Part D-II The Economics of Tort Law

Part D-II The Economics of Tort Law Tort_D

Objectives • Bilateral precaution • No liability/strict liability rules under bilateral precaution • The problem of efficient tort rules under bilateral precaution Tort_D

Recall that we considered two classes of risk A risk situation is one of unilateral precaution if only the potential victim or only the potential injurer can take precaution but not both. A risk situation is one of bilateral precaution if both the potential victim and the potential injurer can take precaution. Tort_D

Unilateral Precaution Recall The efficient tort rule for risks characterized by unilateral precaution is: - if only the potential victim can take precaution, then no liability - if only the potential injurer can take precaution, then strict liability with perfect damages Tort_D

Bilateral Precaution There are many risk situations which are not unilateral risk situations For many types of risk both the potential victim and the potential injurer can take precautions - driving safely/seatbelts - driving safely/bicycle helmets - walking (not running) over an icy sidewalk - taking medication as directed Tort_D

Bilateral Precaution In such situations, neither the rule of no liability nor the rule of strict liability will lead to the ‘efficient’ level of precaution being taken. Both the potential injurer and the potential victim should be taking precaution – they share control over the risk. But the rules of no liability and strict liability/ perfect damages lead to only the potential victim or only the potential injurer taking precaution. Tort_D

Bilateral Precaution NOTE: The potential victim’s precaution is different from the potential injurer’s precaution. They are essentially different activities. Important point Getting the potential injurer (victim) to take more precaution when the potential victim (injurer) takes too little precaution will not be efficient. One agent cannot generally compensate for the shortfall of the other agent (not in an efficient manner) Tort_D

REMINDER: When we say ‘take precaution’ we mean do something (or not do something) that results in a decrease in the probability of an accident occurring (lower the risk of an accident). Tort_D

Recall the social costs of accidents can be expressed as: SC = wv xv + wi xi + p(xv, xi)A Under unilateral precaution: If only the potential victim can control risk, then Δp(xv, xi)/Δxi = 0 we wrote p(xv, xi=0) = p(xv) If only the potential injurer can control risk, then Δp(xv, xi)/Δxv = 0 we wrote p(xv=0, xi) = p(xi) Tort_D

The change in the probability of an accident as the amount of precaution changes Δp(xv, xi)/Δxv p(xv, xi) p1(xv, xi) Δp(xv, xi) p2(xv, xi) Δxv p(xv , xi) x= xv 0 xv1 xv2 Precaution Tort_D

But under bilateral precaution: Δp(xv, xi)/Δxi < 0 and Δp(xv, xi)/Δxv < 0 Note: the potential victim and potential injurer control different aspects of the risk (xv and xi are generally different types of expenditures, actions, etc.) Tort_D

Will a rule of no liability be efficient if the risk requires bilateral precaution? No, because no liability causes the potential injurer to completely externalize the cost of harm and therefore take no precaution. Will a rule of strict liability/perfect damages be efficient if the risk requires bilateral precaution? No, because strict liability/perfect damages causes the potential victim to completely externalize the cost of harm and therefore take no precaution. Tort_D

If both the potential injurer and the potential victim control the risk, efficiency will require that both of them take precaution. How much precaution should each take? That depends on the nature of the risk and the types and costs of precaution available. Tort_D

The answer to the previously question will differ in each risk situation (for each type of potential accident) We want a general rule that will ensure that the potential victim and the potential injurer will each take the efficient amount of precaution for any given type of potential accident Does such a legal rule exist? Tort_D

What is the efficient amount of precaution for each agent? SC = wv xv + wi xi + p(xv, xi)A If we want to minimize the social costs of accidents with respect to both xv and xi our friends in mathematics would say: - take the derivative of SC with respect to xv and set it equal to zero: wv + Δp(xv, xi)/Δxv A = 0 or wv = - Δp(xv, xi)/Δxv A 1) And - take the derivative of SC with respect to xi and set it equal to zero: wi + Δp(xv, xi)/Δxi A = 0 or wi = - Δp(xv, xi)/Δxi A 2) Tort_D

What is the efficient amount of precaution for each agent? Conclusion #1 In order to minimize the expected social costs of accidents both the potential victim and the potential injurer must ‘purchase’ an amount of precaution such that the marginal cost of precaution (w) is just equal to the decrease in the expected cost of harm from the expenditure (- Δp(xv, xi)/Δx A) for each of them. Tort_D

What is the efficient amount of precaution for each agent? We can divide expression 1) by expression 2) and get: wv / wi = [Δp(xv, xi)/Δxv] / [Δp(xv, xi)/Δxi] or [Δp(xv, xi)/Δxv] / wv = [Δp(xv, xi)/Δxi] / wi Conclusion #2 The ratio of the prices of a unit of precaution taken by the potential victim and that taken by the potential injurer must equal the inverse of the ratio of marginal declines in the probability of an accident occurring resulting from an additional unit of xv and xi. Tort_D

What is the efficient amount of precaution for each agent? Conclusion to this point: The efficient level of precaution for the potential victim and potential injurer will depend on the price of each type of precaution and the nature of the impact of each type of precaution on the probability of an accident Tort_D

A little bit of intuition Efficiency requires that: to the extent that the cost of precaution to the potential victim is relatively inexpensive, or the precaution taken by the potential victim is relatively effective, the potential victim should take relatively more precaution. to the extent that the cost of precaution to the potential injurer is relatively inexpensive, or the precaution taken by the potential injurer is relatively effective, the potential injurer should take relatively more precaution. Tort_D

Such a general rule will need to account for wv and wi - how much each type of precaution cost and Δp(xv, xi)/Δxi and Δp(xv, xi)/Δxv - the marginal effect of the alternative types of precaution on the probability of an accident Does such a general rule exist? Tort_D

Again, will a rule of no liability be efficient if the risk requires bilateral precaution? No, because no liability causes the potential injurer to completely externalize the cost of harm and therefore take no precaution. Will a rule of strict liability/perfect damages be efficient if the risk requires bilateral precaution? No, because strict liability/perfect damages causes the potential victim to completely externalize the cost of harm and therefore take no precaution. Tort_D

We need both the potential victim and potential injurer to internalize the full cost of harm p(xv, xi)A When they determine how much precaution to take xv and xi So no liability and strict liability/perfect damages will not be efficient tort rules – they will create the wrong incentives Tort_D

An intuitive rule that won’t work Since both the potential injurer and the potential victim can take precaution, why not just set damages at 50% of harm for each? This means that the potential victim and the potential injurer will each bear 50% of the cost of harm. Under this rule of liability/damages D = 0.5 A Tort_D

What is the cost of accidents to the potential victim? wv xv + p(xv, xi)(0.5A) since D = 0.5 A What is the optimal amount of precaution for the potential victim to take? What will be in the potential victim’s own self-interest? Keep ‘buying’ precaution until, wv = - Δ p(xv, xi)/Δxv (0.5A) Potential victim’s = 0.5 of the potential victim’s marginal cost of marginal benefit precaution from precaution Tort_D

What is the cost of accidents to the potential injurer? wi xi + p(xv, xi)(0.5A) since D = 0.5 A What is the optimal amount of precaution for the potential injurer to take? What will be in the potential injurer’s own self-interest. Keep ‘buying’ precaution until, wi = - Δ p(xv, xi)/Δxi (0.5A) Potential injurer’s = 0.5 of the potential injurer’s marginal cost of marginal benefit precaution from precaution Tort_D

What’s wrong with this outcome? The potential victim and the potential injurer are each minimizing their private costs of accidents (the portion of the cost that they are responsible for) but they are ignoring 50% of the cost of harm – the 50% for which they are not liable. Each of them is only internalizing 50% of the expected cost of harm – they will only make half an effort at precaution A simple 50%/50% rule (or any other arbitrary split of the liability) results in each agent only internalizing their assigned share of the cost of harm. There will be too little precaution taken by both the potential victim and the potential injurer Tort_D

We have a real problem. How can we encourage (provide the appropriate incentives to) both the potential injurer and the potential victim to internalize the total cost of harm (A) when they decide on the appropriate level of precaution? Simply dividing up the cost of harm will not work. Tort_D

Part D-II The Economics of Tort Law