Econ 522 Economics of Law

1. Econ 522Economics of Law Dan Quint Fall 2009 Lecture 16

2. Logistics • HW2 due now • Midterm Thursday

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

4. Precaution

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

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

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

8. x level of precautionw marginal cost of precautionp(x) probability of an accidentA cost of an accident Model of unilateral harm $ wx + p(x) A(Total Social Cost) wx (Cost of Precaution) p(x) A (Cost of Accidents) Precaution (x) x* (Efficient Level of Precaution)

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

10. x level of precautionw marginal cost of precautionp(x) probability of an accidentA cost of an accident Model of unilateral harm $ wx + p(x) A wx p(x) A x x < x* x* x > x*

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

12. Effect of liability rules on precaution • No liability • Strict liability • Negligence

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

14. Effect of liability rules on precaution Victimprecaution Injurerprecaution No Liability Efficient Zero

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

16. Effect of liability rules on precaution Victimprecaution Injurerprecaution No Liability Efficient Zero Strict Liability Zero Efficient

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

18. Rule 3: 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

19. x level of precautionw marginal cost of precautionp(x) probability of an accidentA cost of an accident Injurer precaution under anegligence rule $ Private cost to injurer wx + p(x) A wx p(x) A x xn = x* • If legal standard of care is set to efficient level (xn = x*), negligence rule leads to efficient injurer precaution

20. Effect of liability rules on precaution Victimprecaution Injurerprecaution No Liability Efficient Zero Strict Liability Zero Efficient Negligence,with xn = x* Efficient Efficient

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

22. For bilateral precaution, different ways to implement a negligence rule 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

23. For bilateral precaution, different ways to implement a negligence rule 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 Comparative Negligence No No Yes Partial Strict Liability with Defense of Contributory Negligence Yes No Yes No

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

25. Even in a setting with bilateral precaution… Victimprecaution Injurerprecaution No Liability Efficient Zero Strict Liability Zero Efficient Efficient Efficient Any negligence rule with efficient legal standard of care

26. (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

27. So far, our results seem to favor negligence rules… but… Victimprecaution Injurerprecaution No Liability Efficient Zero Strict Liability Zero Efficient Efficient Efficient Any negligence rule with efficient legal standard of care • Up next: activity levels • Steven Shavell, “Strict Liability Versus Negligence”

28. Good luckon Thursday!