn’t “no accidents”; goal is “efficient number of accidents” Tort law

11  Question: how to structure the law to get people to behave in a way that leads to efficient outcomes?  Deliberate harms: make punishment severe (criminal law)  Accidental harms: trickier  Goal isn’t “no accidents”; goal is “efficient number of accidents”  Unlike nuisance law, injunctive relief is not an option  Unlike contract law, no agreement ahead of time  Cooter and Ulen: essence of tort law is “the attempt to make injurers internalize the externalities they cause, in situations where transaction costs are too high to do this through property or contract rights” Tort law

12  Plaintiff – person who brings a lawsuit  Defendant – person who is being sued  In a nuisance case, the defendant caused a nuisance, plaintiff was bothered by it, might be asking for injunction or damages  In a contract case, defendant breached a contract or violated its terms  In a tort case, defendant caused some harm to plaintiff, plaintiff is asking for damages  Plaintiff is the victim; defendant is the injurer Cast of characters

13  Harm  Causation  Breach of Duty “Classic” legal theory of torts

14  For a tort to exist, the plaintiff needs to have been harmed  “Without harm, there is no tort”  Gas company sold gas with a defective additive  Dangerous for cars with turbocharged carburetors  You have a car with normal carburetors  You might be angry; but you weren’t harmed, so you can’t sue  Similarly, no compensation for exposure to risk  Manufacturer exposed workers to some chemical  Exposure will cause 15% of them to develop cancer later in life  Can’t sue now – have to wait, see who gets cancer, then they can sue Element 1: Harm

15 Element 1: Harm Money Health  Perfect compensation  restores victim to original level of well-being  generally done through money damages

16 Perfect Compensation Emotional harm Pain and suffering Loss of companionship Medical costs Lost income Damaged property Intangible harmsTangible harms  Historically, courts less willing to compensate for intangible or hard- to-measure losses  Over time, American courts have started compensating for more intangible harms  Pro: closer liability is to actual harm done, better incentives for avoidance of these harms  Con: disparity in award sizes, unpredictability

17  Harm  Causation  Breach of Duty “Classic” legal theory of torts

18  For a tort to exist, the defendant needs to have caused the harm to the plaintiff  Cause-in-fact  “But for the defendant’s actions, would the harm have occurred?” Element 2: Causation

19  For a tort to exist, the defendant needs to have caused the harm to the plaintiff  Cause-in-fact  “But for the defendant’s actions, would the harm have occurred?”  Proximate cause  Immediate cause – defendant’s action can’t be too distant from the harm  Palsgraf v Long Island Railway (NY Ct Appeals, 1928):  Guard pushed a passenger to help him onto train, passenger dropped fireworks he was carrying, they went off, explosion knocked down scales at the other end of the platform, which fell on Mrs. Palsgraf  Guard’s actions were not the proximate cause Element 2: Causation

20 “A tree fell on a moving trolly, injuring passengers. One of them sued. He succeeded in demonstrating that in order for the trolly 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 trolly would not have been under the tree when it fell, so, the plaintiff argued, the driver’s negligence caused the injury.”  Court ruled driver’s negligence “had not caused the accident in the legally relevant sense” Element 2: Causation

21  Harm  Causation  Breach of Duty “Classic” legal theory of torts

22 Element 3: Breach of Duty Harm Causation Breach of duty (fault) Harm Causation NegligenceStrict Liability  When someone breaches a duty he owes to the defendant, and this leads to the harm, the injurer is at fault, or negligent  Under a negligence rule, even if I caused you harm, I’m not liable if I had taken the required standard of care and the accident happened anyway (Sometimes required, sometimes not)

23 “A tree fell on a moving trolly, injuring passengers. One of them sued. He succeeded in demonstrating that in order for the trolly 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 trolly would not have been under the tree when it fell, so, the plaintiff argued, the driver’s negligence caused the injury.” Hence the language in the trolly example

24  If I breach my duty of due care and injure you, I am liable  If I exercise the appropriate level of care but still injure you, I’m not liable  How is the standard of care determined?  That is, how careful do I have to be to avoid liability, and who decides?  Is it negligent to drive 40 MPH on a particular road at a particular time of day? What about 41 MPH? 42? So under a negligence rule…

25  Some settings: government imposes safety regulations that set standard for negligence  Speed limits for highway driving  Requirement that bicycles have brakes  Workplace regulations  Some standards are left vague  “Reckless driving” may depend on road, time of day, weather…  Common law focuses on duty of reasonable care  Level of care a reasonable person would have taken  (Civil law relies less on “reasonableness” tests, tries to spell out what level of care is required) How is the standard of care determined?

26  Strict liability rule: plaintiff must prove harm and causation  Negligence rule: must prove harm, causation, and negligence  A little history  Early Europe: strict liability was usual rule  By early 1900s, negligence became usual rule  Second half of 1900s, strict liability became more common again, especially for manufacturer liability in American consumer products  U.S. manufacturers now held liable for harms caused by defective products, whether or not they were at fault Strict liability versus negligence

27  Harm  Causation  Breach of Duty “Classic” legal theory of torts

28 The law as a set of incentives

29 Something to remember distribution but not efficiency efficiency

30 A physician comes upon an auto accident, stops, and treats an unconscious and badly bleeding victim. A week later the victim receives a bill for services rendered. Must he pay it? Under current U.S. law the answer is yes. Consider the following alternatives: i.The victim need not pay anything ii.The victim must pay only the value of whatever materials were used up in treating him (bandages, etc.) iii.The victim must pay the going market rate for comparable medical services iv.The victim must pay whatever the doctor demands Which of these do you expect to lead to the most efficient outcomes? Why? The law as incentives – HW2 Q3 (from old midterm)

31 If we think about payoffs after the fact (after accident, after treatment)…  Suppose value of treatment is $100,000, cost of materials $50, value of doctor’s time $450, market rate $1,000  After the fact, all remedies are equally efficient  So this can’t be the right way to think about the problem! 99,500 Combined Payoffs 999, Doctor’s Payoff -$900,000$99,000$99,950$100,000Patient’s Payoff Whatever Doc Asks Market Rate Cost of Materials Pay Nothing

32  Need to think about incentive each rule creates, therefore the behavior it will lead to  Patient pays nothing  Patient pays for materials  Patient pays market rate  Patient pays whatever doctor asks So what is the right way to think about the problem?