1. Econ 522 Economics of Law
Dan Quint
Fall 2011
Lecture 16

2. Monday… Elements of a tort
Harm; causation; breach of duty (negligence)
Strict liability rule: need to prove harm and causation
Negligence rule: need to prove all three elements
Precaution: any actions taken to reduce likelihood of an accident
Began to set up simple model to evaluate liability rules
unilateral harm; no insurance; both parties know law

3. 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)
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)

4. Effect of Liability Rules on Precaution

5. Effect of liability rules on precaution
Already know what’s efficient
Level of precaution that minimizes total social cost = wx + p(x) A
We’ll consider what happens if there is…
no liability rule in place
a strict liability rule
a negligence rule

6. Rule 1: No Liability In a world with no liability…
Injurer does not have to pay for accidents
So, bears cost of any precautions he takes, but does not receive any benefit
Injurer has no incentive to take precaution
Victim bears cost of any accidents, plus cost of precaution he takes
(Victim precaution imposes no externality on injurer)
Victim precaution will be efficient
First, we consider a world without lawsuits, where nobody is liable for any harms that they cause accidentally
In a world without liability, the victim gets no compensation, so he is stuck bearing the cost of any accidents that occur
Plus he bears the cost of any precaution he takes
The injurer, on the other hand, does not have to pay for accidents, so he only bears the cost of precautions he takes

7. Rule 1: No Liability Injurer’s private cost is just wx
Minimized at x = 0
Victim’s private cost is p(x) A + wx
Minimized at efficient precaution level x = x*
So rule of no liability leads to efficient precaution by victims, no precaution by injurers $
Private cost to injurer
Private cost to victim
wx + p(x) A wx
First, we consider a world without lawsuits, where nobody is liable for any harms that they cause accidentally
In a world without liability, the victim gets no compensation, so he is stuck bearing the cost of any accidents that occur
Plus he bears the cost of any precaution he takes
The injurer, on the other hand, does not have to pay for accidents, so he only bears the cost of precautions he takes
p(x) A x* x

8. Rule 1: No Liability So in a world with no liability…
Injurer takes inefficiently low level of precaution
(zero, or minimal amount)
Victim takes efficient amount of precaution

9. Rule 2: Strict Liability
Perfect compensation: damages D = A
Under strict liability…
Injurer pays damages for any accidents he causes
So injurer bears cost of accidents, plus his own precaution
Injurer internalizes externality his actions cause  chooses efficiently
Victim is fully insured, no incentive for precaution
Next, we consider Rule 2: Strict Liability
Suppose we are in a world with strict liability, where in the event of an accident, the injurer will have to pay damages D to the victim
And suppose that compensation is perfect – D = A, so the damages exactly compensate the victim for the harm.
Go back to the example of reflective clothing
Now the bicyclist knows that if he’s in an accident, he’ll incur harm of A and receive damages of D, so now the costs he faces are
w x + p(x) (A – D) = wx
So the cyclist minimizes this by setting x = 0
Under strict liability, the victim doesn’t bear the cost of accidents, so he has no reason to take any precaution
Is this efficient? No. The total social cost of accidents is
wx + p(x) A
the transfer of money from injurer to victim is just a transfer
So it would be efficient to set a higher level of precaution.
So a strict liability rule leads the victim to select an inefficiently low level of precaution.
But on the other hand, if it’s the injurer who affects the probability of accidents, strict liability ends up working pretty well
The injurer knows if there’s an accident, he’ll have to pay damages of D, so he minimizes
wx + p(x) D
and with D = A, this is
So he’s facing the same problem as minimizing the total social cost of accidents – so he chooses x efficiently!
(This is because, under strict liability, the victim is actually indifferent between accident and no accident – so the injurer’s actions cause no externality, so he chooses efficiently.)
So a strict liability rule leads the injurer to take efficient precaution.

10. Rule 2: Strict Liability
(Damages = A)
Injurer’s private cost is p(x) A + wx
Minimized at efficient precaution level x = x*
Victim’s private cost is just wx
Minimized at x = 0
So rule of strict liability leads to efficient precaution by injurers, no precaution by victims $
Private cost to injurer
Private cost to victim
wx + p(x) A wx
Next, we consider Rule 2: Strict Liability
Suppose we are in a world with strict liability, where in the event of an accident, the injurer will have to pay damages D to the victim
And suppose that compensation is perfect – D = A, so the damages exactly compensate the victim for the harm.
Go back to the example of reflective clothing
Now the bicyclist knows that if he’s in an accident, he’ll incur harm of A and receive damages of D, so now the costs he faces are
w x + p(x) (A – D) = wx
So the cyclist minimizes this by setting x = 0
Under strict liability, the victim doesn’t bear the cost of accidents, so he has no reason to take any precaution
Is this efficient? No. The total social cost of accidents is
wx + p(x) A
the transfer of money from injurer to victim is just a transfer
So it would be efficient to set a higher level of precaution.
So a strict liability rule leads the victim to select an inefficiently low level of precaution.
But on the other hand, if it’s the injurer who affects the probability of accidents, strict liability ends up working pretty well
The injurer knows if there’s an accident, he’ll have to pay damages of D, so he minimizes
wx + p(x) D
and with D = A, this is
So he’s facing the same problem as minimizing the total social cost of accidents – so he chooses x efficiently!
(This is because, under strict liability, the victim is actually indifferent between accident and no accident – so the injurer’s actions cause no externality, so he chooses efficiently.)
So a strict liability rule leads the injurer to take efficient precaution.
p(x) A x* x

11. 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

12. So for accidents with unilateral precaution…
When it’s the injurer who can take precautions, a rule of strict liability is more efficient
When it’s 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 saw in contract law
Negligence rule may allow us to get both incentives right
Our results so far suggest that when only the victim is able to take precautions to prevent the accident, a rule of no liability is preferable
And when only the injurer is able to take precautions, a rule of strict liability is preferable.
(This is exactly analogous to the problem we saw in contract law, of allocating a risk to the lowest-cost avoider
When one party – in this case, victim or injurer – can take precautions and the other cannot, that first party is the low-cost avoider
Making them bear the cost of the accident leads to efficient unilateral precaution.)
With contracts, we saw that there was no breach remedy that set efficient incentives for both the promisor and the promisee – the paradox of compensation
Here, we find the same thing: a rule that sets the correct incentive for injurer precaution leads to too little victim precaution, and vice versa
So in settings with bilateral precaution – situations where both parties have the possibility of precaution – neither of these rules will lead to efficiency
(With bilateral precaution, things get a little more complicated – you’ll see an example of this on the homework.)
However, in tort law, there is a trick
We already defined a negligence rule, under which the injurer is liable for harm only if he did not take certain precautions
That is, in tort law, we can make damages depend not only on whether an accident occurred, but also on the level of precaution that the parties took ahead of time
This may allow us to get both incentives right.

13. Rule 3: “Simple Negligence”
Legal standard of care xn
Injurer is liable for damages if precaution level was below the legal standard of care
x < xn  D = A
x ³ xn  D = 0
So on our graph from before, private cost to injurer is…
wx + p(x) A for x < xn
wx for x ³ xn
Since we’re shooting for efficiency, we’ll suppose xn = x*
Rule 3: Negligence Rule
Let’s think first about just injurer precaution
A negligence rule says that the injurer is liable for damages if his precaution level was below the legal standard of care, xn
So for x < xn, damages would be D = A
For x >= xn, damages would be D = 0
If we go back to the graphs we drew earlier, then, the total expected cost to the injurer (from both precaution and expected damages) will be
wx + p(x) A for x < xn, and just wx for x >= xn, since when x >= xn, the injurer is not liable for damages.
How this actually looks will depend on how xn, the legal standard for precaution, relates to x*, the efficient level of precaution
For now, let’s assume they’re equal, that is, xn = x*
(Our goal is to design an efficient legal system; so for now, let’s assume the court can set the efficient legal standard for negligence. We’ll see later what happens when it can’t.)

14. Rule 3: Simple Negligence Injurer precaution$
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

15. Rule 3: Simple Negligence Victim precaution
What about victim?
We just said, injurer will take efficient precaution
Which means injurer will not be liable
So victim bears costs of any accidents
(Victim bears residual risk)
So victim’s private cost is wx + p(x) A
Victim minimizes private cost by taking efficient level of precaution too! $
Private cost to victim
(assuming injurer takes efficient level of precaution and is therefore not liable for damages)
wx + p(x) A wx
p(x) A x*

16. 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

17. In fact, there are several ways we could implement a negligence rule
Rule we just saw: injurer is liable if he was negligent, not liable if he wasn’t
“Simple Negligence”
Doesn’t consider whether victim was negligent, only injurer
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

18. 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

19. 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

20. 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.

21. 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 always best-response 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 20 20

22. 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
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

23. 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 22 22

24. 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
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

25. 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 24 24

26. 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

27. (Aside: 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)

28. 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

29. Activity Levels

30. Activity levels
Precaution – actions which make an activity less dangerous
Driving carefully
Wearing bright-colored clothing while bicycling
The amount we do each activity also affects the number of accidents
I decide how much to drive
You decide how much to bicycle
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 wearing bright-colored clothing; you can also reduce accidents by bicycling less

31. 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 bicycling, minus the cost of precautio, 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.

32. 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

33. 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 bike
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.

34. 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
Efficient
Too High
Simple Negligence
Efficient
Efficient
Negligence with a Defense of Contributory Negligence
Efficient
Efficient
(We can also think about this via externalities.
Under strict liability, you are fully compensated for any accidents I cause
So my choice of how much to drive doesn’t affect your well-being
So there is no externality, and I drive the efficient amount.
On the other hand, under strict liability, if you bicycle more, it increases the likelihood that I hit you and have to pay,
so it imposes a negative externality on me,
so you do it too much.)
Comparative Negligence
Efficient
Efficient
Strict Liability with Defense of Contributory Negligence
Efficient
Efficient

35. 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 bikes carefully, and bikes efficient amount

36. 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
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

37. 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

38. 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
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

39. 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

40. 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
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

41. Adding activity levels to our results on precaution…
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

42. Adding activity levels to our results on precaution…
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

43. 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

44. 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.

45. 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

46. Shavell’s Take (won’t get to this Wednesday)

47. 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.”

48. Steven Shavell, Strict Liability Versus Negligence
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…)

49. Steven Shavell, Strict Liability Versus Negligence
Injurer Precaution
Injurer Activity
ACCIDENTS BETWEEN STRANGERS
Simple Negligence
Efficient
Too High
Strict Liability
Efficient
Efficient

50. 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

51. 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

52. Steven Shavell, Strict Liability Versus Negligence
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

53. 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

54. 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.

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

56. 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

57. Accidents between businesses and their own customers
Risk Perception?
Seller Precaution
Buyer Activity
Strict Liability
Yes
Efficient
Efficient No
Efficient
Efficient
Negligence
Yes
Efficient
Efficient No
Efficient
Too High

58. 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

59. Accidents between businesses and their own customers
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

60. 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?