Econ 522 Economics of Law Dan Quint Fall 2010 Lecture 16.

Econ 522 Economics of Law Dan Quint Fall 2010 Lecture 16

Logistics… Homework due 5 p.m. Friday Midterm next Wednesday
In 272 Bascom (like first one) Not covering tort law Cumulative – everything up to end of contract law (but more weight on contracts than earlier stuff) UW Law School symposium: “Intergenerational Equity and Intellectual Property” November 12-13 Free, but register by Nov 5 Details at

Monday… Elements of a tort
Harm; causation; breach of duty (negligence) Strict liability: no need to prove negligence, just harm and causation Negligence: need to prove all three elements Precaution: any actions taken to reduce likelihood of an accident Incentives for precaution under various liability rules

Model of unilateral harm
x level of precaution w marginal cost of precaution p(x) probability of an accident A cost of an accident Model of unilateral harm $ wx + p(x) A (Total Social Cost) x < x* x > x* Let’s graph some important quantities – with x (the level of precaution taken) on the x axis, and money on the y We said the probability of an accident, p(x), is decreasing in the level of precaution Since A is a constant, this means p(x) A – the expected cost of accidents – is downward-sloping The cost of precaution is just a line, w times x And we can add these together to calculate the total expected social cost related to accidents, wx + p(x) A And now our goal in tort law becomes clear: to achieve the efficient level of precaution, which is the level of x that minimizes the total social cost So we’ll put this in gold, and call it x* (Of course, this assumes precaution is continuous – that you can take any amount you choose Some precaution is discrete – you either turn on your headlights while you’re driving, or you don’t But the conceptual goal is the same: to get headlight use when the reduction in accidents is greater than the cost And to not get headlight use when the cost would be greater than the reduction in accidents) wx (Cost of Precaution) p(x) A (Cost of Accidents) x* (Efficient Level of Precaution) Precaution (x)

Party who doesn’t bear cost of accidents…
$ wx + p(x) A wx Private cost p(x) A x* x Injurer in a no-liability world, or victim in strict-liability world No reason to take any precaution

Party who bears the cost of accidents…
$ Private cost wx + p(x) A wx p(x) A x* x Victim in no-liability world, injurer in strict-liability world To minimize this, victim takes efficient level of precaution

Effect of liability rules on precaution
Victim precaution Injurer precaution No Liability Efficient Zero Strict Liability Zero Efficient Can also explain this via externalities Injurer precaution reduces accidents In a no-liability world, this creates a positive externality – the victim bears the cost of accidents, which is reduced by injurer precaution Activities with positive externalities happen less than efficient amount, so we get less than efficient injurer precaution Victim precaution does not cause an externality, since the victim is bearing the cost of accidents, and is therefore the only one who benefits when they are reduced So victim precaution happens the efficient amount In a strict liability world, the injurer bears the cost of accidents Now injurer precaution does not create an externality – the injurer is the one who benefits from his own action, since he owes damages less often So injurer precaution happens the efficient amount But now victim precaution creates a positive externality – it’s good for the injurer, since it reduces the damages he’ll owe Again, activities with positive externalities happen less than the efficient amount So under strict liability, we get less than the efficient amount of victim precaution

Injurer under simple negligence
(avoids liability by taking due care) $ Private cost to injurer wx + p(x) A wx What will injurer do? At x < x*, we know that wx + p(x)A is decreasing; and so the injurer’s expected costs are decreasing Similarly, we know that wx is increasing, so above x*, the injurer’s expected costs, which are just wx, are increasing So expected costs are minimized by setting x = x*, the efficient level. So a negligence rule, with a legal standard of care x~ equal to the efficient level x*, leads to an efficient level of injurer precaution. But now, what about the victim’s incentives? The victim knows that under a negligence rule, the injurer will take precaution x*; and therefore, if an accident occurs, the injurer will not be liable So now the victim is facing the full cost of any accident which occurs; which means that the victim also takes the efficient level of precaution. So now we’ve found a solution to the paradox of compensation A negligence rule, combined with an efficient legal standard for care, leads to efficient precaution by both injurer and victim. Which is pretty cool. (We’ll come back to what happens when standard for care is set incorrectly later.) p(x) A xn = x* x Private cost is wx + p(x) A if x < xn, only wx otherwise If standard of care is set efficiently (xn = x*), injurer minimizes private cost by taking efficient precaution

Victim under simple negligence
(expects injurer to take due care) $ Private cost to victim, expecting injurer to avoid liability by taking sufficient precaution wx + p(x) A wx p(x) A x* x Victim is “residual risk bearer” Minimizes private cost by taking efficient precaution

Effect of liability rules on precaution
Victim precaution Injurer precaution No Liability Efficient Zero Strict Liability Zero Efficient Simple Negligence, with xn = x* Efficient Efficient

For bilateral precaution, there are several ways to implement a negligence rule
Rule we just saw: injurer is liable if he was negligent, not liable if he was not “Simple Negligence” But we can consider both whether injurer was negligent, and whether victim was negligent, in determining liability Negligence with a defense of contributory negligence – injurer owes nothing if victim was also negligent Comparative negligence – if both were negligent, share cost Strict liability with defense of contributory negligence – injurer is liable unless victim was negligent

The cool part… When standards of care for both injurer and victim are set to the efficient level… …any of these negligence rules leads to efficient level of precaution by both parties Already saw this works for simple negligence Could show the others the same way Instead, we’ll do a discrete example

Discrete example of bilateral precaution
A $1,000 w $20 for either party p 10% / 6% / 2% No “levels” of precaution – each party can either take precaution or not Each accident causes $1,000 of harm Precaution costs $20 for each party Chance of an accident is 10% if nobody takes precaution 6% if one party takes precaution 2% if both parties take precaution Note that precaution is efficient for both parties Costs $20; reduces expected accidents by 4% X $1,000 = $40

Different negligence rules
A $1,000 w $20 for either party p 10% / 6% / 2% Does injurer owe victim damages when… Neither party negligent? Only victim negligent? Only injurer negligent? Both parties negligent? Simple Negligence No No Yes Yes Negligence with Defense of Contributory Negligence No No Yes No The negligence rule we’ve already seen is called simple negligence Under a simple negligence rule, the injurer is liable if his level of precaution was below the legal standard; if it was above the legal standard, he is not liable And that’s the whole story (What the victim was doing doesn’t matter.) So if Under a different rule, however, a negligent injurer can escape liability if the victim was also being negligent For example, if I’m driving carelessly (talking on my phone, changing CDs) and hit someone, I may be liable But if I can show that the guy I hit was drunk, and stumbled into the street right in front of me, his negligence cancels out mine and I don’t owe him damages This type of rule is called negligence with a defense of contributory negligence Under this rule, if the injurer took insufficient precautions, and the victim took sufficient precautions, then the injurer is liable for damages However, if the injurer took sufficient care; OR the injurer was negligent, but so was the victim, then the injurer is not liable for damages.

Negligence with a Defense of Contributory Negligence
A $1,000 w $20 for either party p 10% / 6% / 2% Injurer is liable if he failed to take precaution… Unless victim did too Precaution is a dominant strategy for victim If injurer is not taking precaution, victim wants to avoid liability If injurer is taking precaution, victim bears residual risk, wants to minimize accidents For injurer, precaution is the best-response to precaution “Both take precaution” is the only Nash equilibrium And, is the efficient outcome victim pays for precaution, and any accidents that happen injurer pays for precaution, not liable for accidents Victim Precaution None -20, -40 -20, -60 Precaution Injurer -60, -20 0, -100 None 14 14

A $1,000 w $20 for either party p 10% / 6% / 2% Does injurer owe victim damages when… Neither party negligent? Only victim negligent? Only injurer negligent? Both parties negligent? Simple Negligence No No Yes Yes Negligence with Defense of Contributory Negligence No No Yes No A third type of negligence rule holds that if both parties are negligent and an accident occurs, then since they share the blame, they should share the responsibility This is referred to as comparative negligence If the injurer is not negligent, he owes no damages If the injurer is negligent, and the victim is not, then the injurer bears the full cost of the accident But if both were negligent, then they share the cost of the accident; damages are paid, but they are less than the full cost of the accident. (In theory, the damages are based on the relative contribution of each side’s negligence to the accident, or the relative amounts that each one is at fault.) Comparative Negligence No No Yes Partial

Comparative Negligence
A $1,000 w $20 for either party p 10% / 6% / 2% If both parties were negligent… …divide cost proportionally Precaution is again a dominant strategy for victim Now it’s a dominant strategy for injurer too Again, “both take precaution” is the only equilibrium (And the efficient outcome) Victim Precaution None -20, -40 -20, -60 Precaution Injurer -60, -20 -50, -50 None 16 16

A $1,000 w $20 for either party p 10% / 6% / 2% Does injurer owe victim damages when… Neither party negligent? Only victim negligent? Only injurer negligent? Both parties negligent? Simple Negligence No No Yes Yes Negligence with Defense of Contributory Negligence No No Yes No A third type of negligence rule holds that if both parties are negligent and an accident occurs, then since they share the blame, they should share the responsibility This is referred to as comparative negligence If the injurer is not negligent, he owes no damages If the injurer is negligent, and the victim is not, then the injurer bears the full cost of the accident But if both were negligent, then they share the cost of the accident; damages are paid, but they are less than the full cost of the accident. (In theory, the damages are based on the relative contribution of each side’s negligence to the accident, or the relative amounts that each one is at fault.) We’ve now considered three variations of a negligence rule: Simple negligence Negligence with a defense of contributory negligence Comparative negligence One other variation to consider is a rule of strict liability with a defense of contributory negligence That is, regardless of his level of care xi, the injurer is liable for damages, unless the victim was negligent, in which case he is not Formally, if xv >= xv~, the injurer is liable; if xv < xv~, the injurer is not This rule is sometimes used with consumer products A manufacturer of a defective product is often liable for damages, except when the consumer was negligent in how they used the product (If a coke bottle explodes in my hand, Coca-Cola is liable; but if I left it in the sun and shook it, then not so much.) Comparative Negligence No No Yes Partial Strict Liability with Defense of Contributory Negligence Yes No Yes No

Strict Liability with a Defense of Contributory Negligence
A $1,000 w $20 for either party p 10% / 6% / 2% Now, injurer is liable, regardless of whether he took precaution… …unless victim was negligent Once again, “both take precaution” is the only equilibrium Victim Precaution None -40, -20 -20, -60 Precaution Injurer -60, -20 0, -100 None 18 18

So with bilateral precaution…
Victim precaution Injurer precaution No Liability Efficient Zero Strict Liability Zero Efficient Simple negligence Efficient Efficient Negligence with Defense of Contributory Negligence Efficient Efficient So we have now seen the following: No liability leads to efficient care by the victim, but no care by the injurer Strict liability leads to no care by the victim, efficient care by the injurer Any of the four variations on a negligence rule (with legal standards equal to efficient levels of precaution) lead to efficient care by both parties (With basically any version of a negligence rule, one of the two parties can escape liability by meeting the legal standard for care As long as that legal standard coincides with the efficient level, that leads one party to take efficient precaution But this leaves the other party facing the entire social cost of the accident, and therefore leads that party to take the efficient level of precaution as well, for the purely selfish reason of minimizing expected private cost.) So negligence rules seem to work better for cases of bilateral precaution – cases where some degree of care from both parties is efficient. assuming standards of care are set equal to efficient levels Comparative negligence Efficient Efficient Strict Liability with Defense of Contributory Negligence Efficient Efficient

(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 (I said that under most conditions, our model works fine for bilateral precaution One situation where it gets more complicated There are some instances where either party could take precaution, but efficiency only requires one of them to Picture two drivers on a dark road that both of them know well Really only one of them needs to have his headlights on – it could be either one. This is referred to as redundant precaution When precaution is continuous – you can take any amount – everything still carries through However, when precaution is discontinuous – such as your headlights being on or off – different negligence rules will not all lead to efficient precaution Cooter and Ulen give an example: A driver can fasten his seat belt a lot more easily than a car company could design a seat belt that fastens automatically Under a simple negligence rule, a driver who didn’t buckle his seat belt could sue the car company, so the car company might choose to incur the higher costs of the auto-buckle Under a negligence rule with a defense of contributory negligence, the car company would not have to do this to escape liability, and a rational driver might choose to buckle up manually. As long as things are continuous, though, redundant precaution isn’t a problem)

So far, our results seem to favor negligence rules…
but… Victim precaution Injurer precaution No Liability Efficient Zero Strict Liability Zero Efficient But in general, our results so far seem to suggest negligence rules are preferable to either strict liability or no liability And this is true, when we’re only concerned with precaution However, there is another dimension in which peoples’ choices affect the likelihood of an accident: activity level I can choose to drive carefully or recklessly, and I can also choose to drive more or less often You can look both ways before crossing the street, or not; and you can choose how many streets to cross Next week, we’ll extend our model of torts to include both precaution and activity levels We’ll see that while a negligence rule leads to efficient precaution by both parties, it does not lead to an efficient activity level by both parties The Shavell paper on the syllabus, “Strict Liability versus Negligence,” is all about these incentives, including some other cases we didn’t talk about today – we’ll discuss it next week, take a look if you’re interested Any negligence rule with efficient legal standards of care Efficient Efficient Next twist: activity levels

Activity Levels

Activity levels Precaution – actions which make an activity less dangerous Driving carefully Looking both ways before crossing street The amount we do each activity also affects the number of accidents I decide how much to drive You decide how many streets to cross Liability rules create incentives for activity levels as well as precaution So far, we’ve talked about precaution I can choose to drive carefully or recklessly; you can choose whether to look both ways before crossing the street That is, we can take actions to make an activity more or less dangerous But there’s another variable that affects how many accidents we have: How much we do these activities in the first place That is, I can reduce accidents by driving more carefully; I can also reduce accidents by driving less often You can reduce accidents by crossing streets more carefully, and by crossing fewer streets

Activity levels under a rule of no liability
With no liability, I’m not responsible if I hit you I don’t consider cost of accidents when deciding how fast to drive… …or when deciding how much to drive So I drive too recklessly, and I drive too much With no liability, you bear full cost of accidents You maximize benefit of activity, minus cost of precaution, minus cost of accidents You take efficient level of precaution, and efficient level of activity A rule of no liability leads to an inefficiently high level of injurer activity, but the efficient level of victim activity First, let’s think about what happens under no liability Under no liability, I’m never responsible if I hit you So I don’t consider the cost of accidents when I decide how carefully to drive, or how much to drive my precaution level will be too low (relative to the efficient level) and my activity level will be too high What about you? You bear the costs of all accidents; so you look to maximize the benefit of walking, minus the cost of precaution (paranoia?), minus the expected cost of accidents Your actions have no externalities (since only you get hurt by accidents, not me); so your incentives are correct, and you will set the efficient level of precaution and the efficient activity level So a rule of no liability leads to too much injurer activity, but the efficient level of victim activity; just like it leads to too little injurer precaution, but the efficient level of victim precaution.

Adding activity levels to our results on precaution…
Injurer Precaution Victim Precaution Injurer Activity Victim Activity No Liability Zero Efficient Too High Efficient Strict Liability Efficient Zero Simple Negligence Efficient Efficient Negligence with a Defense of Contributory Negligence Efficient Efficient Comparative Negligence Efficient Efficient Strict Liability with Defense of Contributory Negligence Efficient Efficient

Activity levels under a rule of strict liability
Under strict liability, injurer internalizes cost of accidents Weighs benefit from driving against cost of accidents Takes efficient activity level Under strict liability, victim does not bear cost of accidents Ignores cost of accidents when deciding how much to walk Sets inefficiently high activity level A rule of strict liability leads to the efficiently level of injurer activity, but an inefficiently high level of victim activity The exact opposite will happen under strict liability Under strict liability, you know you will be compensated for any accidents, so you don’t worry about their costs Therefore, you take insufficient precautions, and you set too high an activity level On the other hand, I know I’m paying for any accidents that happen, so I consider their costs when I make my decisions I take efficient precautions and I set an efficient activity level.

Injurer Precaution Victim Precaution Injurer Activity Victim Activity No Liability Zero Efficient Too High Efficient Strict Liability Efficient Zero Efficient Too High Simple Negligence Efficient Efficient Negligence with a Defense of Contributory Negligence Efficient Efficient Comparative Negligence Efficient Efficient Strict Liability with Defense of Contributory Negligence Efficient Efficient

What about activity levels under negligence rules?
Simple negligence: injurer is only liable if he was negligent Leads injurer to take efficient precaution, so injurer expects to not be liable for any accidents that do occur So injurer ignores cost of accidents when deciding on activity level (how much to drive) Injurer drives carefully, but still drives too much Victim bears “residual risk” Victim walks carefully, and walks efficient amount

Injurer Precaution Victim Precaution Injurer Activity Victim Activity No Liability Zero Efficient Too High Efficient Strict Liability Efficient Zero Efficient Too High Simple Negligence Efficient Efficient Too High Efficient Negligence with a Defense of Contributory Negligence Efficient Efficient Comparative Negligence Efficient Efficient Strict Liability with Defense of Contributory Negligence Efficient Efficient

Negligence with Defense of Contributory Negligence, and Comparative Negligence
Either rule: efficient precaution by both parties Either rule: if neither party was negligent, injurer does not owe damages So victim is residual risk bearer (pays for accidents) So victim weighs cost of accidents against benefits of activity, takes efficient activity level Injurer ignores cost of accidents, takes inefficiently high activity level

Injurer Precaution Victim Precaution Injurer Activity Victim Activity No Liability Zero Efficient Too High Efficient Strict Liability Efficient Zero Efficient Too High Simple Negligence Efficient Efficient Too High Efficient Negligence with a Defense of Contributory Negligence Efficient Efficient Too High Efficient Comparative Negligence Efficient Efficient Too High Efficient Strict Liability with Defense of Contributory Negligence Efficient Efficient

Strict Liability with Defense of Contributory Negligence
If victim is not negligent, injurer is liable Leads to efficient precaution by both, so injurer is liable Injurer is residual risk bearer Injurer weighs cost of accidents against benefits of activity, takes efficient activity level Victim ignores cost of accidents, takes inefficient high activity level

Injurer Precaution Victim Precaution Injurer Activity Victim Activity No Liability Zero Efficient Too High Efficient Strict Liability Efficient Zero Efficient Too High Simple Negligence Efficient Efficient Too High Efficient Negligence with a Defense of Contributory Negligence Efficient Efficient Too High Efficient Comparative Negligence Efficient Efficient Too High Efficient Strict Liability with Defense of Contributory Negligence Efficient Efficient Efficient Too High

take precaution only to AVOID liability precaution is efficient, but activity level is too high Injurer Precaution Victim Precaution Injurer Activity Victim Activity No Liability Zero Efficient Too High Efficient Strict Liability Efficient Zero Efficient Too High Simple Negligence Efficient Efficient Too High Efficient Negligence with a Defense of Contributory Negligence Efficient Efficient Too High Efficient Comparative Negligence Efficient Efficient Too High Efficient Strict Liability with Defense of Contributory Negligence Efficient Efficient Efficient Too High

to reduce accidents, since he bears their cost precaution and activity level are both efficient Injurer Precaution Victim Precaution Injurer Activity Victim Activity No Liability Zero Efficient Too High Efficient Strict Liability Efficient Zero Efficient Too High Simple Negligence Efficient Efficient Too High Efficient Negligence with a Defense of Contributory Negligence Efficient Efficient Too High Efficient Comparative Negligence Efficient Efficient Too High Efficient Strict Liability with Defense of Contributory Negligence Efficient Efficient Efficient Too High

With each negligence rule…
One party can avoid liability by taking efficient precaution Leads to efficient precaution But inefficient activity level Other party is the residual risk bearer – even when he takes precaution, he is still liable And also efficient activity level Who should bear residual risk? One way to answer is to ask whose activity level has greater impact on efficiency

So which rule is best? “Put the incentive where it does the most good”
Efficient rule depends on which choices have greatest impact If only injurer’s choices (precaution + activity) matter  strict liability is better rule If bilateral precaution  negligence Which negligence rule – depends whose activity level is more important Friedman (citing Posner): this is why very dangerous activities often covered by strict liability Blasting with dynamite, keeping a lion as a pet Even with proper precaution, still very dangerous, so injurer activity level is important Which rule is the most efficient, then, depends on the situation That is, it depends on whose choices have the bigger impact. In situations with unilateral precaution – situations where only one party needs to take steps to avoid accidents – no liability or strict liability work perfectly well In situation with bilateral precaution, negligence rules give appropriate incentives for precaution on both sides However, under any negligence rule, one of the two parties still bears whatever losses do occur – one party is the residual bearer of the harm of accidents, and the other party is not Any negligence rule yields an efficient activity level by the residual risk bearer, but an inefficient activity level by the other party Thus, the optimal rule depends on whose activity level is most important. Friedman mentions that Posner uses this to explain why highly dangerous activities – blasting with dynamite, or keeping a lion as a pet – are often governed by strict liability if they’re dangerous enough, the only meaningful type of precaution may be to not do them at all Strict liability leads to efficient levels of both care (if you choose to do them) and a choice of whether or not to do them in the first place.

Friedman: activity is just unobservable precaution
Activity is just another type of precaution, but type where court can’t determine efficient level Court can tell inefficient for me to drive at night with headlights off Can’t tell how many miles it’s efficient for me to drive Determination of negligence can only be based on observable precaution, not unobservable Negligence rule leads to efficient levels of observable precaution by both parties Simple negligence leads only to efficient observable precaution by injurer, but efficient precaution by victim as well Strict liability leads to efficient observable and unobservable precaution by injurer, but no precaution by victim Friedman has a different take on activity levels He argues that reducing your activity level is just another type of precaution But it’s a type of precaution where it’s impossible for the court to determine the efficient level (A court might be able to figure out that it’s efficient for me to drive with my headlights on at night, but unable to figure out how many miles it’s optimal for me to drive in a given day Therefore, a court might find me negligent if I was driving without headlights But it’s hard for a court to decide whether a particular trip was socially efficient, and therefore whether I was negligent by being in my car!) Instead of distinguishing precaution from activity levels, Friedman distinguishes observable precaution from unobservable precaution He points out that any negligence rule only causes an efficient level of observable precaution, since that’s all that can be used to determine whether someone exercised due care or was negligent So a negligence rule does not lead to an efficient level of unobservable precaution Strict liability, on the other hand, leads the injurer to internalize the cost of accidents, so it leads to efficient levels of both observable and unobservable precaution – the same result as we already saw, just in different words

Shavell’s Take

Steven Shavell, Strict Liability Versus Negligence
Focuses on injurer precaution and activity Compares strict liability to negligence rules Accidents between strangers (what we’ve been doing): “Under a negligence rule, all that an injurer has to do to avoid the possibility of liability is to make sure to exercise due care if he engages in his activity. Consequently he will not be motivated to consider the effect on accident losses of his choice of whether to engage in his activity or, more generally, of the level at which to engage in his activity; he will choose his level of activity in accordance only with the personal benefits so derived. But surely an increase in his level of activity will typically raise expected accident losses. Thus he will be led to choose too high a level of activity.” The Shavell paper, “Strict Liability versus Negligence,” is about exactly the incentives we’ve been discussing Shavell refers to the types of cases we’ve been considering so far “accidents between strangers” That is, when a car hits a bicyclist, there is no preexisting relationship between the two parties However, Shavell also looks at cases where the injurer is a business, engaged in selling some product (either to the victim or to someone else) Under the assumption of competitive markets, this changes the story significantly. Shavell assumes it is only injurer precaution that affects the likelihood of accidents – that is, he ignores victim precaution He looks at a number of different cases Under injurer precaution, a rule of no liability is obviously bad, so he focus on comparing negligence to strict liability. And, like we’ve been doing, he assumes there is no insurance. First, as we’ve already seen, is the case of accidents between strangers As he puts it, “injurers and victims are strangers, neither are sellers of a product, and injurers may choose to engage in an activity which puts victims at risk” He gives a nice explanation of what happens under a simple negligence rule: “Under the negligence rule, all that an injurer needs to do to avoid the possibility of liability is to make sure to exercise due care if he engages in his activity. Consequently he will not be motivated to consider the effect on accident losses of his choice of whether to engage in his activity or, more generally, of the level at which to engage in his activity; he will choose his level of activity in accordance only with the personal benefits so derived. But surely any increase in his level of activity will typically raise expected accident losses. Thus he will be led to choose too high a level of activity.”

Whereas under strictly liability… “Because an injurer must pay for losses whenever he in involved in an accident, he will be induced to consider the effect on accident losses of both his level of care and his level of activity. His decisions will therefore be efficient. Because drivers will be liable for losses sustained by pedestrians, they will decide not only to exercise due care in driving but also to drive only when the utility gained from it outweights expected liability payments to pedestrians.” (This is exactly what we had already concluded…)

Injurer Precaution Injurer Activity ACCIDENTS BETWEEN STRANGERS Simple Negligence Efficient Too High Strict Liability Efficient Efficient

Next case: accidents between “sellers and strangers”
Injurer is in a competitive business, but not with victim victim is not injurer’s customer, but a stranger Example: taxi drivers provide service to their passengers risk hitting other pedestrians Shavell assumes perfect competition Price = marginal cost of “production” Sales = number of passengers who demand rides at that price Next, Shavell considers accidents between sellers and strangers That is, injurers are engaged in some sort of competitive business, but not with their victims He gives the example of taxi drivers – taxis provide a service to passengers, but still run the risk of hitting other pedestrians who aren’t their passengers Shavell assumes that there is perfect competition – taxis lower their prices to compete against each other, up till prices equal the costs of “production”; and the number of passengers who demand rides at those prices determine the level of sales

Accidents between businesses and strangers
Strict liability Taxi drivers pay for accidents, set x = x* to minimize costs Perfect competition  cost of remaining accidents is built into price Taxi passengers face price that includes cost of accidents Passengers internalize risk of accidents, demand efficient number of rides Negligence rule Taxi drivers still take efficient precaution, to avoid liability But since drivers don’t bear residual risk, cost of accidents not built into price Passengers face prices that are too low Demand for taxi rides inefficiently high For accidents between strangers, strict liability led to efficient precaution and efficient activity For accidents between businesses and strangers, the results are the same, but the reason is different Under strict liability, taxi drivers pay for accidents, so they will take the efficient level of precaution – it’s cheaper for them to take precaution than to pay for more accidents And the expected costs of any remaining accidents is still borne by the taxi drivers So under competition, it is built into the price of a taxi ride (That is, once taxi fares reach the level that just covers costs plus expected damage payments, taxi drivers stop lowering prices, so that sets the price.) This means that taxi passengers face the “socially optimal” price – given efficient precaution, they now internalize the cost of accidents, so they take the efficient number of taxi rides A negligence rule led to efficient precaution but inefficiently high activity for accidents between strangers Here, the result is the again the same, but again, for a different reason Under a negligence rule, taxi drivers take efficient precaution, to avoid liability for any accidents that occur But once they’re taking efficient precaution, they’re no longer liable, so they do not bear the costs of accidents So the cost of accidents is not built into prices So passengers face prices that are too low – taxi passengers don’t internalize the cost of accidents when they decide how often to ride So the demand for taxi rides will be inefficiently high – again, we get an inefficiently high activity level

Injurer Precaution Injurer Activity ACCIDENTS BETWEEN STRANGERS Simple Negligence Efficient Too High Strict Liability Efficient Efficient ACCIDENTS BETWEEN BUSINESSES AND STRANGERS The two cases look exactly the same, but for different reasons Simple Negligence Efficient Too High Strict Liability Efficient Efficient

Final case: accidents between businesses and their own customers
Example: restaurants taking precaution to reduce risk of food poisoning How accurately do customers perceive risks? 1. Customers can accurately judge risk of each restaurant 2. Customers can accurately judge average level of risk, but not differences across restaurants 3. Customers ignorant of risks The third case that Shavell considers is that of accidents between sellers and their customers Here, he uses the example of restaurants taking precautions to reduce the risk of food poisoning (He also points out that accidents between sellers and their employees are very similar) In this case, it ends up vitally important how accurately customers perceive risks He looks at three separate cases: customers can accurately perceive the risk of each restaurant customers can accurately perceive the average level of risk, but not differences between different restaurants customers are just generally ignorant of the risks

Accidents between businesses and their own customers: strict liability
Seller bears cost of accidents  efficient precaution Seller bears residual risk  expected cost of accidents is built into prices Even if customers don’t perceive risk, price leads them to make efficient choices Price of shellfish = cost of shellfish + expected cost of food poisoning Even if I don’t know that, I buy shellfish when benefit > price, so I’m forced to choose efficiently Under strict liability, customer perception of risk ends up not mattering after all Under strict liability, the seller bears the cost of accidents, so he takes efficient precaution to prevent them And since he still bears the remaining risk of accidents, their expected cost is built into the price of meals That is, menu prices include a premium for expected damage payments when food poisoning does occur Which means that regardless of whether they perceive risk, customers make efficient choices about how often to eat out, because they explicitly see the cost of risk through prices That is, if I like seafood, I don’t have to know that if I eat raw shellfish, I have a 1-in-100 chance of an unpleasant experience that costs me $500 I don’t need to know this because the cost of a raw shellfish meal is $5 more than it would be otherwise, since the restaurant needs to charge this just to break even since if I ever do get sick, he knows I’ll sue So the prices I face include the expected cost of food poisoning; so even if I don’t realize that, I choose efficiently.

Accidents between businesses and their own customers
Risk Perception? Seller Precaution Buyer Activity Strict Liability Yes Efficient Efficient No Efficient Efficient

Accidents between businesses and their own customers: negligence
Restaurants take efficient precaution, to avoid liability But since they avoid liability, cost of accidents not built into prices If customers perceive risk correctly, no problem Weigh benefit of meal versus price + expected pain due to food poisoning Demand efficient number of meals But if customers don’t perceive risk, they’ll demand inefficiently many dangerous meals Under negligence, however, this doesn’t work Under negligence, restaurants will still take efficient precaution, to avoid liability (they’ll keep the kitchen clean, wash hands after using the bathroom, etc.) But since they then won’t be liable when accidents do occur, prices won’t reflect these risks If customers correctly perceive risks, this won’t matter – customers will consider the money cost of the meal, plus the expected cost due to food poisoning, and will choose efficiently But if customers underestimate the risk of food poisoning, they’ll order an inefficiently large number of risky meals – the level of activity will be too high

Risk Perception? Seller Precaution Buyer Activity Strict Liability Yes Efficient Efficient No Efficient Efficient Negligence Yes Efficient Efficient No Efficient Too High

Accidents between businesses and their own customers: no liability
If customers correctly judge risks… Restaurants take efficient precaution to attract customers And customers demand efficient number of meals If customers can only judge average level of risk… Restaurants take no precautions But customers know this, demand efficient (low) number of meals If customers are oblivious to risk… Cost of food poisoning not built into prices Customers demand inefficiently high number of meals We can also look at what will happen under a rule of no liability If customers correctly judge the risk, then sellers will still take efficient precaution – it gives them a way to attract customers If the restaurant can spend $3 to make a meal $5 cheaper in expected costs, they could charge $4 more for the meal and still get more customers Competition means that this will happen So if risk is judged accurately, sellers will take efficient precautions, and buyers, judging risk correctly, will buy the efficient number of meals Next, suppose customers can accurately judge the average level of risk across all restaurants, but can’t differentiate between restaurants In this case, restaurants have no reason to take precaution – since they won’t be rewarded with higher sales, and they won’t be liable if there are accidents – so precaution will be zero But, at least customers will know that precaution is low and the product is risky, so they’ll eat the efficient number of meals Under no liability in a city without any health inspectors, maybe people don’t eat much sushi Finally, consider the case where customers are just completely oblivious to the risk of the product Like the last case, there is no reason for sellers to take any precaution And since there is no liability, risk will not be built into prices And since customers can’t perceive risk, not only is precaution too low, but activity is too high – customers don’t consider the risks when deciding how often to eat out

Risk Perception? Seller Precaution Buyer Activity Strict Liability Yes Efficient Efficient No Efficient Efficient Negligence Yes Efficient Efficient No Efficient Too High No Liability Yes Efficient Efficient Average None Efficient No None Too High

Next few lectures… How do we determine legal standard for negligence?
What happens if we get it wrong? What happens when the world is more complicated than we’ve been imagining so far?

Econ 522 Economics of Law Dan Quint Fall 2010 Lecture 16.

Similar presentations

Presentation on theme: "Econ 522 Economics of Law Dan Quint Fall 2010 Lecture 16."— Presentation transcript:

Similar presentations

About project

Feedback

Log in

Auth with social network:

Econ 522 Economics of Law Dan Quint Fall 2010 Lecture 16.

Similar presentations

Presentation on theme: "Econ 522 Economics of Law Dan Quint Fall 2010 Lecture 16."— Presentation transcript:

Similar presentations

About project

Feedback