Hazards Liability and Tort

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Hazards Liability and Tort

• Lecture 8

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Outline

• Another economic role for the government is
  regulating hazards and risks
• Factory producing explosives (location care in
  operation)
• Dangerous Dogs
• Food hygiene
• Driving
• How much should we spent on precautions?

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Outline

• Regulating Hazards and Risks
• Factory producing explosives (location care in
  operation)
• Dangerous Dogs
• Food hygiene
• Driving
• How much should we spent on precautions?
• Regulating Risk with Liability
• Liability for costs gt incentives for
  precautionary spending. Is this efficient?

4
Outline

• Regulating Hazards and Risks
• Factory producing explosives (location care in
  operation)
• Dangerous Dogs
• Food hygiene
• Driving
• How much should we spent on precautions?
• Regulating Risk with Liability
• Liability for costsgt incentives for
  precautionary spending. Is this efficient?
• Liability versus Ex Ante regulation
• Is it more efficient to regulate hazards ex ante?
  Or, should we rely on incentives created by
  liabilities?

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A Simple Model

• Let us suppose
• w is the marginal cost of precaution (cost of
  inspecting food hygiene)

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A Simple Model

• Let us suppose
• w is the marginal cost of precaution (cost of
  inspecting food hygiene)
• x is the amount of precaution (inspection).

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A Simple Model

• Let us suppose
• w is the marginal cost of precaution (cost of
  inspecting food hygiene)
• x is the amount of precaution (inspection).
• p(x) is the probability that an accident occurs.

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A Simple Model

• Let us suppose
• w is the marginal cost of precaution (cost of
  inspecting food hygiene)
• x is the amount of precaution (inspection).
• p(x) is the probability that an accident occurs.
• A is the cost of an accident.

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Total Costs
Total Costs

p(x)A Expected Accident costs
x Amount of precaution
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Total Costs
Total Costs

wx precaution cost
p(x)A Expected Accident costs
x Amount of precaution
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Total Costs
Total Costs

Total Cost p(x)A wx
wx precaution cost
p(x)A Expected Accident costs
x Amount of precaution
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Total Costs
Total Costs
Minimum Efficient amount of precaution

Total Cost p(x)A wx
wx precaution cost
p(x)A Expected Accident costs
x Amount of precaution
x
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The same issue with slopes
Marginal Costs

Rate at which Accident costs decrease
x Amount of precaution
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The same issue with slopes
Marginal Costs

Marginal cost of precaution
w
Rate at which Accident costs decrease
x Amount of precaution
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The same issue with slopes
Marginal Costs
Minimum Efficient amount of precaution

Marginal cost of precaution
w
Rate at which Accident costs decrease
x Amount of precaution
x
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Regulating Risk with Liability
We will examine the following 2 cases (1)
Strict Liability gt Injurer always liable for
the costs of any accident.

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Regulating Risk with Liability
We will examine the following 2 cases (1) Strict
Liability gt Injurer always liable for the costs
of any accident. (2) Liability Based on
Negligence Rule gt Injurer is liable for damages
only if the court judges that the injurer has
been negligent.

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1. Precautionary Incentives Under Strict Liability

• (Strict Liability gt Injurer liable for accident
  damages regardless of level of precaution taken).
• The cost to the injurer
• Precautionary Costs Accident Costs

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1. Precautionary Incentives Under Strict Liability

• (Strict Liability gt Injurer liable for accident
  damages regardless of level of precaution taken).
• The cost to the injurer
• Precautionary Costs Accident Costs
• As a result, costs imposed on victims are
  internalized by the injurer (the injurer bears
  these costs too).

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1. Precautionary Incentives Under Strict Liability

• (Strict Liability gt Injurer liable for accident
  damages regardless of level of precaution taken).
• The cost to the injurer
• Precautionary Costs Accident Costs
• As a result costs imposed on victims are
  internalized by the injurer (the injurer bears
  these costs too).
• Strict liability achieves the efficient level of
  precaution.

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1. Precautionary Incentives Under Strict Liability

• (Strict Liability gt Injurer liable for accident
  damages regardless of level of precaution taken).
• The cost to the injurer
• Precautionary Costs Accident Costs
• As a result costs imposed on victims are
  internalized by the injurer (the injurer bears
  these costs too).
• Strict liability achieves the efficient level of
  precaution.
• However, this is not true if victims can affect
  the probability and size of the injuries!

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2. Liability Under a Negligence Rule

• Injurer is liable for damages only if the court
  judges the injurer has been negligent.

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2. Liability Under a Negligence Rule

• Injurer is liable for damages only if the court
  judges the injurer has been negligent.
• Negligence ? Less precaution is taken than the
  standard of due care.

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2. Liability Under a Negligence Rule

• Injurer is liable for damages only if the court
  judges the injurer has been negligent.
• Negligence ? Less precaution is taken than the
  standard of due care.
• Injurer bears all costs only if found negligent.
• Otherwise the victim bears these costs.

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2. Liability Under a Negligence Rule

• SDC Standard of Due Care
• The incentives now depend on the SDC applied by
  the court.
• SDC too low gt Marginal cost for injurer too low.
  Too little precaution.
• The injurer bears none of the accident costs if
  it has already provided SDC.

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If the SDC is too low
Total Costs
Minimum Efficient amount of precaution

Total Costs
wx precaution cost
Expected Accident costs
x Amount of precaution
x
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If the SDC is too low
Total Costs
Minimum Efficient amount of precaution

SDC
wx precaution cost
Expected Accident costs
x Amount of precaution
x
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If the SDC is too low costs are as before for low
levels of precaution
Total Costs
Minimum Efficient amount of precaution

SDC
wx precaution cost
Expected Accident costs
x Amount of precaution
x
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If the SDC is low costs jump down at SDC
Total Costs
Minimum Efficient amount of precaution

SDC
wx precaution cost
Expected Accident costs
x Amount of precaution
x
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If the SDC is too low dont pay accident costs if
satisfy SDC
Total Costs
Minimum Efficient amount of precaution

SDC
Total Costs
wx precaution cost
Expected Accident costs
x Amount of precaution
x
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On the other hand

• If the SDC is too high
• May get optimal precaution if the SDC is set just
  right.
• However,
• May get excessive investment in precaution and an
  inefficient outcome if it is unclear what the SDC
  is.
• Hand Rule formulated in US Gov. versus Carroll
  Towing Company applies a cost-benefit test on
  precaution to determine the SDC.

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If the SDC is high
Total Costs
Minimum Efficient amount of precaution

SDC
Total Costs
wx precaution cost
Expected Accident costs
x Amount of precaution
x
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If the SDC is high can get excessive caution
Total Costs
Minimum Efficient amount of precaution

SDC
Total Costs
wx precaution cost
Expected Accident costs
x Amount of precaution
x
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If the SDC is high or can get efficient caution
Total Costs
Minimum Efficient amount of precaution

SDC
Total Costs
wx precaution cost
Expected Accident costs
x Amount of precaution
x
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Judge Learned Hand

• Since there are occasions when every vessel will
  break from her moorings, and since, she becomes a
  menace to those about her the owners duty, as
  in other similar situations , 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.
• Possibly it serves to bring this notion into
  relief to state in algebraic terms if the
  probability be called P the injury L the burden
  B liability depends upon whether BltPL.(1947)

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What he is saying

• If the partys cost of preventing accidents
  (burden) is less than the expected losses from
  accidents that party should be deemed negligent.
• Otherwise it is better for accidents to occur and
  the party to compensate accordingly.

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Comparing Strict Liability (SL) and Negligence (N)

• Who bears the costs of the accident differs.
• N- Victim sometimes bears the cost.
• SL- Injurer always bears the cost.
• What are the Incentives?

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Comparing Strict Liability (SL) and Negligence (N)

• Who bears the costs of the accident differs.
• N- Victim sometimes bears the cost.
• SL- Injurer always bears the cost.
• What are the Incentives?
• If victims cannot affect risks
• Both could be efficient but need to get SDC just
  right and consistent for N to be efficient.

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Comparing Strict Liability (SL) and Negligence (N)

• Who bears the costs of the accident differs.
• N- Victim sometimes bears the cost.
• SL- Injurer always bears the cost.
• What are the Incentives?
• If victims cannot affect risks
• Both could be efficient but need to get SDC
  just right and consistent for N to be efficient.
• If victims can affect risks
• SL is inefficient as the victim has no incentive
  to exert precaution and because injurer has
  excessive incentive.
• N could be more efficient as it provides
  incentives for victim precaution too.

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Ex Ante Regulation or Ex Post Liability

• Liability
• Avoids potentially complex legislation.

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Ex Ante Regulation or Ex Post Liability

• Liability
• Avoids potentially complex legislation.
• Regulations may give inadequate weight to
  particular and even unforeseen circumstances.

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Ex Ante Regulation or Ex Post Liability

• Liability
• Avoids potentially complex legislation.
• Regulations may give inadequate weight to
  particular and even unforeseen circumstances.
• Regulation reduces the incentives to innovate in
  precautionary technology.

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Ex Ante Regulation or Ex Post Liability

• Pro-Regulation
• (1) Not everyone can bring court cases.
• (Litigation costs, free rider problems in class
  actions, causality is often hard to prove).

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Ex Ante Regulation or Ex Post Liability

• Pro-Regulation
• (1) Not everyone can bring court cases
• (Litigation costs, free rider problems in class
  actions, causality is often hard to prove)
• (2) Bankruptcy limits individuals potential
  liability costs

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If A gt value of the firm. gt F is the most the
firm can pay
Total Costs
Minimum Efficient amount of precaution

Total Costs
wx precaution cost
Expected Accident costsA p(x)
Actual Payout when accident F p(x)
x Amount of precaution
x
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Originally
Total Costs
Minimum Efficient amount of precaution

Total Costs
wx precaution cost
Expected Accident costsA p(x)
x Amount of precaution
x
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If A gt value of the firm. gt F is the most the
firm can pay
Total Costs
Minimum Efficient amount of precaution

Total Costs
wx precaution cost
Expected Accident costsA p(x)
Actual Payout when accident F p(x)
x Amount of precaution
x
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Resulting in inefficient amounts of precaution
Total Costs
Minimum Efficient amount of precaution

Total Costs
wx precaution cost
Expected Accident costsA p(x)
Actual Payout when accident F p(x)
x Amount of precaution
x
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Bankruptcy under Liability

• Bankruptcy
• Reduces the incentives for taking care.
• Firms may escape the consequences of litigation
  if they go bankrupt while the trial proceeds.
• Corporate restructuring can allow firms to escape
  consequences of litigation.

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Uncertainty about the legal process

• If the legal process or the standard applied in
  the courts in unclear or uncertain, then
• This introduces

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Uncertainty about the legal process

• If the legal process or the standard applied in
  the courts in unclear or uncertain, then
• this introduces
• a potential risky decision for claimants
  benefiting injurers and reducing the incentives
  for care.

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Uncertainty about the legal process

• If the legal process or the standard applied in
  the courts in unclear or uncertain, then
• this introduces
• a potential risky decision for claimants
  benefiting injurers and reducing the incentives
  for care.
• a potential of escaping even when negligent again
  reducing the incentives for care.

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Ex Post and Ex Ante Together

• Often these may be complementary rather than
  substitute policy choices.
• If injurer may not be held liable, or does not
  correctly asses the probabilities of being held
  liable,
• then a little ex ante regulation may push him in
  the right direction!