1. Product Safety TechnologyVersusBehavior

2. Information Problem Occurs when safety/performance aspects of a product cannot be observed in advance Occurs when safety/performance aspects of a product cannot be observed in advance Experience with good provides information but risks harm to the consumer Experience with good provides information but risks harm to the consumer Remedies: Remedies: After-the-fact: Consumer Complaints, Product Liability After-the-fact: Consumer Complaints, Product Liability Before-the-fact: Regulation with Fines/Penalties Before-the-fact: Regulation with Fines/Penalties Intermediate: Disclosure requirements, Government provision of information Intermediate: Disclosure requirements, Government provision of information

3. Consumer Complaints, Product Liability Litigation Consumer suffers loss first Consumer suffers loss first May create proper incentives in long run May create proper incentives in long run No enforcement costs (for government) No enforcement costs (for government) Appropriate when Appropriate when Loss from failure is small or highly uncertain Loss from failure is small or highly uncertain No technological solution exists No technological solution exists Losses excludable Losses excludable Example: product defects Example: product defects

4. Regulation Standards imposed before loss incurred Standards imposed before loss incurred May create proper incentives May create proper incentives Enforcement costs incurred Enforcement costs incurred Appropriate when Appropriate when High costs of failure High costs of failure Technological solutions exist Technological solutions exist “Lemons problem” is present “Lemons problem” is present Losses not excludable (externalities) Losses not excludable (externalities) Example: prescription drugs, anti-lock brakes Example: prescription drugs, anti-lock brakes

5. Disclosure/Information Provision Provide information, but allow consumer choice Provide information, but allow consumer choice Influence behavior (choice) with information Influence behavior (choice) with information Appropriate when Appropriate when No technological solution (inherently risky) No technological solution (inherently risky) Low cost of failure Low cost of failure Losses are excludable Losses are excludable Examples: alcohol, cigarettes, o-t-c drugs Examples: alcohol, cigarettes, o-t-c drugs

6. Why won’t markets work? “Lemons” market “Lemons” market Bad drives out the good Bad drives out the good Consumers only observe average safety, so are unwilling to pay for high safety goods Consumers only observe average safety, so are unwilling to pay for high safety goods Solution: brand names build reputations for quality Solution: brand names build reputations for quality Free-rider problem Free-rider problem Enjoy safe behavior/choices of others Enjoy safe behavior/choices of others Drivers of unsafe cars benefit from others driving safe cars – reduced risk of accident Drivers of unsafe cars benefit from others driving safe cars – reduced risk of accident

7. Pre-testing and approval: FDA Product testing should minimize total costs to society (t*) Product testing should minimize total costs to society (t*) Bureaucrats may not weigh costs this way Bureaucrats may not weigh costs this way B’s cost of approving unsafe drug > cost of delaying safe drugs B’s cost of approving unsafe drug > cost of delaying safe drugs Reg. agency chooses “too much” testing (t B >t*) Reg. agency chooses “too much” testing (t B >t*) If cost of delay goes up, accelerated approval process adopted (t* declines) If cost of delay goes up, accelerated approval process adopted (t* declines)

8. Technology vs. Behavior Safer products may lead to more unsafe behavior (“moral hazard”) Safer products may lead to more unsafe behavior (“moral hazard”) Example: Seat belts Example: Seat belts Safer technology reduces P(Death) at any speed Safer technology reduces P(Death) at any speed Reduced P(D) induces increase in speed Reduced P(D) induces increase in speed Safety improvement less than expected Safety improvement less than expected SUV’s encourage less safe driving, more accidents SUV’s encourage less safe driving, more accidents “Safer” cigarettes cause more smoking “Safer” cigarettes cause more smoking