Econ 522 Economics of Law

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Econ 522Economics of Law
Dan Quint Fall 2009 Lecture 17
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Logistics

• HW2 back today
• Midterm back next Tuesday
• Today
• A very brief experiment
• Recap of tort law so far
• Continuing the model of accidents and precaution

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The story so far
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The story so far

• Torts accidental harms
• Elements harm, causation, breach of duty
• Strict liability versus negligence rules
• Strictly liability injurer is liable for any
  harms he causes
• Negligence injurer only liable if he breached a
  duty (was negligent) and this led to the harm
• Effect of different liability rules on
• Injurer precaution
• Victim precaution

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Model of unilateral harm
x level of precautionw marginal
cost of precautionp(x) probability of an
accidentA cost of an accident

wx p(x) A(Total Social Cost)
wx (Cost of Precaution)
p(x) A (Cost of Accidents)
Precaution (x)
x (Efficient Level of Precaution)
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Injurer precaution under arule of no liability
x level of precautionw marginal
cost of precautionp(x) probability of an
accidentA cost of an accident

Private cost to injurer
wx p(x) A
wx
p(x) A
x
x

• Injurer has no incentive to take any precaution,
  sets x 0

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Victim precaution under arule of no liability
x level of precautionw marginal
cost of precautionp(x) probability of an
accidentA cost of an accident

Private cost to victim
wx p(x) A
wx
p(x) A
x
x

• Victim bears cost of accidents and precaution
• Sets x x to minimize wx p(x) A

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Our results from last week
Victim Precaution
Injurer Precaution
Efficient
Zero
No Liability
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Injurer precaution under arule of strict
liability
x level of precautionw marginal
cost of precautionp(x) probability of an
accidentA cost of an accident

Private cost to injurer
wx p(x) A
wx
p(x) A
x
x

• Injurer bears cost of accidents and precaution
• Sets x x to minimize wx p(x) A

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Victim precaution under arule of strict liability
x level of precautionw marginal
cost of precautionp(x) probability of an
accidentA cost of an accident

Private cost to victim
wx p(x) A
wx
p(x) A
x
x

• Victim has no incentive to take any precaution,
  sets x 0

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Our results from last week
Victim Precaution
Injurer Precaution
Efficient
Zero
No Liability
Zero
Efficient
Strict Liability
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Injurer precaution under asimple negligence rule
x level of precautionw marginal
cost of precautionp(x) probability of an
accidentA cost of an accident

Private cost to injurer
wx p(x) A
wx
p(x) A
x
xn x

• Injurer is only liable if x lt xn
• Sets x xn x to avoid liability

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Victim precaution under asimple negligence rule
x level of precautionw marginal
cost of precautionp(x) probability of an
accidentA cost of an accident

Private cost to victim
wx p(x) A
wx
p(x) A
x
x

• Injurer takes efficient precaution, to avoid
  liability
• So victim bears cost of accidents, sets x x to
  minimize

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Our results from last week
Victim Precaution
Injurer Precaution
Efficient
Zero
No Liability
Zero
Efficient
Strict Liability
Efficient
Efficient
Simple Negligence
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Our results from last week
Victim Precaution
Injurer Precaution
Efficient
Zero
No Liability
Zero
Efficient
Strict Liability
Efficient
Efficient
Simple Negligence
Efficient
Efficient
Negligence with a Defense of Contributory
Negligence
Efficient
Efficient
Comparative Negligence
Efficient
Efficient
Strict Liability with Defense of Contributory
Negligence
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Activity Levels
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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

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Activity levels under a rule of no liability

• With no liability, Im not responsible if I hit
  you
• I dont 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

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

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

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

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

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

• Activity is just another type of precaution, but
  type where court cant determine efficient level
• Court can tell inefficient for me to drive at
  night with headlights off
• Cant tell how many miles its 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, but
• strict liability only leads to efficient
  unobservable precaution by injurer
• while simple negligence only leads to efficient
  unobservable precaution by victim

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So which rule is best?

• Depends on which choices have most impact
• Only concerned about injurer (precaution
  activity) ? strict liability
• Bilateral precaution ? negligence
• Which negligence rule depends on 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

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Shavells Take
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Steven Shavell, Strict Liability Versus
Negligence

• Focuses on injurer precaution and activity
• Compares strict liability to negligence rules
• Accidents between strangers (what weve 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.

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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)

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Steven Shavell, Strict Liability Versus
Negligence
InjurerActivity
InjurerPrecaution
ACCIDENTS BETWEEN STRANGERS
Too High
Efficient
Simple Negligence
Efficient
Efficient
Strict Liability
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Next case accidents between sellers and
strangers

• Injurer is in a competitive business, but not
  with victim
• victim is not injurers 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

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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 dont bear residual risk, cost
  of accidents not built into price
• Passengers face prices that are too low
• Demand for taxi rides inefficiently high

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Steven Shavell, Strict Liability Versus
Negligence
InjurerActivity
InjurerPrecaution
ACCIDENTS BETWEEN STRANGERS
Too High
Efficient
Simple Negligence
Efficient
Efficient
Strict Liability
ACCIDENTS BETWEEN BUSINESSES AND STRANGERS
Too High
Efficient
Simple Negligence
Efficient
Efficient
Strict Liability
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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

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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 dont perceive risk, price
  leads them to make efficient choices
• Price of shellfish cost of shellfish expected
  cost of food poisoning
• Even if I dont know that, I buy shellfish when
  benefit gt price, so Im forced to choose
  efficiently

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Accidents between businesses and their own
customers
BuyerActivity
SellerPrecaution
RiskPerception?
Efficient
Efficient
Yes
Strict Liability
Efficient
Efficient
No
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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 dont perceive risk, theyll
  demand inefficiently many dangerous meals

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Accidents between businesses and their own
customers
BuyerActivity
SellerPrecaution
RiskPerception?
Efficient
Efficient
Yes
Strict Liability
Efficient
Efficient
No
Efficient
Efficient
Yes
Negligence
Too High
Efficient
No
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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
• Restaurants take no precautions
• Cost of food poisoning not built into prices
• Customers demand inefficiently high number of
  meals

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Accidents between businesses and their own
customers
BuyerActivity
SellerPrecaution
RiskPerception?
Efficient
Efficient
Yes
Strict Liability
Efficient
Efficient
No
Efficient
Efficient
Yes
Negligence
Too High
Efficient
No
Efficient
Efficient
Yes
No Liability
Efficient
None
Average
Too High
None
No
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Due Care andthe Hand Rule
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Setting the legal standard of care

• Weve been assuming xn x
• court could set legal standard for avoiding
  negligence equal to efficient level of precaution
• In some cases, this is what court actually tries
  to do
• U.S. v Carroll Towing (1947, U.S. Court of
  Appeals)
• Several barges secured together to piers
• Defendants tugboat was hired to tow one out to
  harbor
• Crew readjusted mooring lines to free barge,
  adjustment done incorrectly, one barge broke
  loose, collided with ship, sank
• Barge owner sued tug owner, saying his employees
  were negligent
• Tug owner claimed barge owner was also negligent
  for not having an agent on board to help
• Question was it negligent to not have a bargee
  on board?

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The Hand Rule

• Judge Learned Hand, in Carroll Towing decision
• It appears that there is no general rule
• Since there are occasions when every vessel will
  break away from her moorings, and since, if she
  does, she becomes a menace to those around her
  the owners duty to provide against resulting
  injuries is a function of three variables
• (1) the probability that she will break away
  (2) the gravity of the resulting injury, if she
  does (3) the burden of adequate precautions.
• Perhaps it serves to bring this notion into
  relief to state it in algebraic terms
• if the probability be called P the injury, L
  and the burden, B
• liability depends upon whether B is less than L
  multiplied by P.

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The Hand Rule

• What does the Hand Rule mean?
• If cost of precaution lt reduction in accidents X
  size of accident, and you didnt take precaution,
  that counts as negligence
• But if cost lt expected benefit, this means
  precaution is efficient
• (Or, cost-justified)
• So Hand Rule says, whenever precaution is
  efficient, you have to take it to avoid liability
• But if precaution is not cost-justified (not
  efficient), you dont have to take it to avoid
  liability
• So Hand Rule basically says, the legal standard
  of care is the efficient level of precaution

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The Hand Rule

• Hand rule precaution is required to avoid
  negligence if
• Cost of precaution lt reduction in accidents X
  size of accident
• Having/not having a bargee is discontinuous, but
  if precaution were a continuous variable, think
  of these as marginals
• Cost is w (marginal cost of precaution)
• Reduction in accidents is p(x)
• Size of accidents is A
• Hand rule says, if w lt p(x) A, you were
  negligent, because more precaution would have
  been efficient

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So how is legal standard established?

• One way successive application of Hand Rule
• Another laws and regulations can specify legal
  standard
• Third law can enforce social norms or industry
  best-practices

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Two difficulties in establishing legal standards
for negligence

• American courts have misapplied Hand Rule
• To calculate efficient level of precaution,
  reduction in harm should be based on total social
  cost of an accident
• Should include harm to victim (risk to others)
  and to injurer himself (risk to self)
• Courts have tended to only count risk to others
  when calculating benefit of precaution
• Hindsight bias
• After something happens, we assume it was likely
  to occur
• Hard to get unbiased estimate of probability
  after something happens likely to overestimate