Econ 522 Economics of LawSlide 1The story so far…Effects of liability rules on behavior…Effects of various liability rulesSlide 5Steven Shavell, Strict Liability Versus NegligenceSlide 8Slide 9Next case: accidents between “sellers and strangers”Accidents between businesses and strangersSlide 12Final case: accidents between businesses and their own customersAccidents between businesses and their own customers: strict liabilityAccidents between businesses and their own customersAccidents between businesses and their own customers: negligenceSlide 17Accidents between businesses and their own customers: no liabilitySlide 19Next couple lectures…Slide 20Setting the legal standard of care“The Hand Rule”Slide 24Slide 25So how is legal standard for negligence established?Two difficulties in establishing legal standards for negligenceSlide 27Strict liability versus negligenceStrict liability versus negligence: informationErrors and uncertainty in evaluating damagesEffect of errors and uncertainty under strict liabilitySlide 33Slide 34What about under a negligence rule?What about errors in setting xn?What about random errors in setting xn?To sum up the effects of errors and uncertainty…What about relative administrative costs of the two systems?Slide 39Gary Schwartz, Reality in the Economic Analysis of Tort Law: Does Tort Law Really Deter?Slide 42Slide 43Slide 44Slide 45Slide 45Our model thus far has assumed…Assumption 1: RationalitySlide 49Slide 50Slide 51Assumption 2: Injurers pay damages in fullAssumption 3: No regulationSlide 54Assumption 4: No insuranceSlide 56Slide 57Assumption 5: Litigation costs nothingEcon 522Economics of LawDan QuintSpring 2011Lecture 172The story so far3Precaution – costly actions that reduce the likelihood of an accidentActivity – how much a “dangerous” activity is doneEffects of different liability rules on precaution and activity levelsThe story so far…4Strict liability…Injurer internalizes cost of accidents he causesEfficient precaution and efficient activity by injurersVictim is “fully insured” – too little precaution, too much activitySimple negligence…Injurer takes required level of care to avoid liability – efficient injurer precautionInjurer is then “safe” – too much activityVictim bears residual risk of accidents – efficient precaution, efficient activityOther negligence rules – similar to simple negligenceEffects of liability rules on behavior…5Effects of various liability rulesEfficientToo HighEfficientEfficientNegligence with a Defense of Contributory NegligenceToo HighEfficientEfficientEfficientStrict Liability with Defense of Contributory NegligenceEfficientToo HighEfficientEfficientComparative NegligenceEfficientToo HighEfficientEfficientSimple NegligenceToo HighEfficientZeroEfficientStrict LiabilityEfficientToo HighEfficientZeroNo LiabilityVictim ActivityInjurer ActivityVictim PrecautionInjurer Precaution6Shavell’s Take7Focuses on injurer precaution and activityCompares strict liability to negligence rulesAccidents between strangers (what we’ve 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.”Steven Shavell, Strict Liability Versus Negligence8Whereas 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…)Steven Shavell, Strict Liability Versus Negligence9Steven Shavell, Strict Liability Versus Negligence EfficientEfficientStrict LiabilityToo HighEfficientSimple NegligenceACCIDENTS BETWEEN STRANGERSInjurerActivityInjurerPrecaution10Injurer is in a competitive business, but not with victimvictim is not injurer’s customer, but a strangerExample: taxi driversprovide service to their passengersrisk hitting other pedestriansShavell assumes perfect competitionPrice = marginal cost of “production”Sales = number of passengers who demand rides at that priceNext case: accidents between “sellers and strangers”11Strict liabilityTaxi drivers pay for accidents, set x = x* to minimize costsPerfect competition cost of remaining accidents is built into priceTaxi passengers face price that includes cost of accidentsPassengers internalize risk of accidents, demand efficient number of ridesNegligence ruleTaxi drivers still take efficient precaution, to avoid liabilityBut since drivers don’t bear residual risk, cost of accidents not built into pricePassengers face prices that are too lowDemand for taxi rides inefficiently highAccidents between businesses and strangers12Steven Shavell, Strict Liability Versus Negligence EfficientEfficientStrict LiabilityToo HighEfficientSimple NegligenceACCIDENTS BETWEEN BUSINESSES AND STRANGERSEfficientEfficientStrict LiabilityToo HighEfficientSimple NegligenceACCIDENTS BETWEEN STRANGERSInjurerActivityInjurerPrecaution13Example: restaurants taking precaution to reduce risk of food poisoningHow accurately do customers perceive risks?1. Customers can accurately judge risk of each restaurant2. Customers can accurately judge average level of risk, but not differences across restaurants3. Customers ignorant of risksFinal case: accidents between businesses and their own customers14Seller bears cost of accidents efficient precautionSeller bears residual risk expected cost of accidents is built into pricesEven if customers don’t perceive risk, price leads
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